A fixed exchange rate , sometimes called a pegged exchange rate , is a type of exchange rate regime where a currency value is set against the value of another single currency, into another currency basket, or to another size of value, such as gold.
There are benefits and risks for using a fixed exchange rate. A fixed exchange rate is usually used to stabilize the value of a currency by instantly fixing its value in a predetermined ratio to a different, more stable or more international currency (or currency) currency, whose price is pegged. Accordingly, the exchange rate between the currency and its peg does not change based on market conditions, the way the floating currency does. This makes trading and investment between two areas of currency easier and more predictable, and very useful for small economies, economies that borrow primarily in foreign currency, and where external trade forms a large part of their GDP.
The fixed exchange rate system can also be used as a tool to control currency behavior, such as by limiting the rate of inflation. However, thus, the pegged currency is then controlled by its reference value. Thus, when the reference value rises or falls, the value of the pegged currency will also rise and fall in relation to currencies and other commodities with pegged currencies tradable. In other words, the pegged currency depends on its reference value to dictate how the current value is defined at a given time. Moreover, according to the Mundell-Fleming model, with perfect capital mobility, the exchange rate prevents the government from using domestic monetary policy to achieve macroeconomic stability.
In a fixed exchange rate system, a country's central bank usually uses an open market mechanism and is committed at all times to buy and/or sell its currency at a fixed price to maintain a fixed ratio and, therefore, a stable value of its currency in relation to the pegged reference. The central bank provides the asset and/or foreign currency or currency required to finance the imbalance of payments.
In the 21st century, currencies associated with large economies usually do not fix or fix exchange rates to other currencies. The last major economy that uses a fixed exchange rate system is the People's Republic of China which, in July 2005, adopted a slightly more flexible exchange rate system called managed exchange rates. The European Exchange Rate Mechanism is also used temporarily to establish the final conversion rate against the Euro (EUR) of the local currency of countries that join the Euro Zone.
Video Fixed exchange-rate system
History
The gold standard or gold exchange standard of the exchange rate remained in effect from about 1870 to 1914, before many countries followed bimetallism. The period between two world wars was temporary, with the Bretton Woods system emerging as a new fixed exchange rate regime after World War II. It was formed with a view to rebuilding war-ravaged countries after World War II through a series of currency stabilization and infrastructure lending programs. The early 1970s saw the system damage and its replacement with mixed fluctuations and fixed exchange rates.
Chronology
Timeline of fixed exchange rate system:
Gold Standard
The initial stipulation of the gold standard was in England in 1821 followed by Australia in 1852 and Canada in 1853. Under this system, the external value of all currencies was denominated in gold with the central bank ready to buy and sell an unlimited amount. gold at a fixed price. Every central bank maintains its gold reserves as their official reserve asset. For example, during the standard period of "classical" gold (1879-1914), the US dollar is defined as 0.048 troy oz. pure gold.
Bretton Woods System
After the Second World War, the Bretton Woods system (1944-1973) replaced gold with the US dollar as an official reserve asset. The regime is intended to combine binding legal obligations with multilateral decision-making through the International Monetary Fund (IMF). The rules of this system are set out in the terms of the IMF agreement and the International Bank for Reconstruction and Development. This system is a monetary order intended to regulate currency relations among sovereign nations, with 44 member states being asked to set their national currency parity in terms of US dollars and maintain exchange rates in 1% of parity ("band")) by intervening in their foreign exchange market (ie, buying or selling foreign money). The US dollar is the only currency strong enough to meet the increasing demand for international currency transactions, and therefore the United States agrees to link dollars with gold at the rate of $ 35 per ounce of gold and to turn the dollar into gold at that price..
Due to concerns about the rapidly deteriorating American payments situation and the massive flight of liquid capital from the US, President Richard Nixon suspended the convertibility of dollars into gold on August 15, 1971. In December 1971, the Smithsonian Agreement paved the way for an increase in the value of the gold dollar price from US $ 35.50 to US $ 38 per ounce. Speculation against the dollar in March 1973 led to the birth of an independent buoy, effectively ending the Bretton Woods system.
Current monetary regime
Since March 1973, a floating exchange rate has been followed and officially recognized by the Jamaican agreement in 1978. Countries still need international reserves to intervene in the foreign exchange market to balance short-term fluctuations in exchange rates. The prevailing exchange rate regime is in fact often regarded as a revival of Bretton Woods policy, namely Bretton Woods II.
Maps Fixed exchange-rate system
Mechanism
Open market trading
Usually, the government that wants to keep the exchange rate does it by buying or selling its own currency on the open market. This is one of the reasons the government maintains foreign currency reserves.
