Foreign Exchange

Foreign Exchange

1. Exchange rate

   • Fixed Exchange rate
     • Conventional - 1% daily fluctuation band
     • Intermediate - wider fluctuation band
     • Currency board - the natoinal currency is entirely baked by foreign assets
     • No separate legal tender - adopt the currency of another country without a say in monetary policy
       • Advantages
         • Solves inflation problems
         • Strengthens commercial links
       • Disadvantages
         • Adopting the monetary policy of a third country might not always be suitable
         • Monetary policy caannot accomodate shocks
         • Encourages financial attacks
   • Flexible Exchange rate
     • No Foreign exchange intervantion
     • Intervention only to reduce volatility

2. International transactions recorded in the:

   • Balance of Payments: Current account
     • Deficit
       • Buy more abroad than sell financed by inflows from foreigners
         • Generates liabilities with the rest of the world
       • Problems of sustainability of the deficit
         • Mainly being unable to as a country repay international creditors
         • Natural tendency to depreciate the Currency
     • Surplus
       • Sell more than buy
         • Generates assets in foreign countries
       • might be caused by lower investment or consumption than optimal although there be large savings
         • Has effects on medium term growth
         • Natural Tendency of the currency to appreciate
           • To avoid appreciation countries buy and accumulateforeign reserves
             • Invested in Soveraign wealth funds to manage the resreves gainig higher interest than with usual management

3. Influenced by:

   • Monetary Policy
     • Fixed Exchange rate
       • Impossible trinity: drop one
         • Independent Monetary Policy
         • Fixed Exchange rate
         • Free movement of Capital
       • In both cases
         • Increase in interest rate in developed world, leads to in emerging countries
           • Capital outflow
             • Reserves deplation
           • Depreciation
           • increase in risk
         • Decrase in interest rate in developed countries, leads developing countries to
           • Capital inflow
             • Macroeconomic Imbalances
               • easy and excessive credit / debt
               • Asset Bubbles
     • Floating exchange rate
       • Expansive monetary Policy
         • Causes the currency depreciate: at equal number of foreign currency more national currency. Mignt not be the targetted effect
           • Generates a loss of relativecompetitiveness for third countries
             • Might lead to a Currency war
         • Nowadays, to solve the problems posed by the crisis