Fixed FX Regimes

FNCE 4070 – Financial Markets and Institutions

Floating FX Regimes

• The value of a currency is allowed to fluctuate against all other currencies.

• The USD floats against most major currencies

Fixed FX Regimes

• In a fixed FX regime a currency is pegged relative to the value of another currency (the anchor currency) or basket of currencies

Recent Headlines

• Danish Central Banker: Negative Deposit Rate Successful So Far (1 September 2012 WSJ)

• RBC Offers Negative Interest Rates on Danish Krone, Swiss Franc (9 October 2012 Bloomberg)

Intervention in a Fixed Exchange Rate System

Monetary Policy for a Pegged Currency

• Generally speaking a country that ties its exchange rate to a currency of a larger country loses control of its monetary policy.– If the larger country purses a more contractionary

monetary policy and decreases its money supply then the smaller country will have to do the same.

The Euro – Convergence Criteria

• In order to join the Euro there were strict criteria– A debt to GDP ratio of less than 60%– Government budget deficits had to under control– Inflation within a certain band– Interest rates had to be close to European average– Exchange rate stability

Gross Government Debt in Europe 1997-8

European Government Surpluses 1997-8

Greek Trade Deficit 1988 to present

19761977

19781979

19801981

19821983

19841985

19861987

19881989

19901991

19921993

19941995

19961997

19981999

20002001

20022003

20042005

20062007

20082009

20102011

0

5,000,000,000

10,000,000,000

15,000,000,000

20,000,000,000

25,000,000,000

30,000,000,000

35,000,000,000

40,000,000,000

45,000,000,000

German and Greek Interest Rates

1978 1979 1980 1981 1982 1983 1984 1985 1986 1987 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 20000

5

10

15

20

25

30

35

GermanyGreece

Greek Drachma vs Deutsche Mark

19691970

19711972

19731974

19751976

19771978

19791980

19811982

19831984

19851986

19871988

19891990

19911992

19931994

19951996

19971998

0

20

40

60

80

100

120

140

160

180

Greek 10 year Government Bond Yields

Germany 10 year Government Bond Yields

Present Value of $2,000 paid monthly for 30 years

0% 1% 2% 3% 4% 5% 6% 7% 8% 9% 10% 11% 12% 13% 14% 15% 16% 17% 18% 19% 20% 21% 22%$0.00

$100,000.00

$200,000.00

$300,000.00

$400,000.00

$500,000.00

$600,000.00

$700,000.00

$800,000.00

Present Value

Greece Balance of Trade 2001-present

Greece Current Account – includes foreign aid

House Prices In Greece(1997 – prices are 100)

Greek Government External Debt

Target Balances - Europe