Chapter_18.docx

Chapter_18.docx - Chapter 18 The International Financial...

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Chapter 18 The International Financial System Exchange Rate Systems Some countries simply allow the exchange rate to be determined by demand and supply, just as other prices are. A country that allows demand and supply to determine the value of its currency is said to have a floating currency . When countries can agree on how exchange rates should be determined, economists say that there is an exchange rate system . The current exchange rate system under which the value of most currencies is determined by demand and supply with occasional government intervention is known as a managed float exchange rate system . The two most important alternatives to the managed float exchange rate system were the gold standard and the Bretton Woods System . These were both fixed exchange rate systems where exchange rates remained constant for long periods. Under the gold standard, a country’s currency consisted of gold coins and paper currency that the government was committed to redeem for gold. Because of the Great Depression, by the mid-1930s, most countries, including the United States, had abandoned the gold standard. The Current Exchange Rate The current exchange rate system has three important aspects: The United States allows the dollar to float against other major currencies. The dollar increases in value when it takes more units of foreign currency to buy one dollar and falls in value when it takes fewer units of foreign currency to buy one dollar. Most countries in Western Europe have adopted a single currency, the euro .
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Some developing countries have attempted to keep their currencies’ exchange rates fixed against the dollar or another major currency. A. The Floating Dollar The dollar increases in value when it takes more units of foreign currency to buy one dollar and falls in value when it takes fewer units of foreign currency to buy one dollar. Since 1973, the value of the U.S. dollar has fluctuated widely against other major currencies. From the beginning of 1973 to the end of 2006, the U.S. dollar lost about 60 percent in value against the yen, while it increased about 15 percent in value against the Canadian dollar. B. What Determines Exchange Rates in the Long Run? The two most important causes of exchange rate movements are changes in interest rates — which cause investors to change their views of which countries’ financial investments will yield the highest returns — and changes in investors’ expectations about the future values of currencies. The theory that, in the long run, exchange rates move to equalize the purchasing power of
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This note was uploaded on 02/26/2010 for the course ECON 2010 taught by Professor Roussel during the Spring '08 term at LSU.

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Chapter_18.docx - Chapter 18 The International Financial...

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