If the rate floats too far above the reference rate (stronger than necessary), the government sells its own currency (which increases Supply) and buys foreign currency. This causes the currency price to decrease in value (Read: Classic Demand-Supply diagram). Also, if they buy the pegged currency, then the currency price will increase, causing the relative value of the currency to be closer to the relative value in question (unless it exceeds....)
If the rate floats too far below the desired level, the government buys its own currency in the market by selling its reserves. This places greater demand in the market and causes the local currency to become stronger, hopefully returning to its intended value. The reserves they sell may be a pegged currency, in which case the value of the currency will fall.
Fiat
Another less used way of maintaining a fixed exchange rate is to make it illegal to trade currencies at other levels. This is difficult to enforce and often leads to black market in foreign currency. Nevertheless, some countries are very successful in using this method because of the government monopoly over all money conversion. This is a method used by the Chinese government to maintain currency pegs or tossing closely to the US dollar. China buys an average of one billion US dollars per day to maintain currency pegs. Throughout the 1990s, China was very successful at defending the benchmark currency using a government monopoly over all currency conversions between the yuan and other currencies.
Open market example mechanism
Under this system, the central bank first announced a fixed exchange rate for the currency and then agreed to buy and sell the domestic currency at this value. The market equilibrium exchange rate is the rate at which supply and demand will be the same, that is, the market will be clear. In a flexible exchange rate system, this is the spot rate. In a fixed exchange rate system, the rate previously announced may not coincide with the market equilibrium exchange rate. Foreign central banks maintain foreign currency and gold reserves that they can sell to intervene in the foreign exchange market to cover excess demand or take on excess supply
The demand for foreign exchange comes from domestic demand for foreign goods, services and financial assets. The foreign exchange supply also comes from foreign demand for goods, services and financial assets originating from the country of origin. Fixed exchange rates are not allowed to fluctuate freely or respond to daily changes in demand and supply. Government improves currency exchange rates. For example, the European Central Bank (ECB) can fix the exchange rate at EUR1 = $ 1 (assuming that the euro follows a fixed exchange rate). This is the central value or nominal value of the euro. The upper and lower limits for currency movement are charged, beyond that variations in exchange rates are not permitted. The "band" or "spread" in Figure 1 is EUR0.6 (from EUR1.2 to EUR1.8).
Excess demand for dollars
Figure 2 illustrates the excess demand for the dollar. This is a situation where domestic demand for goods, services and foreign financial assets exceeds the foreign demand for EU goods, services and financial assets. If the demand for dollars rises from DD to D'D ', excess demand is made for how far cd . The ECB will sell cd dollars in exchange for the euro to maintain the band's limits. Under the floating exchange rate system, equilibrium will be achieved at e .
When the ECB sells dollars in this way, official dollar reserves decline and domestic money supply shrinks. To prevent this, the ECB can buy government bonds and thus meet the shortage of money supply. This is called sterilization intervention in the foreign exchange market. When the ECB starts to run out of reserves, the ECB can also devalue the euro to reduce excess dollar demand, which narrows the gap between equilibrium and fixed interest rates.
Excess dollar inventory
Fig.3 illustrates the excess dollar inventory. This is a situation where foreign demand for EU goods, services and financial assets exceeds European demand for foreign goods, services and financial assets. If dollar supply rises from SS to S'S ', excess supply is made up to the level ab . The ECB will buy ab dollars in exchange for the euro to maintain a limit within the band. Under the floating exchange rate system, equilibrium will again be achieved at e .
When the ECB buys dollars in this way, its official dollar reserves increase and the domestic money supply expands, which can lead to inflation. To prevent this, the ECB can sell government bonds and thus counter the increase in the money supply.
When the ECB starts to accumulate excess reserves, the ECB can also revalue the euro to reduce the oversupply of dollars, that is, narrow the gap between equilibrium and fixed levels. This is the opposite of devaluation.
Type of fixed exchange rate system
Gold Standard
Under the gold standard, the state government declared that they would exchange their currency with a certain weight in gold. In the pure gold standard, a country's government declares that they will freely exchange the currency for the original gold at a specified exchange rate. This "exchange rule" allows anyone to enter the central bank and exchange coins or currencies for pure gold or vice versa. The gold standard works on the assumption that there are no restrictions on the movement of capital or the export of gold by civilians in various countries.
