slide 1 of slides developed by jeff madura, with additions and enhancements by tim richardson
TRANSCRIPT
Slide 1 of
Slides developed by Jeff Madura, with additions and enhancements by Tim Richardson
Slide 2 of
Slides developed by Jeff Madura, with additions and enhancements by Tim Richardson
Government Influence on Exchange Rates
Chapter 6Chapter 6
Slide 3 of
Slides developed by Jeff Madura, with additions and enhancements by Tim Richardson
Overview
Examine exchange rate systems Explain how governments intervene
to influence exchange rates Describe how intervention in
exchange market can affect economic conditions
Slide 4 of
Slides developed by Jeff Madura, with additions and enhancements by Tim Richardson
Why Do We need to know Government involvement
Internal National governments do things
which have a domestic effect on the value of their own currency
External Internationally, other governments do
things which can effect the value of your currency
Slide 5 of
Slides developed by Jeff Madura, with additions and enhancements by Tim Richardson
Why Do We need to know Government involvement
Internal By doing a bad job with inflation, or
unemployment a National governments can be seen to be not operating effectively, and this will create negative confidence among currency traders and international business people
Slide 6 of
Slides developed by Jeff Madura, with additions and enhancements by Tim Richardson
Why Do We need to know Government involvement
Internal By doing a bad job … the value of the
currency will decline If it declines it makes it very difficult
for consumers in that country to afford imported products
therefore standard of living will decline
Slide 7 of
Slides developed by Jeff Madura, with additions and enhancements by Tim Richardson
Why Do We need to know Government involvement
External Internationally, other governments do
things . . . By using trade barriers and import taxes
and other impediments which make it difficult for a country to export - this can deprive it of situations which can effect the value of its currency
Slide 8 of
Slides developed by Jeff Madura, with additions and enhancements by Tim Richardson
Why Do We need to know Government involvement
External If currency is pegged then it can go up
or down according to the rise and fall of the situation in another country
Slide 9 of
Slides developed by Jeff Madura, with additions and enhancements by Tim Richardson
Exchange Rate Systems
Classified according to the degree by government controls them
Fixed Freely floating Managed float Pegged
Slide 10 of
Slides developed by Jeff Madura, with additions and enhancements by Tim Richardson
Exchange Rate Systems
Fixed– currency fluctuation limited to narrow
bands– Bretton Woods Agreement (1944-1971)
valued each currency in terms of gold permitted fluctuations of 1% from original
rates meant you also had to have gold on hand
– lessened currency risk for MNCs
Slide 11 of
Slides developed by Jeff Madura, with additions and enhancements by Tim Richardson
Exchange Rate Systems
Freely floating exchange rates– market forces determine exchange rates– advantages
increases stability in global economy reduces maintenance of exchange rates by
central banks
– disadvantages may exacerbate a country’s economic
problems
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Slides developed by Jeff Madura, with additions and enhancements by Tim Richardson
Exchange Rate Systems
Managed Float exchange ratesManaged Float exchange rates– a mix of fixed and freely floating characteristicsa mix of fixed and freely floating characteristics– exchange rates fluctuate freely exchange rates fluctuate freely – government intervenes directly to manage the government intervenes directly to manage the
exchange rate exchange rate
Slide 13 of
Slides developed by Jeff Madura, with additions and enhancements by Tim Richardson
Exchange Rate Systems
Pegged exchange ratesPegged exchange rates– ties a currency’s value to a foreign currency or ties a currency’s value to a foreign currency or
to some unit of accountto some unit of account examples include European Economic Community examples include European Economic Community
and the European Currency Unitand the European Currency Unit
– produces dependency upon the movement of produces dependency upon the movement of the foreign currencythe foreign currency
Slide 14 of
Slides developed by Jeff Madura, with additions and enhancements by Tim Richardson
Exchange Rate Systems
Potential barriers to a single European Potential barriers to a single European currencycurrency– meeting specified economic targetsmeeting specified economic targets– impact of monetary policyimpact of monetary policy
consolidation of European monetary policyconsolidation of European monetary policy
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Slides developed by Jeff Madura, with additions and enhancements by Tim Richardson
Government Intervention
