CHAPTER 6 Government Influence on Exchange Rates Chapter

CHAPTER 6 Government Influence on Exchange Rates

Chapter Overview A. Exchange Rate Systems B. A Single European Currency C. Government Intervention D. Intervention as a Policy Tool

Chapter 6 Objectives This chapter will: A. Describe the exchange rate system used by various governments B. Explain how governments can use direct intervention to influence exchange rates C. Explain how governments can use indirect intervention to influence exchange rates D. Explain how government intervention in the foreign exchange market can affect economic conditions

A. Exchange Rate Systems 1. Fixed Exchange Rate System a. Bretton woods Agreement b. Smithsonian Agreement c. Advantages of a Fixed Exchange Rate System d. Disadvantages of a Fixed Exchange Rate System

A. Exchange Rate Systems 2. Freely Floating Exchange Rate System a. Advantages of a Freely Floating Exchange Rate System other 1. ) a country is more insulated from the inflation of other countries 2. ) a country is more insulated from unemployment problems in countries

A. Exchange Rate Systems b. Disadvantages of a Freely Floating Exchange Rate System can adversely affect a country that has high unemployment.

A. Exchange Rate Systems 3. Managed Float Exchange Rate System a. Criticism of a Managed Float System

A. Exchange Rate Systems 4. Pegged Exchange Rate System a. Limitations of a Pegged System b. Creation of Europe’s Snake Arrangement c. Creation of the European Monetary System (EMS) d. Demise of the European Monetary System

A. Exchange Rate Systems 5. Currency Boards a. Exposure of a Pegged Currency to Interest Rate Movements b. Exposure of a Pegged Currency to Exchange Rate Movements

A. Exchange Rate Systems 6. Dollarization a. the replacement of a foreign currency with t dollars. U. S. b. This process is a step beyond a currency board because it forces the local currency to be replaced by the U. S. dollar. c. Although dollarization and a currency board both attempt to peg the local currency’s value, the currency board does not replace the local currency with dollars. 7. Classification of Exchange Rate Arrangements

B. A Single European Currency 1. Membership 2. Impact on European Monetary Policy a. European Central Bank b. Implications of a European Monetary Policy 3. Impact on Business within Europe

B. A Single European Currency 4. Impact on the Valuation of Businesses in Europe 5. Impact on Financial Flows 6. Impact on Exchange Rate Risk 7. Status Report on the Euro

C. Government Intervention 1. Reasons for Government Intervention a. Smooth Exchange Rate Movements b. Establish Implicit Exchange Rate boundaries c. Respond to Temporary Disturbances

Effects of Direct Central Bank Intervention in the Foreign Exchange Market Exhibit 6. 2

C. Government Intervention 2. Direct Intervention a. Reliance on Reserves b. Nonsterilized versus Sterilized Intervention c. Speculating on Direct Intervention

Forms of Central Bank Intervention in the Foreign Exchange Market Exhibit 6. 3

C. Government Intervention 3. Indirect Intervention a. Government Adjustment of Interest Rates b. Government Use of Foreign Exchange Controls

D. Intervention as a Policy Tool 1. Influence of a Weak Home Currency on the Economy 2. Influence of a Strong Home Currency on the Economy

Impact of Government Actions on Exchange Rates Exhibit 6. 4