Slide 1 of
Slides developed by Jeff Madura, with additions and enhancements by Tim Richardson
Slide 2 of
Government Influence on
Exchange Rates
Chapter 6
Slides developed by Jeff Madura, with additions and enhancements by Tim Richardson
Slide 3 of
Overview
 Examine
exchange rate systems
 Explain how governments intervene
to influence exchange rates
 Describe how intervention in
exchange market can affect
economic conditions
Slides developed by Jeff Madura, with additions and enhancements by Tim Richardson
Slide 4 of
Why Do We need to know
Government involvement
 Internal
 National
governments do things
which have a domestic effect on the
value of their own currency
 External
 Internationally, other governments
do things which can effect the value
of your currency
Slides developed by Jeff Madura, with additions and enhancements by Tim Richardson
Slide 5 of
Why Do We need to know
Government involvement
 Internal
 By
doing a bad job with inflation, or
unemployment a National
governments can be seen to be not
operating effectively, and this will
create negative confidence among
currency traders and international
business people
Slides developed by Jeff Madura, with additions and enhancements by Tim Richardson
Slide 6 of
Why Do We need to know
Government involvement
 Internal
 By
doing a bad job … the value of the
currency will decline
 If it declines it makes it very difficult
for consumers in that country to
afford imported products
 therefore standard of living will
decline
Slides developed by Jeff Madura, with additions and enhancements by Tim Richardson
Slide 7 of
Why Do We need to know
Government involvement
 External
 Internationally,
other governments do
things . . .
 By using trade barriers and import taxes
and other impediments which make it
difficult for a country to export - this can
deprive it of situations which can effect
the value of its currency
Slides developed by Jeff Madura, with additions and enhancements by Tim Richardson
Slide 8 of
Why Do We need to know
Government involvement
 External
 If
currency is pegged then it can go up
or down according to the rise and fall of
the situation in another country
Slides developed by Jeff Madura, with additions and enhancements by Tim Richardson
Slide 9 of
Exchange Rate Systems
 Classified
according to the degree by
government controls them
 Fixed
 Freely floating
 Managed float
 Pegged
Slides developed by Jeff Madura, with additions and enhancements by Tim Richardson
Slide 10 of
Exchange Rate Systems
 Fixed
– currency fluctuation limited to narrow
bands
– Bretton Woods Agreement (1944-1971)
 valued
each currency in terms of gold
 permitted fluctuations of 1% from original
rates
 meant you also had to have gold on hand
– lessened currency risk for MNCs
Slides developed by Jeff Madura, with additions and enhancements by Tim Richardson
Slide 11 of
Exchange Rate Systems
 Freely
floating exchange rates
– market forces determine exchange rates
– advantages
 increases
stability in global economy
 reduces maintenance of exchange rates by
central banks
– disadvantages
 may
exacerbate a country’s economic
problems
Slides developed by Jeff Madura, with additions and enhancements by Tim Richardson
Slide 12 of
Exchange Rate Systems
 Managed
Float exchange rates
– a mix of fixed and freely floating characteristics
– exchange rates fluctuate freely
– government intervenes directly to manage the
exchange rate
Slides developed by Jeff Madura, with additions and enhancements by Tim Richardson
Slide 13 of
Exchange Rate Systems
 Pegged
exchange rates
– ties a currency’s value to a foreign currency or
to some unit of account
 examples
include European Economic Community
and the European Currency Unit
– produces dependency upon the movement of
the foreign currency
Slides developed by Jeff Madura, with additions and enhancements by Tim Richardson
Slide 14 of
Exchange Rate Systems
 Potential
barriers to a single European
currency
– meeting specified economic targets
– impact of monetary policy
 consolidation
of European monetary policy
Slides developed by Jeff Madura, with additions and enhancements by Tim Richardson
Slide 15 of
Government Intervention
 Reasons
for intervention
– smoothing exchange rates
– establishing implicit exchange rate boundaries
– responding to temporary disturbances
Slides developed by Jeff Madura, with additions and enhancements by Tim Richardson
Slide 16 of
Government Intervention
Direct Intervention
 Central
bank actively trades on exchange
market to influence currency values
– attempt to weaken home currency
 trade
home currency for foreign currency
– places downward pressure on home currency
– attempt to strengthen home currency
 exchange
foreign currency for home currency
– places upward pressure on home currency
Slides developed by Jeff Madura, with additions and enhancements by Tim Richardson
Slide 17 of
Government Intervention
Direct Intervention
 Nonsterilized
intervention
– intervention in exchange market without
adjusting for the change in money supply
 money
supply increases with attempts to weaken
home currency
 money supply decreases with attempts to strengthen
home currency
Slides developed by Jeff Madura, with additions and enhancements by Tim Richardson
Slide 18 of
Government Intervention
Direct Intervention
 Sterilized
intervention
– intervention in exchange market while making
adjustments to avoid change in money supply
 transact
simultaneously in exchange markets and
Treasury securities markets
– strengthen home currency by:
 1)
exchange home currency for foreign currency
 2) sell holdings of Treasury securities for home
currency
Slides developed by Jeff Madura, with additions and enhancements by Tim Richardson
Slide 19 of
Government Intervention
Indirect Intervention
 Central
banks affect currency values by
influencing factors that determine exchange
rates
– increase or decrease money supply to move
interest rates in desired direction
Slides developed by Jeff Madura, with additions and enhancements by Tim Richardson
Slide 20 of
Exchange Rate Target Zones
 Proposed
to reduce volatility in exchange
rates of major currencies
– suggest creating a central rate with specific
boundaries
– governments would be responsible for
maintaining currencies within the zones
– Louvre Accord established acceptable ranges
 US
intervention quickly declined over time
Slides developed by Jeff Madura, with additions and enhancements by Tim Richardson
Slide 21 of
Intervention as a Policy Tool
 Impact
of weak currency on economy
– may stimulate foreign demand for products
– may reduce imports
– may boost exports and jobs
 Impact
of strong currency on economy
– encourages greater demand for imports
– constrains price increases through competition
Slides developed by Jeff Madura, with additions and enhancements by Tim Richardson
Slide 22 of
Summary
 Exchange
rate systems:
– fixed rate, freely floating, managed and pegged
 Direct
intervention
– buy or sell currencies on exchange market
 Indirect
intervention
– influence economic factors that affect exchange
rates
Slides developed by Jeff Madura, with additions and enhancements by Tim Richardson