Because the central bank should always be ready to provide gold in exchange for coins and currency upon request, it should keep gold reserves. Thus, the system ensures that the exchange rate between the currencies remains. For example, under this standard, the gold coin  £ 1 in the United Kingdom contains 113,0016 pure gold grains, while the $ 1 gold coin in the United States contains 23.22 grains. The mint or exchange rate is thus: R = $/Ã,  £ = 113,0016/23,22 = 4,87. The main argument in favor of the gold standard is that it connects the world price level with the world supply of gold, thus preventing inflation unless there is a gold discovery (gold fever, for example).
Specie price flow mechanism
The automatic adjustment mechanism below the gold standard is a specie price flow mechanism, which operates to improve the balance of disequilibrium payments and adjust to shocks or changes. This mechanism was originally introduced by Richard Cantillon and later discussed by David Hume in 1752 to reject the mercantilist doctrine and stressed that nations can not continuously collect gold by exporting more of their imports.
The assumptions of this mechanism are:
- Flexible pricing
- All transactions use gold
- There is a gold supply in the world
- Gold coins printed at a fixed parity in each country
- No banks and no capital flow
Adjustment based on the gold standard involves an inter-state gold flow resulting in price equity satisfying purchasing power parity, and/or equalization of asset returns that satisfy interest rate parity with the current fixed rate. Under the gold standard, the money supply of each country consists of gold or paper currency supported by gold. The money supply will therefore fall into a deficit-growing nation in surplus countries. As a result, internal prices will fall in a deficit-growing country in surplus countries, making the country's deficit exports more competitive than surplus countries. The country's deficit exports will be encouraged and imports will be discouraged until the deficit in the balance of payments is abolished.
In brief:
Deficit nation : Lower cash supply -> Lower internal price -> More exports, fewer imports -> Elimination of deficit
Excess country : Higher money supply -> Higher internal prices -> Less exports, more imports -> Abolition of surplus
Standard currency reserve
In the reserve currency system, the currencies of other countries perform the functions that gold has in the gold standard. A country fixes the value of its own currency to a unit of currency of another country, generally a currency that is clearly used in an international transaction or is the currency of a major trading partner. For example, suppose India decided to fix its currency against the dollar with an EINR/$ = 45.0 exchange rate. To maintain this fixed exchange rate, the Reserve Bank of India needs to hold the dollar on reserves and be ready to exchange rupees with dollars (or dollars for rupees) on demand at specified exchange rates. In the gold standard, the central bank retains the gold in exchange for its own currency , with the reserve currency standard having reserve currency reserves .
The setting up of the currency board is the most extensive means of exchange rates. Below, a nation rigidly pegs its currency to foreign currency, special withdrawal rights (SDR) or a basket of currencies. The role of the central bank in the country's monetary policy is minimal because the amount of money is equal to its foreign exchange reserves. Currency boards are considered to be a difficult stake because they allow the central bank to overcome shocks to money demand without running out of reserves (11). CBA has operated in many countries including:
- Hong Kong (since 1983);
- Argentina (1991 to 2001);
- Estonia (1992 to 2010);
- Lithuania (1994 to 2014);
- Bosnia and Herzegovina (since 1997);
- Bulgaria (since 1997);
- Bermuda (since 1972);
- Denmark (since 1945);
- Brunei (since 1967)
Gold exchange default
The fixed exchange rate system established after World War II is a gold exchange standard, such as the system prevailing between the 1920s and early 1930s. The gold exchange standard is a mix of standard reserve currency and gold standard. Its characteristics are as follows:
- All non-reserve countries agree to fix their exchange rate to the selected reserve at the announced rate and keep a backup reserve currency reserve.
- The country of the reserve currency fixes the value of its currency to a fixed weight in gold and agrees to exchange its own currency demand for gold with other central banks in the system, on demand.
Unlike the gold standard, the reserve central bank does not exchange gold with the currency with the general public, only with other central banks.
Hybrid exchange rate system
The current state of the foreign exchange market does not allow for a fixed fixed exchange rate system. At the same time, free floating exchange rates expose a country to exchange rate volatility. The hybrid exchange rate system has evolved to incorporate features of fixed and flexible exchange rate characteristics. They allow exchange rate fluctuations without actually exposing the currency to the flexibility of free buoys.
Currency-basket
Countries often have several important trading partners or are concerned about a particular currency that is too rapidly changing over a long period of time. Thus they can choose to peg their currency to a weighted average of several currencies (also known as currency baskets). For example, the combined currency can be made up of 100 Indian rupees, 100 Japanese yen and one Singapore dollar. The country that created the composite will then need to maintain reserves in one or more of these currencies to intervene in the foreign exchange market.
The most popular and widely used composite currency is the SDR, which is a composite currency created by the International Monetary Fund (IMF), consisting of a fixed amount of US dollars, Chinese yuan, euro, Japanese yen, and British pound.
