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Government Policies toward the Foreign Exchange Market


									Chapter Five Government
Policies toward the Foreign
Exchange Market

Instructor: Aijing Song

   Glossary
   Two aspects: rate flexibility and
    restrictions on use
   Floating Exchange Rate
   Fixed Exchange Rate
   Defense through official intervention
   Exchange control

   Clean float
   Fixed/pegged
   Adjustable peg
   Crawling peg
   Parallel market
Two aspects: rate flexibility
and restrictions on use

   rate flexibility
   restrictions on use
    - also called exchange controls, which
    may be broad-based or may be
    applied only to some types of
    transactions (e.g., capital controls).
Floating Exchange Rate

   In the polar case of a clean float the
    government permits private market demand
    and supply to set the exchange rate with no
    direct involvement by government officials.
   In a managed float or dirty float the
    government officials do intervene at times
    to try to influence the exchange rate, which
    otherwise is driven by private demand and
Fixed Exchange Rate
    what to fix to?
    - include gold (or some other commodity), the U.S.
     dollar or some other single currency, or a basket of
    When to change the fixed rate?
    - we often then speak of a pegged exchange rate
     instead of a fixed exchange rate
    - The choice of when to change the peg is closely
     related to how wide is the band around the central
     or par value chosen for the fix.
Fixed Exchange Rate
    Defending a fixed exchange rate
    - official intervention in which the government buys
     and sells currencies;
    - exchange controls, in which the government tries
     to suppress excess demand or supply;
    - altering domestic interest rates to influence short-
     term international capital flows;
    - adjusting the country's macroeconomic position to
     make it fit the fixed exchange rate.
Defense through official
   Defense through official intervention
    - Defending against depreciation
      1) entering the foreign exchange market to
    buy domestic currency and sell foreign
    - Defending against appreciation
      1) the directions reversed compared with
    the abovementioned points
Defense through official
- Temporary disequilibrium
    1) If the imbalance in the country's official settlements
   balance is temporary, then official intervention that smoothes
   the time path of the exchange rate can enhance the country's
   economic well-being
-  Disequilibrium that is not temporary
  1) intervention alone not likely to be able to sustain the fixed
   exchange rate.
  2) the government must shift to one of the other defenses or
  3) not easy for officials to judge whether a payments
   imbalance is temporary or fundamental.
Exchange Control

   Introduction of Exchange Control
    - used by many countries, especially
    developing countries.
    - cause economic inefficiency analogous to
    quantitative limits (quotas) on imports.
    - incur substantial administrative costs.
    - Efforts to evade them lead to bribery and
    parallel markets.

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