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1、Part II Exchange Rate Behavior,locational arbitrage,triangular arbitrage,purchasing power parity,international Fisher effect,covered interest arbitrage,covered interest arbitrage,Fisher effect,Government Influence On Exchange Rates,6,Chapter,South-Western/Thomson Learning 2003,Chapter Objectives,To
2、describe the exchange rate systems used by various governments; To explain how governments can use direct and indirect intervention to influence exchange rates; and To explain how government intervention in the foreign exchange market can affect economic conditions.,Exchange Rate Systems,Exchange ra
3、te systems can be classified according to the degree to which the rates are controlled by the government. Exchange rate systems normally fall into one of the following categories: fixed freely floating managed float pegged,In a fixed exchange rate system, exchange rates are either held constant or a
4、llowed to fluctuate only within very narrow bands. The Bretton Woods era (1944-1971) fixed each currencys value in terms of gold. The 1971 Smithsonian Agreement which followed merely adjusted the exchange rates and expanded the fluctuation boundaries. The system was still fixed.,Fixed Exchange Rate
5、System,Find out more about the Bretton Woods conference and the Smithsonian Agreement at: http:/www.imfsite.org/origins/confer.html http:/www.mises.org/money.asp,Online Application,Pros: Work becomes easier for the MNCs. Cons: Governments may revalue their currencies. In fact, the dollar was devalue
6、d more than once after the U.S. experienced balance of trade deficits. Cons: Each country may become more vulnerable to the economic conditions in other countries.,Fixed Exchange Rate System,In a freely floating exchange rate system, exchange rates are determined solely by market forces. Pros: Each
7、country may become more insulated against the economic problems in other countries. Pros: Central bank interventions that may affect the economy unfavorably are no longer needed.,Freely Floating Exchange Rate System,Pros: Governments are not restricted by exchange rate boundaries when setting new po
8、licies. Pros: Less capital flow restrictions are needed, thus enhancing the efficiency of the financial market.,Freely Floating Exchange Rate System,Cons: MNCs may need to devote substantial resources to managing their exposure to exchange rate fluctuations. Cons: The country that initially experien
9、ced economic problems (such as high inflation, increasing unemployment rate) may have its problems compounded.,Freely Floating Exchange Rate System,In a managed (or “dirty”) float exchange rate system, exchange rates are allowed to move freely on a daily basis and no official boundaries exist. Howev
10、er, governments may intervene to prevent the rates from moving too much in a certain direction. Cons: A government may manipulate its exchange rates such that its own country benefits at the expense of others.,Managed Float Exchange Rate System,In a pegged exchange rate system, the home currencys va
11、lue is pegged to a foreign currency or to some unit of account, and moves in line with that currency or unit against other currencies. The European Economic Communitys snake arrangement (1972-1979) pegged the currencies of member countries within established limits of each other.,Pegged Exchange Rat
12、e System,The European Monetary System which followed in 1979 held the exchange rates of member countries together within specified limits and also pegged them to a European Currency Unit (ECU) through the exchange rate mechanism (ERM). The ERM experienced severe problems in 1992, as economic conditi
13、ons and goals varied among member countries.,Pegged Exchange Rate System,In 1994, Mexicos central bank pegged the peso to the U.S. dollar, but allowed a band within which the pesos value could fluctuate against the dollar. By the end of the year, there was substantial downward pressure on the peso,
14、and the central bank allowed the peso to float freely. The Mexican peso crisis had just began .,Pegged Exchange Rate System,For more information on the Mexican peso crisis, visit: http:/www.cfr.org/public/pubs/mexican.html http:/www.frbatlanta.org/publica/ECO-REV/REV_ABS/janfeb96.html http:/www.broo
15、k.edu/views/papers/lustig/114.htm,Online Application,Currency Boards,A currency board is a system for maintaining the value of the local currency with respect to some other specified currency. For example, Hong Kong has tied the value of the Hong Kong dollar to the U.S. dollar (HK$7.8 = $1) since 19
16、83, while Argentina has tied the value of its peso to the U.S. dollar (1 peso = $1) since 1991.,Currency Boards,For a currency board to be successful, it must have credibility in its promise to maintain the exchange rate. It has to intervene to defend its position against the pressures exerted by economic conditions, as well as by speculators who are betting that the board will not be able to support the specified exchange rate.,Find out more about Hong Kong
