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49-handout - 1/31/2010 To Fix or Float? Economics of...

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1/31/2010 1 To Fix or Float? Economics of currency regimes Choosing an exchange rate regime Is there an optimal exchange rate regime? The choice of exchange rate system affects: Ei th (b th dd d l id Economic growth (both on demand and supply side) Inflation Trade balance Susceptibility to and ability to absorb external economic shocks Si 1992 th UK h h fl ti h t Since 1992 the UK has chosen a floating exchange rate system Value of currency determined by the market No official intervention by the Bank of England
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1/31/2010 2 Key drivers of the currency’s value Macroeconomic performance Inflation in one country relative to another It t i l td f (tbl f International trade performance (net balance of trade) Government finances Interest rate differentials between countries Net capital flows between countries Foreign direct investment Net flows of money into property, bonds, equities Perceptions of currency traders in the market Is the currency at its equilibrium level Exchange rate systems – the options Countries can choose their exchange rate system: (1) Free floating exchange rate (2) Managed floating system (3) Semi fixed exchange rate system (4) Fully fixed exchange rate system (5) Monetary Union with other countries
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1/31/2010 3 Floating exchange rates The value of the currency is determined purely by market demand and supply N ffi i l tt f th h t No official target for the exchange rate There is no need for intervention in the currency market by the central bank Sterling has floated freely on the foreign exchange markets since the UK suspended membership of the ERM in September 1992 Sterling against the US dollar GBP/USD
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1/31/2010 4 Sterling against the Euro Pence per Euro1 Managed floating exchange rates Currency is usually determined by market forces Some market intervention might be considered as part of macroeconomic demand management E.g. intervention by Bank of Japan to influence the Yen a few years ago
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This note was uploaded on 02/08/2012 for the course ECO 51844 taught by Professor Sabet during the Spring '11 term at FIU.

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49-handout - 1/31/2010 To Fix or Float? Economics of...

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