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1 基本概念
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2 PPT
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3 视频小课堂
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4 自我测试
Ⅳ Floating Exchange Rate: 1973-present
A. Exchange Rate System and the Ability of Central Bank to Conduct Monetary Policy
In the dollarization, the central bank hascompletely given up control of money supply by adopting some other country’scurrency.
For free floating, the central bank hascomplete control on its domestic money supply policy.
B. Choice of Exchange Rate System
1. Who tends to fix?
Small economy
Open economy (large amount of trades)
Highly concentrated trade (peg with majortrading partners)
Harmonious inflation rates (similar monetarypolicy to a country that they peg to).
2. Who tends to float?
large economy
Closed economy (relatively small amount oftrades)
Highly diversified trade (trade with manytrading partners)
Divergent inflation rates (remain independentmonetary policy).
C. Standard Peg
Fix the domestic currency with a singleforeign currency or a basket of major currencies.
1. Benefits
--limit exchange rate fluctuations (good for international trade)
2. Drawbacks
--limit ability to use domestic monetary policy (in emergency such asrecession). Also, attract speculative attack on the currency.
Example: the Bahamas should peg its currencyto the U.S. It is a small economy with a lot of trade (tourism), a lot of tradewith the U.S., and the monetary policy is similar to the U.S. (even though theBahamas is a former British colony, it makes sense to peg with dollar thanpound).
3. How to peg the exchange rate?
Suppose Mexican peso is fixed to the U.S.dollar at $0.50 =1 peso.
Then, there is an increase in demand for theU.S. products from Mexicans. So, the supply of peso increases.
In floating, the peso would depreciate.
However, with peg rate, the central bank ofMexico will have to do the official intervention to peg the rate.
4. Speculative attacks on the peg
After the persistent official interventions,the dollar reserves deplete.
Speculators expect that one day the centralbank of Mexico will run out of dollar reserves and the peso will fall invalues.
What would speculators do?Sell, sell, and sell peso (before itbecomes less valuable).
This will increase the supply of peso (red)and lead to greater surplus of peso.
This is called “speculative attack.”
D. Dollarization vs. Currency Board
When public questions the credibility ofgovernment in maintaining exchange rate stability, the country may adopt theextreme measure such as dollarization or the currency board.
1. Dollarization
--adopt someone else’s currency and completely give up your owncurrency.
2. Currency Board
--fix the exchange rate with other country’s currency with 100% foreignreserve backing in the central bank. This is part of a written law that thegovernment commits to fix the exchange rate.
3. Dollarization and Currency Board: Pros and Cons
E. Free Floating vs. Managed Float
Free floating – market mechanism determines the exchange rate, no intervention to setthe exchange rate.
Managed float – appear as a floating exchange rate, but the central bank intervene attimes with no preannounced path for the exchange rate.
1. Floating Exchange Rate
2. Fixed vs. Floating
Target bands: The rate is allowed to varywith the official set bands. Once it wanders too far, the central bank willintervene to put the rate back within the band.
F. European Monetary System (EMS)
This system has been more likely to have thedrawbacks from both fixed and floating.
1. Optimum Currency Areas
Optimum currency area – The geographical areathat would maximize economic benefits by keeping the exchange rate fixed withinthe area.
For example, in Western Europe, a system offixed exchange rates might be appropriate. (The Euro)
One necessary criterion for an optimumcurrency area is that the region should have perfect mobility of the factors ofproduction.
If factors can freely and cheaply migratefrom an area lacking jobs to an area where labor is in demand, then themobility will restore equilibrium.
2. The EU
The European Monetary System (EMS) wasestablished in March 1979.
Small exchange rate fluctuations amongthemselves, while allowing for large fluctuations against outside currencies(target band).
The Maastricht Treaty was signed in December1991
Removed restrictions on European flows ofcapital.
Coordinated monetary policies of theindividual central banks.
Fixed exchange rates among all membercountries (Jan 1999).
Synchronized their macroeconomic policies.
One money requires one central bank. EuropeanCentral Bank (ECB) began operations on June 1, 1998, in Frankfurt, Germany.
Three member countries of the European Unionthat are eligible but not adopted the euro are Denmark, Sweden, and the UnitedKingdom.