Reasons for interventionReasons for intervention– smoothing exchange ratessmoothing exchange rates– establishing implicit exchange rate boundariesestablishing implicit exchange rate boundaries– responding to temporary disturbancesresponding to temporary disturbances
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Slides developed by Jeff Madura, with additions and enhancements by Tim Richardson
Government InterventionDirect Intervention
Central bank actively trades on exchange Central bank actively trades on exchange market to influence currency valuesmarket to influence currency values– attempt to weaken home currencyattempt to weaken home currency
trade home currency for foreign currencytrade home currency for foreign currency– places downward pressure on home currencyplaces downward pressure on home currency
– attempt to strengthen home currencyattempt to strengthen home currency exchange foreign currency for home currencyexchange foreign currency for home currency
– places upward pressure on home currencyplaces upward pressure on home currency
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Slides developed by Jeff Madura, with additions and enhancements by Tim Richardson
Government InterventionDirect Intervention
Nonsterilized interventionNonsterilized intervention– intervention in exchange market without intervention in exchange market without
adjusting for the change in money supplyadjusting for the change in money supply money supply increases with attempts to weaken money supply increases with attempts to weaken
home currencyhome currency money supply decreases with attempts to strengthen money supply decreases with attempts to strengthen
home currencyhome currency
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Slides developed by Jeff Madura, with additions and enhancements by Tim Richardson
Government InterventionDirect Intervention
Sterilized interventionSterilized intervention– intervention in exchange market while making intervention in exchange market while making
adjustments to avoid change in money supplyadjustments to avoid change in money supply transact simultaneously in exchange markets and transact simultaneously in exchange markets and
Treasury securities marketsTreasury securities markets
– strengthen home currency by:strengthen home currency by: 1) exchange home currency for foreign currency1) exchange home currency for foreign currency 2) sell holdings of Treasury securities for home 2) sell holdings of Treasury securities for home
currencycurrency
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Slides developed by Jeff Madura, with additions and enhancements by Tim Richardson
Government InterventionIndirect Intervention
Central banks affect currency values by Central banks affect currency values by influencing factors that determine exchange influencing factors that determine exchange ratesrates– increase or decrease money supply to move increase or decrease money supply to move
interest rates in desired directioninterest rates in desired direction
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Slides developed by Jeff Madura, with additions and enhancements by Tim Richardson
Exchange Rate Target Zones
Proposed to reduce volatility in exchange Proposed to reduce volatility in exchange rates of major currenciesrates of major currencies– suggest creating a central rate with specific suggest creating a central rate with specific
boundariesboundaries– governments would be responsible for governments would be responsible for
maintaining currencies within the zonesmaintaining currencies within the zones– Louvre Accord established acceptable rangesLouvre Accord established acceptable ranges
US intervention quickly declined over timeUS intervention quickly declined over time
Slide 21 of
Slides developed by Jeff Madura, with additions and enhancements by Tim Richardson
Intervention as a Policy Tool
Impact of weak currency on economyImpact of weak currency on economy– may stimulate foreign demand for productsmay stimulate foreign demand for products– may reduce importsmay reduce imports– may boost exports and jobsmay boost exports and jobs
Impact of strong currency on economyImpact of strong currency on economy– encourages greater demand for importsencourages greater demand for imports– constrains price increases through competitionconstrains price increases through competition
Slide 22 of
Slides developed by Jeff Madura, with additions and enhancements by Tim Richardson
Summary
Exchange rate systems:Exchange rate systems:– fixed rate, freely floating, managed and peggedfixed rate, freely floating, managed and pegged
Direct intervention Direct intervention – buy or sell currencies on exchange marketbuy or sell currencies on exchange market
Indirect interventionIndirect intervention– influence economic factors that affect exchange influence economic factors that affect exchange
ratesrates