Stake crawling
In a stake system a country crawls its exchange rate to another currency or basket of currencies. This fixed rate changes from time to time at periodic intervals with a view to eliminating exchange rate volatility to some extent without imposing fixed rate constraints. The stake crawling is adjusted gradually, thus avoiding the need for intervention by the central bank (although it may still choose to do so to maintain a fixed rate in case of excessive fluctuations).
Installed in a band
The currency is said to be pegged in a band when the central bank determines the central exchange rate by referring to a single currency, cooperative arrangement, or a combination of currencies. It also sets the percentage of possible deviations on both sides of this central tariff. Depending on the bandwidth, the central bank has discretion in its monetary policy. The band itself may crawl, which implies that the center rate is adjusted periodically. Bands may be symmetrically maintained around the central parity of a crawl (with the band moving in the same direction as this parity). Alternatively, the band may be allowed to expand gradually without the previously announced central level.
Currency board
A currency board (also known as a 'connected exchange rate system') effectively replaces the central bank through legislation to improve its currency with the currencies of other countries. The domestic currency can still be exchanged with the reserve currency at a fixed exchange rate. the anchor currency is now the basis of the movement of the domestic currency, interest rates and inflation in the domestic economy will be greatly influenced by foreign economies whose domestic currency is bound. Currency boards need to ensure adequate maintenance. reserve currency anchor This is a step away from officially adopting an anchor currency (referred to as currency substitution).
Currency change
This is the most extreme and rigid way of fixing the exchange rate because it requires adopting the currency of another country in exchange for its own currency. The most prominent example is the eurozone, where 19 EU member states have adopted the euro (EUR) as a common currency (euroization). Their exchange rate is effectively established with each other.
There are similar examples of countries that adopt US dollars as their domestic currency (dollarization): British Virgin Islands, Caribbean Netherlands, East Timor, Ecuador, El Salvador, Marshall Islands, Federated States of Micronesia, Palau, Panama, Turks and Caicos and Zimbabwe.
(See ISO 4217 for a full list of regions by currency.)
Monetary cooperation
Monetary cooperation is a mechanism in which two or more monetary or exchange rate policies are concerned, and can occur at the regional or international level. Monetary cooperation need not be a voluntary arrangement between two countries, because it is also possible for a country to link its currency to another country's currency without the consent of another country. Various forms of monetary co-operation exist, ranging from fixed parity systems to monetary union. Also, many institutions have been established to enforce monetary cooperation and to stabilize exchange rates, including the European Monetary Cooperation Fund (EMCF) in 1973 and the International Monetary Fund (IMF)
Monetary cooperation is closely related to economic integration, and is often regarded as a strengthening process. However, economic integration is the economic arrangement between the various regions, characterized by the reduction or elimination of trade barriers and coordination of monetary and fiscal policy, while monetary cooperation is focused on currency relations. The money union is considered a major step in the process of monetary cooperation and economic integration. In the form of monetary cooperation in which two or more countries engage in mutual exchange, capital among the engaged states is free to move, in contrast to capital controls. Monetary cooperation is thought to promote balanced economic growth and monetary stability, but can also work effectively if member countries have (very) different levels of economic development. Especially European and Asian countries have a history of monetary cooperation and exchange rates, but monetary cooperation and European economic integration eventually resulted in European monetary union.
Example: Snake
In 1973, the currencies of the countries of the European Economic Community, Belgium, France, Germany, Italy, Luxemburg and the Netherlands, participated in an arrangement called the Snake . This arrangement is categorized as exchange rate cooperation. Over the next 6 years, this agreement allows the currencies of participating countries to fluctuate in a plus or minus 2% band around the previously announced center tariff. Then, in 1979, the European Monetary System (EMS) was established, with the participating countries at 'Snake' becoming founding member. EMS developed over the next decade and even produced a fixed exchange rate in the early 1990s. Around this time, in 1990, the EU introduced the Economic and Monetary Union (EMU), as a general term for policy groups aimed at uniting the economies of EU member states for three phases
Example: Baht-AS. dollar cooperation
In 1963, the Thai government established the Exchange Equalization Fund (EEF) with the aim of playing a role in stabilizing exchange rate movements. This is related to the US dollar by setting the amount of grams of gold per baht and baht per US dollar. Over the next 15 years, the Thai government decided to depreciate the baht in terms of gold three times, but retained the baht parity against the US dollar. Due to the introduction of the new general floating exchange rate system by the International Monetary Fund (IMF) which spanned a smaller role of gold in the international monetary system in 1978, this permanent parity system as a monetary cooperation policy was terminated. The Thai government changed its monetary policy to be more in line with the new IMF policy.
