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 versus Floating Exchange

Rate
To

determine whether a regime is

fixed or floating you have to
decide where to draw the line
between narrow and wide
fluctuations.
A rule is to use annual variations
in excess of +/- 2% and +/-1% as
the sign of floating regime.

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 foreignexchange 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
short-run 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
Chinese Yuan to One USD
developing countries as
well as communist
countries. Its somewhat
similar to a fixed exchange
rate however a pegged rate
has a wider range of value
versus the fixed 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.

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

American Dollars to 1
Chinese Yuan

American Dollars to 1
JPY

American Dollars to 1
CAD