Exchange Rate Regimes of the World

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Exchange Rate Regimes of the World
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Exchange Rate Regimes

• What is an exchange rate regime?
• the exchange rate regime is the way a country
  manages its currency in respect to foreign
  currencies and the foreign exchange market.
• What are the most common types of exchange rate
  regimes?
• Fixed Exchange Rate
• Floating Exchange Rate
• Pegged Exchange Rate

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Fixed versus Floating Exchange Rate

• To determine whether a regime is fixed or
  floating you have to decide where to draw the
  line between narrow and wide fluctuations.
• A rule is to use annual variations in excess of
  /- 2 and /-1 as the sign of floating regime.

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Fixed Exchange Rate Regimes

• Definition in a fixed exchange rate system the
  government or central bank intervenes in the
  currency market so that the exchange rate stays
  close to an exchange rate target.
• The central bank is unable to affect the exchange
  rate through monetary policy. However, the
  central bank can use fiscal expansion to create
  an excess demand for the currency causing a rise
  in domestic output. The central bank will then
  purchase foreign assets to increase the money
  supply, and prevent the interest rate from rising
  causing an appreciation.
• Due to these limitations the government of a
  country with a fixed exchange rate will want to
  control the amount of currency they let in and
  out. This will prevent any unwanted
  destabilization of the domestic currency.

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Floating Exchange Rate Regimes

• Definition a countrys currency is set by the
  foreign-exchange market through supply and demand
  for that particular currency relative to other
  currencies.
• In a floating exchange rate system the value of
  the currency is affected by everyday markets for
  supply and demand. Therefore trade and capital
  flows play a big role in determining the
  currencys value.
• There are two different types of floating
  exchange rate systems. Dirty Float and Clean
  Float and this depends on whether or not there is
  government intervention.
• The exchange rate can be stabilized through both
  monetary and fiscal policy
• Through monetary policy when there is an excess
  in money supply the government would purchase
  domestic assets to weaken the currency and push
  the interest rate down.
• Fiscal expansion causes an appreciation of the
  currency that forces the government to purchase
  foreign assets. This will increase the money
  supply preventing the currency appreciation.

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Free Float

• The movements between peaks and troughs may take
  months or years to occur.
• The exchange rate will show a great deal of
  short-run volatility, with lots of up-and-down
  movement from day to day.
• Examples between the U.S. dollar with all the
  three foreign countries
• -the yen
• -the pound
• -the loonie

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Free Float Cont.

• The range of variation is about the same, with
  the maximum being about one and a half times the
  minimum
• -The yen ranges from about 0.0065 to 0.010.
• -The pound from 1.3 to 1.95.
• -The loonie from 0.6 to about 0.85.

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Pegged Exchange Rate Regimes

• This is most common under developing countries as
  well as communist countries. Its somewhat
  similar to a fixed exchange rate however a pegged
  rate has a wider range of value versus the fixed
  exchange rate.
• An example of a country with a pegged exchange
  rate would be China. Chinas currency was pegged
  to the U.S. Dollar until 2005 as you can see in
  the graph.

Chinese Yuan to One USD
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Type of Peg

• Currency Board- a type of fixed regime that has
  special legal and procedural rules designed to
  make the peg harder which means more durable.
• Crawling peg- when he exchange rate follows a
  simple trend and if there is any variation than
  its called a crawling band

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American Dollars to 1 Chinese Yuan
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American Dollars to 1 JPY 
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American Dollars to 1 CAD