Exchange Rate System (HEBEI)

8/13/2019 Exchange Rate System (HEBEI)

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GovernmentPolicies toward

the Foreign

ExchangeMarket


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Members

Adnan Renwarin

Arina Nindya Kirana

Azcarlo van Raalten

Dera Karunia Pratama M

Rella Pasca Prasasti

Yolanda Sriepambajeng P


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Chapters

1. Exchange Rate Definitions

2. Floating Exchange Rate System

3. Fixed Exchange Rate System

4. Defense Through Official Intervention

5. Exchange Control

6. International Currency Experience


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Exchange Rate Definitions

1. Value of a countrys currency in termsof some other countrys currency

2. The exchange rate is the price of onecurrency stated in terms of a secondcurrency (James Gerber, 2008: 209)

3. Price for which the currency of a

country can be exchanged foranother country's currency


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Floating Exchange Rate

System in which a currency's value isdetermined solely by the interplay of

the market forces of demand and supplyfor example by the interactions ofthousands of banks, firms and otherinstitutions seeking to buy and sell

currency for purposes of transactionsclearing, hedging, arbitrage andspeculation.


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Fixed Exchange Rate

An exchange rate between currenciesthat is set by the governments involved

rather than being allowed to fluctuatefreely with market forces.

Some flexibility is permitted within a range,called a band.

To implement fixed exchange rategovernment faces 3 major question :


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1. What the things should fix to?

2. When to change fixed exchange rate?

3. How does government defending fixedexchange rate?


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What to fix to

Country can choose to fix the value of itscurrency to some other currency, after the

end of world war II many countries fixedtheir currency to U.S. dollar

And also they could fixed their currency tobasket currency.


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When to change the fixed rate?

Pegged exchange rate

Adjustable peg

Crawling peg


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Defending fixed exchangerate Intervention, buying or selling in the foreign

exchange market to influence the equilibrium spotexchange rate.

Exchange controlsimposed by the govt restrictdemand and/or supply.

Set domestic interest ratesso as to influence short-term capital flows, thus influencing the exchangerate by changing the supply and demand in themarket.

Macroeconomic adjustments(changes in fiscal ormonetary policy) to influence supply and demandin the foreign exchange market.


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Defending againstdepreciation


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Defending against appreciation

Consider now the case in which the pressure from private supply and

demand in the foreign exchange market is attempting to drive theexchange rate, the relativly strong demand for locals is generallyrelated to relatively strong demand by foreigners for the countrysgoods, services and financial asset. This result in an official statementsbalance surplus if the countrys monetary authority intervenes todefend the fixed rate. The intervention provides the local currency forthe foreignersnto but more from the country than they are selling to

the country ( for goods, services, and nonoffical financial assets ). Defending against appreciation The rate of C$ tends to go below the band BoC buys US$ and sells C$ The strong private demand for C$ is due to exports and capital

imports BOC increases its holdings of US$ reserves and foreign countries

increase their holdings of C$ reserves (surplus) What does the BoC do with the US$?increase its holdings of

official reserve assets Sterilizationremove the additional C$ from the economy,

otherwise a monetary expansion will follow


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Intervention to Defend a Fixed Rate: Preventing Appreciation ofthe Countrys Currency :


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Temporary Disequilibrium

We build a bisector reproduction model with classical features in whichthe capitalists aim at maximizing accumulation of their profits. Atvariance with gravitation models, it is assumed that they invest theirprofits in their own industry. Their plans are based on actual productionsand expected prices. Effective prices and effective allocations ofresources are determined by a market-clearing mechanism. A simple lawon the formation of expectations allows us to define the dynamics ofdisequilibria, which let appear endogenous self-sustained fluctuations,

around a long-run path. The long-run rate of growth and the amplitudeof the fluctuations depend on the initial conditions. Intervention (financing temporary BOP deficits and surpluses) is better

than letting the exchange rate float Net gain to the world from the intervention BOC supplied C$ at 1.60 when importers would have had to pay 1.80

BOC bought C$ at 1.60 from people who would have sold for

1.40 Gain is measured by areas ACD and DBE Speculators must not be able to do arbitrage Officials must correctly predict the future demand and supply for foreign

exchange


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A Successful Financing of Temporary Deficits and Surpluses at a FixedExchange Rate :


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Disequilibrium that is not temporary

Monetary authority is continuously losing reserves if it defendsagainst depreciation

Speculators may bet on a future devaluation and selldomestic currency and buy foreign currency further

increasing the imbalance (Mexico) If defending an appreciation (due an ongoing BOP surplus),

the monetary authority builds up foreign currency reserves(China?)

The rates of return on these foreign currency assets is not

high (government bonds, etc.) The value of these reserves will decrease if eventually the

domestic currency appreciates


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EXCHANGE CONTROL

What is Exchang Control?

Exchange rate control are closelyanalogous to quantitave restriction

(quotas) on import.


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EXCHANGE CONTROL (cont)

There are two other effect and cost of actual

exchang control regime

First, in practice, government usually donthold public foreign currency auctions.

Second, annother effect of exchange control,

effort to evade them is predictable.


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International Currency Experience

There are 4 International Currency thathad been experienced by countries :

The Gold Standard Era (18701914)

Interwar Instability (19181939)

The Bretton Woods Era (19441971)

The Current System: Limited Anarchy


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History of Gold Standard Gold Standard, in economics, monetary system wherein all forms of legal

tender may be converted, on demand, into fixed quantities of fine gold,as defined by law. Until the 19th century, most countries of the world

maintained a bimetallic (gold silver) monetary system. The widespreadadoption of the gold standard during the second half of the 19thcentury was largely a result of the Industrial Revolution, which broughtabout a vast increase in the production of goods and widened the basisof world trade. The countries that adopted the gold standard had threeprincipal aims: to facilitate the settlement of international commercialand financial transactions; to establish stability in foreign exchange rates;

and to maintain domestic monetary stability. They believed these aimscould best be accomplished by having a single standard of universalvalidity and relative stability; hence the gold standard is sometimescalled the single gold standard.


