FIXED EXCHANGE RATES1. How the central bank fixes the rate:Assets LiabilitiesBonds MoneyForeign reservesThe CB buys or sells foreign reserves to keep the price - theexchange rate - within a band, usually a couple of percent wide.This is exchange market interventionFor example, suppose currency is depreciating. CB might sellFX (foreign exchange!), to keep its price down:Assets LiabilitiesBonds Money -100Foreign reserves -1002. Some terminology:CBs often try to prevent their FX operations from directlyaffecting the money supply. They do this by sterilizing, makingan offsetting purchase or sale of bonds:Assets LiabilitiesBonds +100 Money -100 +100Foreign reserves -100But in practice sterilized intervention is not very effective, so inthe end money supply is usually altered to support exchangerate.3. Macroeconomics under fixed rate: Because exchange rate isnot expected to change, interest rate must equal foreign rate, andmoney supply adjusts to money demandFixed exchange rate => no independent monetary policyFOREIGN EXCHANGE “REGIMES”Floating ratesFixed exchange rates: Gold standard Bretton Woods system (1944-71/3) European Monetary System (1979-1998) Currency boards (Argentina, Hong Kong)Other schemes: Crawling peg (Brazil) Common currency (EMU)The dilemma: Countries generally want stable exchange rates;they also generally want independent monetary policy. Theycan’t have
View Full Document
Unlocking...