fixed and floating exchange rate

L O G O

FIXED AND FLOATING EXCHANGE RATES

FIXED AND FLOATING EXCHANGE RATES

INTERNATIONAL FINANCE


CONTENTSEvolution of IMS1

Flexible Exchange Rate Regime2

3

4 Effects of BOP on Exchange Rate System

6 Fixed Exchange Rate

Floating Exchange Rate5

Exchange Arrangements 7

Role of International Monetary Fund

EVOLUTION OF INTERNATIONAL MONETARY SYSTEM


Bimetallism

Before 1875

Classical Gold Standa

rd1875-1914

Inter war

period1915-1944

Bretton Woods System1945-1972

Flexible

Exchange

Rate Regim

eSince 1973


BIMETALLISM Double standard in that free coinage was

maintained for both gold and silver Both gold & silver used as a means of international

payment The abundant metal was used as money

E.g. -

When gold poured into the market in 1850s, the value of gold depressed, causing overvaluation of gold under the French official ratio, which equated a gold franc to a silver franc 15.5 times as heavy. So the franc became a gold currency


CLASSICAL GOLD STANDARD

The gold standard dates from 1819 when the British Parliament resumed its practice of exchanging currency notes for gold on demand at a fixed rate

Later in the nineteenth century, Germany, Japan, the US and other countries also adopted the gold standard

No single country occupies a privileged position within the system

Each country fixes the price of its currency in terms of gold by intervening in the foreign exchange market


INTER WAR PERIOD

Similar to Gold Standard but now central banks’ reserves consist of gold and currencies.

As the gold standard, the gold exchange standard restrains excessive monetary growth throughout the world.

But it allows more flexibility in the growth of international reserves, which can consist of assets besides gold.


BRETTON WOODS U.S. dollar is the reserve currency. Every central bank fixes the dollar exchange rate of its

currency through intervention. Drawbacks of the Reserve-Currency Standard:

– U.S. occupies a special position because it never has to intervene in the foreign exchange market

– US can use its monetary policy for macroeconomic stabilization

– US has the power to affect its own economy, as well as foreign economies by using monetary policy

– Other central banks have to import the monetary policy of the US.

– This inherent asymmetry led eventually to policy disputes within the system

INTERNATIONAL FINANCEFLEXIBLE EXCHANGE RATE REGIME1973 to the present.After the breakup of the Bretton

Woods system, the currencies of the industrialized countries’ exchange rates were allowed to float in March 1973.

Currencies of U.S., Japan, Germany and Great Britain continues to float against each other to the present.


Discipline Mean that:•Need to maintain a fixed exchange rate put a brake on competitive devaluations and brought stability to the world trade environment.

•fixed exchange rate regime imposed monetary discipline on countries, thereby curtailing price inflation

Main goal of the IMF was:Avoiding repetition of the chaos that occurred

between the wars through a combination of discipline and flexibility

Flexibility Meant that:•While monetary discipline was a central objective of the agreement, a rigid policy of fixed exchange rates would be too inflexible.•IMF was ready to lend foreign currencies to members to tide them over during short periods of balance-of-payments deficit, when a rapid tightening of monetary or fiscal policy would hurt domestic employment

ROLE OF IMF

EXCHANGE RATE

FIXED EXCHANGE RATE FLOATING EXCHANGE RATE

Rate the government or central bank sets and maintains as the official exchange rate.

Determined by the private market through supply and demand



EFFECTS ON BOP OF EXCHANGE RATE changes

Expo

prices UP

Export demand DOWN

Export volume

DOWN

Trade

deficit GROWING

If currency value rises

If currency value falls

Export prices DOWN

Export demand UP

Export volume

UP

Trade

deficit SHRINKING


FLOATING EXCHANGE RATE FLOATING EXCHANGE RATE

Monetary Policy Autonomy

SymmetryExchange Rates as

Automatic Stabilizers


Monetary Policy Autonomy

Freedom (autonomy) for domestic monetary policy

No country is forced to import inflation (or deflation) from abroad.

Flexibility and the possibility for the country’s economy to be quickly adjusted to changing market conditions.


Symmetry

Floating exchange rates remove two main asymmetries of the Bretton Woods system and allow:

– Central banks abroad to be able to determine their own domestic money supplies

– The U.S. to have the same opportunity as other countries to influence its exchange rate against foreign currencies


Exchange Rates as Automatic Stabilizers

Floating rates promote swift and relatively painless adjustment to certain shocks in the goods market, such as a fall in foreign demand for the country’s exports.

