Fixed vs Floating The exchange rate fluctuates in a narrow range or not at all against a base currency over a sustained period of time Government action is needed to maintain the exchange rate ID: 714298
Download Presentation The PPT/PDF document "Exchange Rate Regimes Julie Harris" is the property of its rightful owner. Permission is granted to download and print the materials on this web site for personal, non-commercial use only, and to display it on your personal computer provided you do not modify the materials and that you retain all copyright notices contained in the materials. By downloading content from our website, you accept the terms of this agreement.
Slide1
Exchange Rate Regimes
Julie HarrisSlide2
Fixed vs. Floating
The exchange rate fluctuates in a narrow range (or not at all) against a base currency over a sustained period of time.
Government action is needed to maintain the exchange rate.
The exchange rate fluctuates in a wider range.
No government intervention to fix the exchange rate against a base currency.Appreciation/Depreciation can occur frequently.
Fixed
FloatingSlide3
Fixed vs. Floating
Fixed
FloatingSlide4
No Separate Legal Tender
Increasingly Floating Increasingly Fixed
Exchange agreements with no separate legal tender come in two forms:
The currency of another country circulates as the sole legal tender. E.g. Ecuador uses the U.S. Dollar – known as “dollarization”
The country belongs to a monetary or currency union in which the same legal tender is shared by the members of the union. E.g. Members of the European Union
These regimes result in a complete surrender of the monetary authorities’ independent control over domestic monetary policy.
No Separate Legal Tender (41)
Currency Boards (7)
Other fixed Pegs
(52)
Pegged within horizontal bands
(6)
Crawling peg
(5)
Managed floating with no pre-determined path for the exchange rate
(51)
Independently Floating
(25)Slide5
Currency Boards
Currency Boards are monetary regimes based on an explicit legislative commitment to exchange domestic currency for a specified foreign currency at a fixed exchange rate, combined with restrictions on the issuing authority to ensure the fulfillment of its legal obligation. E.g. Hong Kong fixes its exchange rate with the U.S.
Domestic currency is issued only against foreign exchange and remains fully backed by foreign assets.
Eliminates traditional central bank functions such as monetary control and lender-of-last-resort. There is very little room for discretionary monetary policy (depends on the strictness of the banking rules in place).
Increasingly Floating Increasingly Fixed
No Separate Legal Tender (41)
Currency Boards (7)
Other fixed Pegs
(52)
Pegged within horizontal bands
(6)
Crawling peg
(5)
Managed floating with no pre-determined path for the exchange rate
(51)
Independently Floating
(25)Slide6
Other Fixed Pegs
The country pegs its currency, at a fixed rate, to another currency or a basket of currencies.
The basket is formed from the currencies of major trading/financial partners and weights reflect the geographical distribution of trade, services, or capital flows.
There is no explicit legislative commitment to keeping the arrangement.
The exchange rate can fluctuate within a narrow range.The monetary authority attempts to maintain the fixed rate.
Directly: sale/purchase of foreign currencies Indirectly: interest rate policy, foreign exchange regulations, etc.
Traditional central banking functions are still possible and the monetary authority can adjust the level of the exchange rate (relatively infrequently).
Increasingly Floating Increasingly Fixed
No Separate Legal Tender (41)
Currency Boards (7)
Other fixed Pegs
(52)
Pegged within horizontal bands
(6)
Crawling peg
(5)
Managed floating with no pre-determined path for the exchange rate
(51)
Independently Floating
(25)Slide7
Pegged within Horizontal Bands
Similar to fixed peg systems – currency is maintained within a small margin (bands) around a fixed central rate.
One key difference: also includes arrangements of countries in the exchange rate mechanism of the European Monetary System. E.g. Denmark
There is a limited degree of monetary policy discretion – the amount depends on the band width.
Increasingly Floating Increasingly Fixed
No Separate Legal Tender (41)
Currency Boards (7)
Other fixed Pegs (52)
Pegged within horizontal bands
(6)
Crawling peg
(5)
Managed floating with no pre-determined path for the exchange rate
(51)
Independently Floating
(25)Slide8
Crawling Pegs
Currency is adjusted periodically in small amounts at a fixed rate or in response to changes in selective quantitative indicators i.e. the exchange rate is allowed to follow a trend. E.g. Columbia
The rate of the crawl can be set to:
generate inflation-adjusted changes in the exchange rate (backward looking)
a preannounced fixed rate and/or below the projected inflation differentials (forward looking)Constraints on monetary policy are similar to a fixed peg system.
Increasingly Floating Increasingly Fixed
No Separate Legal Tender (41)
Currency Boards (7)
Other fixed Pegs (52)
Pegged within horizontal bands
(6)
Crawling peg (5)
Managed floating with no pre-determined path for the exchange rate
(51)
Independently Floating
(25)Slide9
Managed Floating with No Pre-Determined Path for the Exchange Rate
Monetary Authority attempts to influence the exchange rate without having a specific exchange rate path or target. E.g. Afghanistan
Often used to prevent drastic depreciation of the currency (exchange rate crisis) – more common in developing countries.
Indicators for managing the rate are broadly judgmental. E.g. Balance of payments position, international reserves, etc.
Increasingly Floating Increasingly Fixed
No Separate Legal Tender (41)
Currency Boards (7)
Other fixed Pegs (52)
Pegged within horizontal bands
(6)
Crawling peg
(5)
Managed floating with no pre-determined path for the exchange rate
(51)
Independently Floating
(25)Slide10
Independently Floating
The exchange rate is market-determined. E.g. U.S.
Any official foreign exchange market intervention is aimed at moderating the rate of change and preventing undue fluctuations in the exchange rate (as opposed to establishing a level for the exchange rate).
Increasingly Floating Increasingly Fixed
No Separate Legal Tender (41)
Currency Boards (7)
Other fixed Pegs (52)
Pegged within horizontal bands
(6)
Crawling peg
(5)
Managed floating with no pre-determined path for the exchange rate
(51)
Independently Floating
(25)Slide11
Developing Countries
Currencies of developing countries tend to be more volatile – they face exchange rate crisis more often.
Most of the floating systems are from developed countries (with the exception of the EU).
Developing vs. Developed
Exchange Rate Crisis - Example