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McGraw-Hill/Irwin
Chapter 10
Introduction
Question: What is the international monetary system?
The international monetary system refers to the institutional arrangements that govern exchange rates Recall that the foreign exchange market is the primary institution for determining exchange rates
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Introduction
A floating exchange rate system exists in countries where the foreign exchange market determines the relative value of a currency Examples include the U.S. dollar, the European Unions euro, the Japanese yen, and the British pound A pegged exchange rate system exists when the value of a currency is fixed to a reference country and then the exchange rate between that currency and other currencies is determined by the reference currency exchange rate Many developing countries have pegged exchange rates
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Introduction
A dirty float exists when the value of a currency is determined by market forces, but with central bank intervention if it depreciates too rapidly against an important reference currency China adopted this policy in 2005 With a fixed exchange rate system countries fix their currencies against each other at a mutually agreed upon value Prior to the introduction of the euro, some European Union countries operated with fixed exchange rates within the context of the European Monetary System (EMS)
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Introduction
Question: What role does the international monetary system play in determining exchange rates? To answer this question, we have to look at the evolution of the international monetary system The Gold Standard The Bretton Woods system The International Monetary Fund The World Bank
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The Case for Fixed Exchange Rates 3. Uncertainty The uncertainty associated with floating exchange rates makes business transactions more risky 4. Trade Balance Adjustments Floating rates help adjust trade imbalances
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Who is Right?
There is no real agreement as to which system is better History shows that fixed exchange rate regime modeled along the lines of the Bretton Woods system will not work A different kind of fixed exchange rate system might be more enduring and might foster the kind of stability that would facilitate more rapid growth in international trade and investment
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Currency Boards
A country with a currency board commits to converting its domestic currency on demand into another currency at a fixed exchange rate The currency board holds reserves of foreign currency equal at the fixed exchange rate to at least 100% of the domestic currency issued Additional domestic notes and coins can be introduced only if there are foreign exchange reserves to back it
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As with many debates about international economics, it is not clear who is right
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Currency Management
1. Currency Management The current exchange rate system is a managed float So, government intervention and speculative activity influence currency values Firms can protect themselves from exchange rate volatility through forward markets and swaps
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Business Strategy
2. Business Strategy Exchange rate movements can have a major impact on the competitive position of businesses The forward market can offer some protection from volatile exchange rates in the shorter term Firms can protect themselves from the uncertainty of exchange rate movements over the longer term by building strategic flexibility into their operations that minimizes economic exposure Firms can disperse production to different locations Firms can outsource manufacturing
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Corporate-Government Relations
3. Corporate-Governance Relations Firms can influence government policy towards the international monetary system Firms should focus their efforts on encouraging the government to promote the growth of international trade and investment adopt an international monetary system that minimizes volatile exchange rates
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