Figure 1 shows that a temporary fall in a country’s export demand reduces that country’s output more under a fixed rate than a floating rate.


FIXED EXCHANGE RATE

FIXED EXCHANGE RATE

Discipline

Destabilizing speculation and money market disturbances

Injury to international

trade and investment

The illusion of greater autonomy


Discipline

When central banks are free from the obligation to fix their exchange rates, they might embark on inflationary policies.

A stable (fixed) currency acts as a discipline on producers to keep their costs and prices down and may lead to greater pressure for exporters


Destabilizing speculation and money market disturbances

Floating exchange rates allow destabilizing speculation. Countries can be caught in a “vicious circle” of

depreciation and inflation.

Floating exchange rates make a country more vulnerable to money market disturbances.


International Trade and Investment

Trade and Investment:– Currency stability can help to promote trade and investment because of lower currency risk.

– Exporters and importers face lower exchange risk.

– International investments face lower uncertainty about their payoffs.

Reductions in the cost of currency hedging

– With fixed exchange rates, businesses have to spend less on currency hedging if they know that the currency will hold its value in the foreign exchange markets (hedging involves risk)


The illusion of greater autonomy

Floating exchange rates increase the uncertainty in the economy without really giving macroeconomic policy greater freedom.– A currency depreciation raises

domestic inflation due to higher wage settlements.


Who Uses Fixed and FloatList of exchange arrangements

Floating rates are used by many countries• Rich & poor• Large & small• All over the world

Pegged rates are used mostly by small countries

Largest number of countries are between fixed and floating


Exchange Arrangementsof Sample Countries, as of 7/31/06

Independently Floating Exchange Rates

25 countries + euro 12

Australia Mexico

Brazil Tanzania

Canada United Kingdom

Japan United States

Pegged Exchange Rates 58 countries

China, P.R. Latvia

Denmark Nepal

Iraq Saudi Arabia


Exchange Rate Regimes In Practice

Currently:

14% of IMF members follow a free float policy

26% of IMF members follow a managed float system

28% of IMF members have no legal tender of their own

Remaining countries use less flexible systems such as pegged arrangements, or adjustable pegs


Exchange Rate Regimes In PracticeExchange Rate Policies, IMF Members, 2006CURRENCY BOARD

4%ADJUSTABLE PEG

6%

FREE FLOAT14%

MANAGED FLOAT28%

FIXED PEG26%

NO SEPARATE TENDER22%

Exchange Rate System in India

Rupee linked to GBP till 1975

In 1975, Rupee was delinked from GBP and pegged to a multi currency basket of currencies

Devaluation of Re in 1991

1992 –India moved from fixed regime of currency to a more controlled flexi regime, initiating liberalisation & globalisation.


Partial convertibility of Re, 40% to be sold to RBI and 60% at market rates

1st March 1993 – Re came to be traded freely in the market, subject to exchange control and trade control regulations

USD became the intervention currency


INTERNATIONAL FINANCEEXCHANGE RATES AT 16.50 HRS (IST)

CURRENCY NAME

SELL BUY

TT BILL TT BILL

DOLLAR 49.09(+0.17)

49.12(+0.17)

49.00(+0.17)

48.99(+0.17)

EURO 70.18(+0.35)

70.22(+0.34)

70.06(+0.33)

70.04(+0.32)

100 YEN 52.71(+0.15)

52.74(+0.14)

52.59(+0.15)

52.49(+0.15)

Conclusion

Replacement of new factors by new ones in the era of Globalization, Informatization and technical progress play the leading role.

Need of greater flexibility.

In case of poor economical policy and non-balanced government management of the economy can reduce all the advantages of flexibility.


Liberalization of financial markets exceed the risks of instability, and the future is promising greater perspectives for the countries whose financial system is based on the floating exchange rate system

Flexible exchange rate system offers better opportunities for successful economical development than fixed exchange rate system.


L O G ODEVIKA NIGAM-9072

MONIKA JAIN-9090

POOJA CHAWLA-9095

NEHA MISHRA-9092

VIKAS DHRIWAL-9113

SHRADDHA SAPKAL-9118

fixed and floating exchange rate

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