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Exchange Rate Regimes of the World1

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Published on October 6, 2009

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Exchange Rate Regimes of the WorldA PRESENTATION BY: RUPA PANDEY & SHRUTI AGRAWAL : Exchange Rate Regimes of the WorldA PRESENTATION BY: RUPA PANDEY & SHRUTI AGRAWAL Contents… : Contents… Introduction to Exchange Rates Gold Standard Bretton Woods System Triffin Paradox SMITHSONIAN Agreement Floating Exchange rate System Managed Floating Rate Crawling Peg EMS Concepts INTRODUCTION : INTRODUCTION Exchange rates between two currencies specifies how much one currency is worth in terms of the other. The exchange rate history of the nineteenth century highlights the importance of the gold standard in that era. From 1876 to 1913, the exchange rate system was dependent on the respective currency’s comparative convertibility to an ounce of gold. However, this method of determination of the exchange rate had to be reassessed when the gold standard was suspended during World War I. GOLD STANDARD : GOLD STANDARD First to Adopt: United Kingdom in 1821 It pegs currencies to gold; currencies are guaranteed by being convertible to gold There was a fixed rate of exchange GOLD STANDARD GOLD SPECIE GOLD BULLION GOLD SPECIE : GOLD SPECIE In this exchange rate system, the money coins are made of gold The amount of gold contained in the coin equals the face value of coin The trade surplus is automatically settled in this system GOLD BULLION : GOLD BULLION Money in circulation is a paper note Monetary authorities hold stock of gold The amount of currency needed to purchase one ounce of gold is the gold par value. Ex:1 ounce of gold was worth US$20.67 or £4.25. How do you determine the exchange rate between U.S. dollars and pounds? $20.67/ounce of gold = $4.87 per GBP £ 4.25/ounce of gold ADVANTAGES OF GOLD STANDARD : ADVANTAGES OF GOLD STANDARD It provided stable exchange rates, which were conducive for trade policy It ensures automatic adjustment of balance of payments problem It imposes discipline on policy makers regarding expansion of money supply as it is limited by reserves of gold with them DISADVANTAGES OF GOLD STANDARD : DISADVANTAGES OF GOLD STANDARD There is always a problem in selecting an appropriate par value which reflect the external & internal equilibrium The mining process of gold involves huge cost There is an unequal geographic distribution of gold through out the globe The gold standard was dependent on the adequate supply & not the excess supply of new gold BRETTON WOODS SYSTEM : BRETTON WOODS SYSTEM An agreement that governed the international financial relationships from World War II until 1971. It established fixed exchange rate system The Bretton Woods system established : FEATURES : FEATURES USA undertook to covert the US $ freely into gold at a fixed parity of $ 35 per ounce Other countries agreed to maintain their currencies at specific parities with US $, 1% variation in this parity (+ or -) was allowed If there is a genuine problem in maintaining parity to a particular member then it can change its parity itself by 10% (+ or -) ADVANTAGES OF FIXED EXCHANGE RATE SYSTEM : ADVANTAGES OF FIXED EXCHANGE RATE SYSTEM It provides a measure of exchange rate stability It helps to insulate the economy against economic disturbances It encourages trade also Poorer nations could get foreign exchange for development purposes at low costs DISADVANTAGES OF FIXED EXCHANGE RATE SYSTEM : DISADVANTAGES OF FIXED EXCHANGE RATE SYSTEM The system is not self equilibrating therefore over-valuation & under-valuation were rampant It required regular rigorous control and monitoring by the monetary authorities TRIFFIN PARADOX : TRIFFIN PARADOX It was pointed out by Prof. Robert Triffin. Countries other than US wanted to accumulate dollars. BOP deficits faced by US US did not have enough gold to convert dollars SMITHSONIAN AGREEMENT : SMITHSONIAN AGREEMENT Introduced by European Community in 1972. Float agreement was between EEC, Denmark, Ireland, Norway and U.K Collapse of Brettonwood system made snake redundant FLOATING EXCHANGE RATE SYSTEM : FLOATING EXCHANGE RATE SYSTEM It started appearing in 1971 The exchange rate is determined purely by market forces Authorities do not intervene and do not try to maintain the exchange rate at a specific value or in a particular band Slide 16: E D $1=Rs. 36 Exchange rate Demand & Supply D’ S’ $1=Rs. 35 $1=Rs. 34 S S’ D D’ S E1 E2 ADVANTAGES OF FLOATING EXCHANGE RATE SYSTEM : ADVANTAGES OF FLOATING EXCHANGE RATE SYSTEM It is a less painful adjustment mechanism to trade imbalances Better confidence in the country & the international financial system Gains from freer trade It doesn’t require regular monitoring & intervention by the government The absence of need to maintain official reserves eliminates the opportunity cost DISADVANTAGES OF FLOATING EXCHANGE RATE SYSTEM : DISADVANTAGES OF FLOATING EXCHANGE RATE SYSTEM Flexible rates cause uncertainty & inhibit international trade & investment It causes destabilizing speculation Flexible rates are unstable because of small trade elasticities MANAGED OR DIRTY FLOAT : MANAGED OR DIRTY FLOAT It is a compromise between fixed & flexible exchange rates Central banks intervene in the forex markets even when they have declared that exchange rates are flexible The degree and periodicity of intervention by monetary authority is haphazard Sometimes, the intervention is to reduce short-run exchange rate uncertainty CRAWLING PEG : CRAWLING PEG A combination of the advantages of fixed exchange rate with flexibility of floating exchange rate It fixes the exchange rate at a given level which is responsive to changes in market conditions The crawl may be triggered by constant revaluation or devaluation pressures Exchange rates can drift according to the fundamental forces such as, inflation ADVANTAGES OF CRAWLING PEG : ADVANTAGES OF CRAWLING PEG It avoids the economic instability It reduces uncertainty due to volatility characterizing floating exchange rate DISADVANTAGES OF CRAWLING PEG It might prompt monetary authorities to accelerate their currency realignments EUROPEAN MONETARY SYSTEM : EUROPEAN MONETARY SYSTEM In March 1979, 9 members of the EEC established the EMS EMS consisted of 4 components: Creating an ERM Setting of central exchange rates among member countries Creation of European Currency Unit Establishment of rules of intervention Slide 23: Requirements to become a member: Inflation rate in the year before admission must be no more that 1.5% above the average rate of the three EU member states with lowest inflation. The country must have maintained a stable exchange rate within the ERM without devaluing on its own initiative. Public-sector deficit no higher than 3 percent of GDP Public debt no higher than 60 percent of GDP. On January 1, 1999, 11 member countries of the European Union adopted a common currency, the euro. CONCEPTS : CONCEPTS Fiat Money Seignorage LERMS THANK YOU : THANK YOU

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