Exchange Rate Regimes of the World

Exchange Rate Regimes

What is an exchange rate regime?

the exchange rate regime is the way a country manages its currency in respect to foreign currencies and the foreign exchange market.

What are the most common types of exchange rate regimes?

Fixed Exchange Rate Floating Exchange Rate Pegged Exchange Rate

Fixed Exchange Rate Regimes

Definition: in a fixed exchange rate system the government or central bank intervenes in the currency market so that the exchange rate stays close to an exchange rate target. The central bank is unable to affect the exchange rate through monetary policy. However, the central bank can use fiscal expansion to create an excess demand for the currency causing a rise in domestic output. The central bank will then purchase foreign assets to increase the money supply, and prevent the interest rate from rising causing an appreciation. Due to these limitations the government of a country with a fixed exchange rate will want to control the amount of currency they let in and out. This will prevent any unwanted destabilization of the domestic currency.

Floating Exchange Rate Regimes

Definition: a countrys currency is set by the foreign-exchange market through supply and demand for that particular currency relative to other currencies. In a floating exchange rate system the value of the currency is affected by everyday markets for supply and demand. Therefore trade and capital flows play a big role in determining the currencys value.

There are two different types of floating exchange rate systems. Dirty Float and Clean Float and this depends on whether or not there is government intervention.
The exchange rate can be stabilized through both monetary and fiscal policy:
Through monetary policy when there is an excess in money supply the government would purchase domestic assets to weaken the currency and push the interest rate down.
Fiscal expansion causes an appreciation of the currency that forces the government to purchase foreign assets. This will increase the money supply preventing the currency appreciation.

Free Float

The movements between peaks and troughs may take months or years to occur. The exchange rate will show a great deal of shortrun volatility, with lots of up-and-down movement from day to day. Examples between the U.S. dollar with all the three foreign countries: -the yen -the pound -the loonie

Free Float Cont.

The range of variation is about the same, with the maximum being about one and a half times the minimum: -The yen ranges from about $0.0065 to $0.010. -The pound from $1.3 to $1.95. -The loonie from $0.6 to about $0.85.

Pegged Exchange Rate Regimes

This is most common under developing countries as well 10.0000 as communist countries. Its 9.0000 somewhat similar to a fixed 8.0000 exchange rate however a pegged rate has a wider range 7.0000 of value versus the fixed 6.0000 exchange rate. An example of a country with a pegged exchange rate would be China. Chinas currency was pegged to the U.S. Dollar until 2005 as you can see in the graph.
5.0000 4.0000 3.0000 2.0000 1.0000 0.0000

Chinese Yuan to One USD

Series1

1981-01-01 1982-11-01 1984-09-01 1986-07-01 1988-05-01 1990-03-01 1992-01-01 1993-11-01 1995-09-01 1997-07-01 1999-05-01 2001-03-01 2003-01-01 2004-11-01 2006-09-01 2008-07-01

Type of Peg
Currency Board- a type of fixed regime that has special legal and procedural rules designed to make the peg harder which means more durable. Crawling peg- when he exchange rate follows a simple trend and if there is any variation than its called a crawling band

Lesson task
Using the information in this presentation, and additional research, explain in detail the different types of exchange rates regimes and the advantages and disadvantages of each.