Exchange Rates

FREELY FLOATINGCLEAN FLOATING

DIRTY FLOATINGMANAGED FLOATING

ADJUSTABLE PEG EXCHANGE RATES

RIGIDLY FIXEDEXCHANGE RATES

Exchange Rates

Measuring the exchange rate

Spot Exchange Rate - This is determined by the FOREX market on a minute-by-minute basis on the basis.

Forward Exchange Rate - a forward rate involves the delivery of currency at some time in the future at an agreed rate. Companies wanting to reduce risk

Real Exchange Rate - this measure is the ratio of domestic price indices between two countries. A rise in the real exchange rate implies a worsening of international competitiveness for a country.

Free Floating Exchange Rate

The value of £ is determined purely by S & D of the currency

Sterling has floated freely since the UK suspended membership of the ERM in September 1992

Managed Floating Exchange Rate

The value of the pound determined by market demand for and supply of the currency

Central banks may to try to iron out big changes in exchange rates on a day-to-day basis

Managed floating was a policy pursued from 1973-1990

Semi-Fixed Exchange Rates Adjustable Peg

The exchange rate is given a specific target

The currency can move between permitted bands on a day-to-day basis

The National Bank might have to intervene to maintain the value of the currency.

Fully-Fixed Exchange Rates

The government makes a commitment to a fixed exchange rate

There are no fluctuations from the central rate

System achieves exchange rate stability but perhaps at the expense of domestic stability

Fixed versus floating exchange rates – which is best for an economy?

1973-1990: UK operated with a managed floating exchange rate. Intervention by BoE and govt controlled interest rates.

October 1990- September 1992: UK a member of the European exchange rate mechanism (ERM) – the exchange rate was a specific target of economic policy.

September 1992 – present day: the UK has operated with a free-floating exchange rate

1992: UK crashes out of ERM

The government has suspended Britain's membership of the ERM

The UK's prime minister and chancellor tried all day to prop up a failing £.

Chancellor Norman Lamont raised interest rates from 10% to 12%, then to 15% then back to 12% on same day.

Black Wednesday

George Soros the most high profile of the currency market investors, made over 1 billion GBP profit by short selling sterling.

Black Wednesday

Treasury spent £27 billion of reserves in propping up the pound.

Greece and Euro?

Stability and Growth Pact

1997Maastricht convergence criteria Annual budget deficit no higher than 3%

of GDP a national debt lower than 60% of GDP

The case for floating exchange rates:

Reduced need for currency reserves to prop up the currency:

Useful macroeconomic instrument Partial correction for a trade deficit: Reduced risk of currency speculation: Freedom (autonomy) for domestic

monetary policy:

The Case for Fixed Exchange Rates

Trade and Investment: Currency stability

Some flexibility permitted: Disciplines on domestic producers: Reinforcing gains in comparative

advantage

Trends

Value of the Tenge 2003 2004 2005 2006 2007 2008

Exchange rate Tenge: US$ (av) 149.58 136.04 132.88 126.09 122.6 122.55

Exchange rate Tenge: € (av) 168.79 169.04 165.42 158.27 167.8 167.75

SOURCES: Kazakh Statistical Agency, Investor's Guide, Nationalbank Kazakhstan

Kazakhstan

September 2, 2013, Kazakhstan will peg its tenge to:-

Euro 20% US dollar 70% Rouble 10%

Marshall-Lerner Condition and J Curve

when does a real devaluation improve the current-account balance of a country?

Exportsped+Importsped > 1

Rationale behind J-Curve

In short run after a devaluation, M and X will remain unchanged.

In the long run consumers will have a chance to adjust.

The J Curve