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Ch06 PP 06 - Chapter 6 Government Influence On Exchange...

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6 - 1 Chapter 6 Government Influence On Exchange Rates Exchange Rate Systems Exchange rate systems can be classified according to the degree to which the rates are controlled by the government: ¤ fixed ¤ freely floating ¤ managed float ¤ pegged
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6 - 2 System: Rates are held constant or allowed to fluctuate within very narrow bands only. Examples: Bretton Woods era (1944-1971), Smithsonian Agreement (1971) MNCs know the future exchange rates. Governments can revalue their currencies. Each country is also vulnerable to the economic conditions in other countries. Fixed Exchange Rate System
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6 - 3 System: Rates are determined by market forces without governmental intervention. Each country is more insulated from the economic problems of other countries. Central bank interventions just to control exchange rates are not needed. Governments are not constrained by the need to maintain exchange rates when setting new policies. Freely Floating Exchange Rate System
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6 - 4 Less capital flow restrictions are needed, thus enhancing market efficiency. MNCs may need to devote substantial resources to managing their exposure to exchange rate fluctuations. The country that initially experienced economic problems (such as high inflation, increased unemployment) may have its problems compounded. Freely Floating Exchange Rate System
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6 - 5 System: Exchange rates are allowed to move freely on a daily basis and no official boundaries exist. However, governments may intervene to prevent the rates from moving too much in a certain direction. A government may manipulate its exchange rates such that its own country benefits at the expense of other countries. Managed Float Exchange Rate System
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6 - 6 System: The currency’s value is pegged to a foreign currency or to some unit of account, and thus moves in line with that currency or unit against other currencies. Examples: European Economic Community’s snake arrangement (1972), European Monetary System’s exchange rate mechanism (1979), Mexican peso’s peg to the U.S. dollar (1994) Pegged Exchange Rate System
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6 - 7 Currency Boards A currency board is a system for pegging the value of the local currency to some other specified currency.
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