Chapter 5: Exchange Rate Systems
Power Points created by:
Joseph F. Greco Ph. D.,
California State University, Fullerton
Mihaylo College of Business and Economics
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Chapter 5: Exchange Rate Systems
5.1
Alternative Exchange Rate Arrangements and
Currency Risk
5.2
Central Banks
5.3
Flexible Exchange Rate Systems
5.4
Fixed Exchange Rate Systems
5.5
Limited-Flexibility Systems: Target Zones and
Crawling Pegs
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5.1 Alternative Exchange Rate
Arrangements and Currency Risk
Alternative Arrangements: Overview
•
Exchange Rate Systems Around the World
•
Floating Currencies
•
Fixed, or Pegged, Currencies
•
Special Pegged Arrangements
•
Target Zones and Crawling Pegs
•
Currency Risks in Alternative Systems
•
Quantifying Currency Risks
•
Currency Risks in Floating Systems
•
Currency Risk in Target Zones
•
Currency Risk in Pegged Exchange Rate Systems
•
Currency Risk in Currency Boards and Monetary Unions
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5.1 Alternative Exchange Rate
Arrangements and Currency Risk
• Exchange Rate Systems Around the World
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Exhibit 5.1Exchange Rate Systems Around the World
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Exhibit 5.1Exchange Rate Systems Around the World
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5.1 Alternative Exchange Rate
Arrangements and Currency Risk
• Floating Currencies
• Are determined by the market forces of supply
and demand
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5.1 Alternative Exchange Rate
Arrangements and Currency Risk
• Fixed, or Pegged, Currencies
• Fixed currencies
• Pegged currencies
• Basket of currencies
• Special drawing right
• European currency unit (ECU)
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5.1 Alternative Exchange Rate
Arrangements and Currency Risk
• Special Pegged Arrangements
• Target Zones and Crawling pegs
• Currency Risks in Alternative Exchange Rate
Systems
• Quantifying Currency Risks
• Currency Risks in Floating Exchange Rate Systems
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Exhibit 5.2
Currency Risk in Alternative Exchange-rate Systems
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Exhibit 5.3 Contrasting the FRF/DEM and
CAD/USD Exchange Rates
Panel A: Exchange Rate Changes Over Time
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Exhibit 5.3 Contrasting the FRF/DEM and
CAD/USD Exchange Rates
Panel B: Histogram of Log Changes
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5.1 Alternative Exchange Rate
Arrangements and Currency Risk
• Currency Risk in Target Zones
• Currency Risk in Pegged Exchange Rate Systems
• Currency Risk in Currency Boards and Monetary
Unions
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Exhibit 5.4
Exchange Rate Arrangements
Panel A:
April 2006
Total: 186
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Exhibit 5.4
Exchange Rate Arrangements
Panel B:
March 1990
Total: 151
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5.2 Central Banks
• The Central Bank’s Balance Sheet
• Bank Reserves and Currency in Circulation
• Required reserves
• Monetary base
• Domestic Credit
• Open market operations
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Exhibit 5.5
Central Bank Balance Sheet
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5.2 Central Banks
• Official Reserves
• Foreign exchange reserves
• Money Creation and Inflation
• Seigniorage
• The Impossible Trinity
• Foreign Exchange Interventions
• Non-Sterilized Interventions
• Sterilized Interventions
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Exhibit 5.6
Foreign Exchange Reserves
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Exhibit 5.7
Sterilized and Non-Sterilized Foreign Exchange
Intervention
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5.2 Central Banks
• How Do Central Banks Peg a Currency?
• Pegging the Exchange Rate
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Exhibit 5.8
Fixing the $/£ Exchange Rate
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5.3 Flexible Exchange Rate Systems
• The Effects of Central Bank Interventions
• Direct Effects of Interventions
• Indirect Effects of Interventions
• Empirical Evidence on the Effectiveness of
Interventions
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5.4 Fixed Exchange Rate Systems
Fixed Exchange Rate Systems: Overview
• The International Monetary System Before 1971: A Brief History
• Individual Incentives Versus Aggregate Incentives
• Special Drawing Rights
• Pegged Exchange Rate Systems in Developing Countries
• Illegal Currency Markets
• Why Not Simply Float?
• Currency Boards
• Dollarization
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Exhibit 5.9
The Effects of Foreign Exchange Interventions
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5.4 Fixed Exchange Rate Systems
• The International Monetary System Before 1971: A
Brief History
• The Gold Standard
• Hyperinflation and the Interwar Period
• The Bretton Woods System
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5.4 Fixed Exchange Rate Systems
• Individual Incentives Versus Aggregate Incentives
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5.4 Fixed Exchange Rate Systems
• Special Drawing Rights
• An alternative reserve asset with the same gold
value as the dollar
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5.4 Fixed Exchange Rate Systems
• Pegged Exchange Rate Systems in Developing
Countries
• Illegal Currency Markets
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Exhibit 5.10
Pegging an Exchange Rate in a Developing
Country
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5.4 Fixed Exchange Rate Systems
• Why Not Simply Float?
• Currency Boards
• Dollarization
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Exhibit 5.11
The Balance Sheet of a Currency Board
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5.5 Limited-Flexibility Systems:
Target Zones and Crawling Pegs
• Target Zones
– Speculative Attacks
– Defending the Target Zone
– Lead-Lag Operations
• Crawling Pegs
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Exhibit 5.12
An Example of a Target Zone
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Exhibit 5.13
An Example of a Crawling Peg
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5.6 How to See an Emu Fly:
The Road to Monetary Integration in Europe
• The European Monetary System (EMS)
– The ERM
– Intervention Rules
– Realignment Rules
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5.6 How to See an Emu Fly:
The Road to Monetary Integration in Europe
• On ECUs, Euros, and Franken
– The Politics of Naming the Euro
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Exhibit 5.14
Composition of the ECU Basket
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5.6 How to See an Emu Fly:
The Road to Monetary Integration in Europe
• Was the EMS Successful?
– Day-to-day variability was down
– Inflation and interest differentials narrowed
– Asymmetric adjustments
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5.6 How to See an Emu Fly:
The Road to Monetary Integration in Europe
• The Maastricht Treaty and the Euro
– ERM II
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5.6 How to See an Emu Fly:
The Road to Monetary Integration in Europe
(Advanced)
• Pros and Cons of a Monetary Union
– Optimum currency areas
– Is Europe an Optimum currency area?
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