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History of Gold Standard The first country to go on the gold standard was Britain, in

1816. The United States made the change in 1873, andmost other countries followed suit by 1900. With someexceptions, the prevalence of the gold standard lasteduntil the economic crisis of 1929 and the ensuingdepression.

Between 1931 and 1934, the governments of virtually allcountries found it expedient or necessary to abandon thegold standard. This policy was partly motivated by thebelief that the exports of a country could be stimulated bydevaluating its currency in terms of foreign exchange. Intime, however, the advantage thus gained was offset as

other countries also abandoned the gold standard. In theU.S., a policy of devaluation of the currency was initiatedby President Franklin D. Roosevelt. Shortly after hisinauguration in April 1933, the U.S. went off the full goldstandard in favor of the modified gold bullion standard.


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Definition The gold standard is a monetary system in which the standard

economic unit of account is a fixed weight of gold.

There are distinct kinds of gold standard. First, the gold speciestandardis a system in which the monetary unit is associated with

circulating gold coins, or with the unit of value defined in terms ofone particular circulating gold coin in conjunction with subsidiarycoinage made from a less valuable metal.

Similarly, the gold exchange standardtypically does not involvethe circulation of gold coins, instead using notes or coins made ofsilver or other metals, but where the authorities guarantee a fixed

exchange rate with another country that is on the gold standard.This creates a de factogold standard, in that the value of thesilver coins has a fixed external value in terms of gold that isindependent of the inherent silver value. Finally, the gold bullion

standardis a system in which gold coins do not circulate, but inwhich the authorities have agreed to sell gold bullion on demandat a fixed price in exchange for the circulating currency.


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How the Gold Standard Worked

The gold standard was a domestic standard regulating the quantityand growth rate of a countrys MONEY SUPPLY. Because new

production of gold would add only a small fraction to theaccumulated stock, and because the authorities guaranteed freeconvertibility of gold into non gold money, the gold standardensured that the money supply, and hence the price level, wouldnot vary much. But periodic surges in the worlds gold stock, such as

the gold discoveries in Australia and California around 1850, causedprice levels to be very unstable in the short run.

The gold standard was also an international standard determiningthe value of a countrys currency in terms of other countries

currencies. Because adherents to the standard maintained a fixed

price for gold, rates of exchange between currencies tied to goldwere necessarily fixed. For example, the United States fixed the priceof gold at $20.67 per ounce, and Britain fixed the price at 3 17s. 10per ounce. Therefore, the exchange rate between dollars andpoundsthe par exchange ratenecessarily equaled $4.867 perpound.


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Interwar Instability If the gold standard era before 1914 has been viewed as

the classic example of international monetary soundness,the interwar period has played the part of a nightmare,which postwar officials have been determined to avoidrepeating. Payments, balances, and exchanges, gyrated

chaotically in response to World War I, and The GreatDepression.

After World War I, the European countries had to strugglewith a legacy of inflation and political instability. Theircurrencies had become inconvertible during the war, sincetheir rates of inflation were much higher than thatexperienced in the United States, the new financial leader.

It appears to have caused considerable unemploymentand stagnation in the traded goods industries, as theoriespredicted.


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Interwar Instability (cont) Money became totally worthless; by late 1923 not

even a wheel barrowful of paper money couldbuy a week's groceries. The mark had to be

reissued in a new series equal to the prewar dollarvalue, with old marks forever unredeemable.

On September 19, 1931, Britain abandoned thegold standard it had championed, letting thepound sink to its equilibrium market value.

Between early 1933 and early 1934, the UnitedStates followed suit and let the dollar drop all goldvalue


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What lessons do the interwar experiencehold for postwar policymakers?

During World War II expert opinionseemed to be that the interwar

experience called for a compromisebetween fixed and flexible exchangerates, with emphasis on fixity.


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The Bretton Woods Era1994-1971

Bretton Woods was established with theintention of aiding governments inexercising their powers of inflationaryfinance.

If only there were enough reserves to tidecountries over temporary disequilibrium,and if only countries followed policies thatmade all disequilibriums temporary, thenwe could capture those welfare gainsfrom successful stabilization


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Its central feature was the adjustable peg , which called

for a fixed exchange rate and temporary financing outof internatioal reserves unless a country's balanced of

payments was seen to be in " fundamental

disequilibrium".


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The current system:Limited Anarchy

Since the early 1970's, a growing numberof countris , including many major

industrialized countries, have floating orrelatively flexible exchange rates, butgovernment authorities often attempt tohave an impact though intervention or

some other form of management of thefloating or flexible exchange rates.


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A noteworthy feature of the experience since 1973 is the

extent of official resistance to floating. Some of this

resistance is seen in the management of the floating .Some of this resistance is seen in the management of the

float. For instance , the government of japan has tried to

hold down the dollar value of the yen, apparently to

prevent a loss in the international price competitiveness of

japanese product. In the process, the japanese centralbank has bought huge number of dollars .


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The current international monetary system , perhaps its best todescribe it as a nonsystem-countries can choose almost any

exchange rate policies they want and change them wheneverthey want. The policies of various countries in mid-2007 areshown in figure 6.9.


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Exchange Rate System (HEBEI)

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