ECON303 Topic 4 - TOPIC 4 Fixed exchange rates and foreign...

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TOPIC 4 Fixed exchange rates and foreign exchange intervention; exchange rate crises 1
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troduction Introduction Many countries try to fix or “peg” their exchange rate to a currency or group of currencies by intervening in the foreign change market exchange market. Many with a flexible or “floating” exchange rate in fact ti d fl ti h t practice a managed floating exchange rate . The central bank “manages” the exchange rate from time to time by uying and selling currency and assets especially in periods of buying and selling currency and assets, especially in periods of exchange rate volatility. ow do central banks intervene in the foreign exchange How do central banks intervene in the foreign exchange market? 2
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Introduction here are many types of rex gimes There are many types of forex regimes 40 floating independently (eg Australia, US ) 44 countries with managed floats (eg Thailand) 8 with a crawling peg ( eg Nicaragua) 2 with a crawling band ( eg Costa Rica) 3 pegged in a horizontal band (eg Syria) 52 pegged to a single currency (eg Saudi Arabia) 7 pegged to a composite basket (eg Fiji) 13 with a currency board (eg Hong Kong) 15 with a common currency (Euro countries) + Slovakia nce 2009 since 2009 10 with no separate legal tender (eg Panama) – see http://www.imf.org/external/np/mfd/er/2008/eng/0408.htm for 188 countries 3
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Central Bank Intervention and the Money Supply To study the effects of central bank intervention in the foreign exchange market, first construct a simplified balance sheet for the central bank. This records the assets and liabilities of a central bank. Balance sheets use double booking keeping: each ansaction enters the balance sheet twice. transaction enters the balance sheet twice. 4
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entral Bank’s Balance Sheet Central Bank s Balance Sheet Assets reign government bonds + gold (official international Foreign government bonds + gold (official international reserves) omestic government bonds Domestic government bonds Loans to domestic banks Liabilities – base money eposits of domestic banks Deposits of domestic banks Currency in circulation 5
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entral Bank’s Balance Sheet (cont ) Central Bank s Balance Sheet (cont.) ssets Liabilities + Net worth Assets = Liabilities + Net worth If we assume that net worth of the central bank always equals zero then assets = liabilities. An increase in assets leads to an equal increase in liabilities. A decrease in assets leads to an equal decrease in liabilities. hanges in the central bank’s balance sheet lead to changes in base Changes in the central bank s balance sheet lead to changes in base money, which lead to changes in the money supply. If their deposits at the central bank increase, banks typically have more funds vailable to lend to customers, so that the amount of money in circulation available to lend to customers, so that the amount of money in circulation increases.
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This note was uploaded on 05/26/2010 for the course ECON 1160 taught by Professor Byrke during the Spring '10 term at Macomb Community College.

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ECON303 Topic 4 - TOPIC 4 Fixed exchange rates and foreign...

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