Foreign Exchange Balance Policy

Foreign Exchange Balance Policy

1. Fixed Exchange Rates

   • Benefits
     • More credibility, less inflation risk
     • Eliminate uncertainty about exchange volatility
       • Attracts foreign investment
     • Easy to implement and understand
   • Costs
     • Renuncing exchange rate as economic tool
     • Risk of speculative attacks that may lead to financial crises

2. Incompatibility between

   • Fixed exchange rate
   • Free capital flows
     • Lead to trilemma of the open economy
   • Independent monetary policy

3. When there is flexible exchange rates

   • Economic authorities can influence it
     • By the Central bank intervention
     • Economic policymakers can affect price of the currency via monetary or fiscal policy

4. Correcting the current account surplus

   • Oppositors
     • Argue that is the result of economies' competitiveness
     • Argue that it is not too much of a risk for Europe
   • Warning note for Germany
     • Very large current account surplus
       • Could indicate imbalances in the German economy

5. Accumulation of foreign exchange reserves in some economies with big surpluses (China, Japan, Qatar...)

   • Invested in assets such as US bonds
   • Creation of Sovereign funds

6. Quantitative easing and inclusion of sovereing bonds

   • Impact on the euro and dolar exchange rate
     • ECB monetary policy has a big impact on the decisions of the rest of the european central banks