TCQT4 exchange rate policy

IV Exchange Rate Policy and Regime Outline Exchange rate policy Target zones The Snake in the Tunel Exchange rate regimes (fixed, floating and managed) TS Nguyễn Phúc Hiền - ðại học Ngoại thương Exchange rate policy Concept Exchange rate policy is activities of the government (central banks) through a specific exchange rate regime and a system of tools to intervene to maintain the fixed exchange rate, or to affect exchange rate to a necessary and suitable level of macroeconomic policies objectives Objective: Price stability (no high inflation and deflation) Economic growth and employment Balance of current account TS Nguyễn Phúc Hiền - ðại học Ngoại thương Exchange rate policy Instruments (Tools) Direct instruments: - Devaluation or revaluation Central banks operations in the foreign exchange markets Surrender Restrictive regulation TS Nguyễn Phúc Hiền - ðại học Ngoại thương Exchange rate policy Indirect instruments: - Discount rate Tariffs Quotas Other special tools: required reserve adjustment on foreign currencies, low ceiling rate regulation on foreign currency deposits, regulation on foreign exchange position of commercial banks TS Nguyễn Phúc Hiền - ðại học Ngoại thương Target zones Target zone • • • Is one that private foreign exchange market partipants believe is a government commitment which can help keep exchange rates within the declared zone The zone in the gold exchange rate standard was 2% band around parity, in the EMS it was 4.5% band If exchange rate is at ceiling or floor of the target zone exchange rate intervention occurs TS Nguyễn Phúc Hiền - ðại học Ngoại thương Target zones Exchange rate Target ceiling Fundamentals Target floor TS Nguyễn Phúc Hiền - ðại học Ngoại thương The Snake in the Tunel the Snake in the Tunel Reasons: • • • • Following the collapse of the BWS (1971) The EEC countries members allowed their exchange rates to be determined solely by market forces Large and sudden changes in international competitiveness associated with exchange rate movements that could undermine the development of free trade within the Community and emergence of protectionist pressure Desire a single currency and exchange rate stability TS Nguyễn Phúc Hiền - ðại học Ngoại thương The Snake in the Tunel Exchange rate Tunel ±2,25% Snake ±1,125% TS Nguyễn Phúc Hiền - ðại học Ngoại thương The Snake in the Tunel • The Snake in the tunel commenced operation (1972) and was made up of the original six EEC members (Germany, France, Holland, Italy, Luxembourg, Belgium then UK, Denmark and Norway • The snake system has been characterized as a miniBretton Woods The member currencies could vary by a maximum of ±1.125% against each other (the snake) While the member currencies could float by ±2.25% against the US (the tunel) as permitted by Smithsonian agreement The smaller band of fluctuations for the member currencies vis-à-vis each other than permitted against the US dollar, so called the snake in the tunel • • • TS Nguyễn Phúc Hiền - ðại học Ngoại thương 10 (1) Fully fixed exchange rates Interventions keep the exchange rate stable against one or more currencies A currency is linked to another currency at an unchanged rate The exchange rate volatility is very small or equal to zero USD/Yuan (1994-2005) = 8,2 (band width ±0.1%) TS Nguyễn Phúc Hiền - ðại học Ngoại thương 15 USD/CNY USD/CNY 1990 1992 1994 1996 1998 2000 2002 TS Nguyễn Phúc Hiền - ðại học Ngoại thương 2004 2006 2008 16 (1) Fully fixed exchange rates Features: • Fixed exchange rates promote international trade and investment Stable price, no risk of exchange rate fluctuations Profitable certainty Reducing costs of transactions • Require discipline for macroeconomic policies • Depended monetary policy(followed the anchor monetary policy and import inflation if) • Promote international cooperation • Private Speculation is likely destablizing • Need a huge foreign reserves TS Nguyễn Phúc Hiền - ðại học Ngoại thương 17 (1) Fully fixed exchange rates Role of central banks Interventions overvalued undervalued A huge foreign reserves TS Nguyễn Phúc Hiền - ðại học Ngoại thương 18 (1) Chế ñộ tỷ giá cố ñịnh E(USD/VND) Demand shock (Do-D1) So S1 Interv E* Ecr D1 Do Qo Q1 Q(USD) TS Nguyễn Phúc Hiền - ðại học Ngoại thương 19 (1) Chế ñộ tỷ giá cố ñịnh E(USD/VND) Supply shock (So-S1) So S1 Ecr E* D1 Interv Do Qo Q1 Q(USD) TS Nguyễn Phúc Hiền - ðại học Ngoại thương 20 (2) Flexible exchange rates Fully flexible exchange rate is solely determined by supply and demand on currency markets Central banks not, or at least rarely, intervene in foreign exchange markets The exchange rate volatility tends to be high EUR/USD; AUD/USD, USD/CAD TS Nguyễn Phúc Hiền - ðại học Ngoại thương 21 (2) Flexible exchange rates Features: • Floating exchange rates ensure balance of payments equilibrium • Ensure monetary autonomy • Insulate economies (avoid external shocks) • Promote for economic stability • Private speculation is stablizing • Foreign reserves is unnecessary TS Nguyễn Phúc Hiền - ðại học Ngoại thương 22 (2) Flexible exchange rates E(USD/VND) Demand shock (Do-D1) S E* Eo D1 Do Qo Q* Q(USD) TS Nguyễn Phúc Hiền - ðại học Ngoại thương 23 (2) Flexible exchange rates E(USD/VND) Supply shock (So-S1) So S1 Eo E* Do Qo Q* Q(USD) TS Nguyễn Phúc Hiền - ðại học Ngoại thương 24 (3) Managed floating exchange rate Under a managed float, the exchange rate is basically flexible but monetary authorities (Central Banks, Ministry of Finance) intervene from time to time to smooth extreme trading ranges For example: Japan, Turkey, TS Nguyễn Phúc Hiền - ðại học Ngoại thương 25 (3) Managed floating exchange rate Features: • Hybrid of fixed and flexible exchange rates • Authorities might be able to produce a more appropriate exchange rate • Intervention need to mitigate costs of exchange rate overshooting • Intervention to smooth the economic adjustment process • Need an amount of foreign reserves TS Nguyễn Phúc Hiền - ðại học Ngoại thương 26 (3) Managed floating exchange rate E(USD/VND) Demand shock (Do-D1) S1 So E1 Interv E* Eo D1 Do Qo Q1 Q* Q(USD) TS Nguyễn Phúc Hiền - ðại học Ngoại thương 27 (3) Chế độ tỷ giá thả có điều tiết E(USD/VND) Supply shock (So-S1) So S1 Interv Eo E* E1 D1 Do Qo Q1 Q* Q(USD) TS Nguyễn Phúc Hiền - ðại học Ngoại thương 28 Classification of exchange rate regime (IMF) TS Nguyễn Phúc Hiền - ðại học Ngoại thương 29 ... Exchange rate policy Target zones The Snake in the Tunel Exchange rate regimes (fixed, floating and managed) TS Nguyễn Phúc Hiền - ðại học Ngoại thương Exchange rate policy Concept Exchange rate. .. rate policy is activities of the government (central banks) through a specific exchange rate regime and a system of tools to intervene to maintain the fixed exchange rate, or to affect exchange rate. .. giá (Exchange rate regime) Types of exchange rate regime There are many different exchange rate regimes relying on market forces and government interventions, however, three main types of exchange