free and floating ex rate

7/29/2019 Free and Floating Ex Rate

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$ ` $ `


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Topics

Meaning

Exchange rate regime

Types Determination

Factors


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Exchange rate

An exchange rate between two currencies is the rate atwhich one currency will be exchanged for another.

It is also known as the

foreign-exchange rate,

Forex rate or

FX rate.

E.g. An exchange rate of 91 Japanese Yen (JPY, ) to theUnited state dollars(US, $) means that 91 will beexchanged for each US$1 or that US$1 will be exchangedfor each 91.


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Exchange rate regime

It is the way an authority manages its currency

in relation to other currencies and the foreign

exchange market.

Three types of exchange rates are

Fixed exchange rate

Pegged floating exchange rate

Floating exchange rate


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Fixed exchange rate

It is also called pegged exchange rate system

It is a currency system in which governments try to

maintain their currency value constant against one

another. The countrys government decides the worth of its

currency in terms of either a fixed weight of gold, a

fixed amount of another currency or a basket of

other currencies.


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Chronology

1880-1914 Classical gold standard period

July 1944 Bretton woods conference

August 1971 United States suspends convertibility of dollar into gold

Bretton Woods system collapses

December 1971 Smithsonian agreement

March 1973 Managed float regime came into being

Gold standard The value of the currency was denominated in terms of the

gold reserves present with the central bank. Each central bank

maintained gold reserves with it as a official reserve asset. (1879-1914)

Bretton Woods system After the second world war, the gold standard was

replaced by the Bretton Woods system. The rules for this system were

given by IMF and IBRD.


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Pegged float

Pegged floating currencies are pegged to

some band or value, either fixed or

periodically adjusted.

Crawling bands - the rate is allowed to

fluctuate in a band around a central value,

which is adjusted periodically. This is done at a

preannounced rate or in a controlled wayfollowing economic indicators.


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Floating exchange rate

A floating exchange rate or fluctuating exchangerate is a type of exchange rate regime wherein acurrency's value is allowed to fluctuate according

to the foreign exchange market. They are preferable to fixed exchange rate. As

floating exchange rates automatically adjust, theyenable a country to dampen the impact of

1. Shocks and foreign business cycle,2. pre-empt the possibility of having a balance

of payment crisis.
http://en.wikipedia.org/wiki/Shock_(economics)


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In theUnited

States

$ 40

InIndia

Rs. 750

$ 15


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If this happens:1. American consumers demand for Indian

Rupees would increase which will cause the Indian

Rupee to become more expensive2. The demand for cricket bats sold in the US would

decrease and hence its prices would tend to decrease

3. The increase in demand for cricket bats in India wouldmake them more expensive


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In the

UnitedStates

$ 40

InIndia

Rs. 750

Rs.1200$ 30

At these levels, you can see that there is a purchasingpower parity between both the currencies.


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Factors affecting exchange rate

Differentials in Inflation- Lower inflation rate

exhibits a rising currency value, as its purchasing

power increases relative to other currencies.

Differentials in Interest Rates - higher interestrates attract foreign capital and cause the

exchange rate to rise.

Current-Account Deficits - The excess demand forforeign currency lowers the country's exchange

rate when Current account deficit happens.


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A million thanks

free and floating ex rate

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