IFM_IM_ch06 - Chapter 6 Government Influence on Exchange...

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Chapter 6 Government Influence on Exchange Rates Lecture Outline Exchange Rate Systems Fixed Exchange Rate System Freely Floating Exchange Rate System Managed Float Exchange Rate System Pegged Exchange Rate System Currency Boards Used to Peg Currency Values Dollarization Classification of Exchange Rate Arrangements A Single European Currency Membership Impact on European Monetary Policy Impact on Business within Europe Impact on the Valuation of Businesses in Europe Impact on Financial Flows Impact on Exchange Rate Risk Status Report on the Euro Government Intervention Reasons for Government Intervention Direct Intervention Indirect Intervention Intervention as a Policy Tool Influence of a Weak Home Currency on the Economy Influence of a Strong Home Currency on the Economy 79
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80 International Financial Management Chapter Theme This chapter introduces the various exchange rate systems. In addition, it stresses the manner by which governments can influence exchange rates. Since exchange rate movements are critical to an MNC’s performance, and the government has much influence over these exchange rates, the MNC is affected by government intervention. Topics to Stimulate Class Discussion 1. If you were elected to choose between a fixed, freely floating, or a dirty float exchange rate system, which would you choose for your home country? Why? a. Assume that both the U.S. and Europe experience high unemployment. How can the U.S. central bank attempt to adjust the dollar value to reduce this problem? Is the European central bank likely to go along with the U.S. central bank’s strategy or retaliate? Why? POINT/COUNTER-POINT: Should China Be Forced to Alter the Value of Its Currency? POINT: U.S. politicians frequently suggest that China needs to increase the value of the Chinese yuan against the U.S. dollar, even since China has allowed the yuan to float (within boundaries). The U.S. politicians claim that the yuan is the cause of the large U.S. trade deficit with China. This issue is periodically raised not only with currencies tied to the dollar, but also with currencies that have a floating rate. Some critics argue that the exchange rate can be used as a form of trade protectionism. That is, a country can discourage or prevent imports and encourage exports by keeping the value of its currency artificially low. COUNTER-POINT: China might counter that its large balance of trade surplus with the U.S. has been due to the differences in prices between the two countries, and that it should not be blamed for the high U.S. prices. It might argue that the U.S. trade deficit can be partially attributed to the very high prices in the U.S., which are necessary to cover the excessive compensation for executives and other employees at U.S. firms. The high prices in the U.S. encourage firms and consumers to purchase goods from China. Even if China’s yuan is revalued upward, this does not necessarily mean that the U.S. firms and consumers will purchase U.S. products. They may shift their purchases from China to
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IFM_IM_ch06 - Chapter 6 Government Influence on Exchange...

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