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ch 14(1) - Chapter 14 The International Financial System...

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Chapter 14 The International Financial System
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Chapter Preview We examine the differences between fixed and managed exchange rate systems. We also look at the controversial role of capital controls and the IMF in the international setting. Topics include: Intervention in the Foreign Exchange Market Exchange Rates Regimes in the International Financial System Capital Controls The Role of the IMF
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Intervention in the Foreign Exchange Market Foreign exchange markets are not free of government intervention. Foreign exchange interventions occur when central banks engage in international transactions to influence exchange rates.
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Intervention in the Foreign Exchange Market: the Money Supply The first step is to understand the impact on the monetary base and the money supply when a central bank intervenes in the foreign exchange market. International reserves refers to a central bank’s holdings in a foreign currency.
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Federal Reserve System Assets Liabilities Foreign Assets (international reserves) - 1 billion Currency or Reserves (Monetary Base) -1 billion Results: Fed holding in international reserves falls by 1 billion. Currency in circulation falls by 1 billion. Intervention in the Foreign Exchange Market: the Money Supply Suppose the Fed sells $1 billion in a foreign currency in exchange for $1 billion in U.S. currency.
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Federal Reserve System Assets Liabilities Foreign Assets (international reserves) - 1 billion Deposits with the Fed (reserves) -1 billion Intervention in the Foreign Exchange Market: the Money Supply Suppose the Fed sells $1 billion in a foreign currency in exchange for a check written on a domestic bank.
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Intervention in the Foreign Exchange Market: the Money Supply In either case, we draw the same conclusion: a central bank’s purchase of domestic currency and corresponding sale of a foreign currency leads to an equal decline in its international reserves and the monetary base.
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Intervention in the Foreign Exchange Market: the Money Supply Obviously, the opposite is true is the transaction reversed: a central bank’s sale of domestic currency and corresponding purchase of a foreign currency leads to an equal increase in its international reserves and the monetary base.
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Intervention in the Foreign Exchange Market: the Money Supply A central bank, knowing these results, can engage in one of two types of foreign exchange interventions: Unsterilized Sterilized
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Federal Reserve System Assets Liabilities Foreign Assets (international reserves) + 1 billion Currency or Reserves (Monetary Base) +1 billion Results: International reserves, +1 billion Monetary base, +1 billion Then analysis in figure 13-1, E t Intervention in the Foreign Exchange Market: Unsterilized Intervention Unsterilized:
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Figure 14.1:
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