Benefits
- Fixed exchange rates can minimize instability in real economic activity
- Central banks can gain credibility by improving their country's currency into a more disciplined country currency
- At the microeconomic level, countries with under-developed or illiquid money markets can set their exchange rates to provide synthetic money markets with the liquidity of the country's markets that provide vehicle currencies
- The fixed exchange rate reduces volatility and relative price fluctuations
- Eliminate exchange rate risk by reducing related uncertainties
- This forces discipline on the monetary authority
- International trade and investment flows between countries facilitated
- Speculation in the currency market tends to be less stable under the fixed exchange rate system than is flexible, since it does not amplify the fluctuations resulting from the business cycle
- Fixed exchange rates impose price discipline on countries with higher inflation rates than any other country in the world, as such a country is likely to face a persistent deficit in the balance of payments and loss of reserves
- Prevent, monetize debt, or fiscal expenditures financed by debt purchased by the monetary authorities. This prevents high inflation. (11)
Loss
The main criticism of the fixed exchange rate is that the flexible exchange rate serves to adjust the trade balance. When the trade deficit occurs below the floating exchange rate, there will be an increase in demand for foreign currency (not domestic) which will raise the price of foreign currency in terms of domestic currency. Which in turn makes the prices of foreign goods less attractive to the domestic market and thereby drive the trade deficit. Below the fixed rate, automatic rebalancing is not the case.
The government should also invest a lot of resources to get foreign exchange reserves to accumulate to keep the pegged exchange rate. In addition, the government, when it has a fixed and non-dynamic exchange rate, can not use monetary or fiscal policy with a free hand. For example, by using reflex tools to regulate the rolling economy (by reducing taxes and injecting more money in the market), the government's risk of a trade deficit. This may happen because the purchasing power of ordinary households increases with inflation, thus making imports relatively cheaper.
In addition, the stubborn government maintains a fixed exchange rate when in a trade deficit will force it to use deflationary measures (increase taxes and reduce the availability of money), which can lead to unemployment. Finally, other countries with fixed exchange rates can also retaliate in response to certain countries by using their currency in maintaining their exchange rates.
Other recorded losses:
- The need for a fixed exchange rate regime is challenged by the emergence of sophisticated derivatives and financial tools in recent years, allowing firms to protect exchange rate fluctuations
- The announced exchange rate may not coincide with the market equilibrium exchange rate, resulting in excess demand or oversupply
- The central bank needs to withhold stocks of foreign and domestic currency at any time to adjust and maintain exchange rates and absorb excess demand or supply
- The fixed exchange rate does not allow automatic correction of imbalances in the state's balance of payments because the currency can not be appreciated/depreciated as dictated by the market
- Failed to identify the level of comparative advantage or state loss and can lead to inefficient allocation of resources worldwide
- There is the possibility of delays and policy errors in achieving an external balance
- The cost of government intervention is imposed on the foreign exchange market
- Not working well in countries with different economies and different economic shocks (11)
Fixed exchange rate regime versus capital control
The belief that the fixed exchange rate regime brings that stability is only partly true, since speculative attacks tend to target currencies with fixed exchange rate regimes, and in fact, the stability of the economic system is maintained primarily through capital controls. The fixed exchange rate regime should be seen as a tool in capital control.
FIX Line: Trade-off Between Shock Symmetry and Integration
- The exchange between shock symmetry and market integration for countries reflecting on pegged currencies is outlined in Feenstra and Taylor 2014's "International Macroeconomics" publication through a model known as the FIX Path Diagram.
- This symmetry integration diagram shows two regions, divided by a 45-degree line with a slope of -1. This line can be shifted left or right depending on the additional cost or the floating benefits. The line has a slope of = -1 is because the benefits of greater symmetry are, the benefits of less obvious integration should be and vice versa. The right territory contains countries that have positive potential to group, while the left region contains countries at significant risk and deterrents to pegging.
- This diagram highlights two key factors that drive a country to reflect on the grouping of currencies into other currencies, shock symmetry and market integration. Symmetry Shock can be characterized as two countries that have similar demand shocks due to similar industrial and economic damage, while market integration is a factor of trade volume occurring between stake member countries.
- In extreme cases, it is possible for a country to show only one of these characteristics and still have positive pegging potential. For example, a country that shows complete shock symmetry but has zero market integration can benefit from fixing the currency. The reverse is true, a country that has zero surprise symmetry but has maximum trade integration (effective one market among member countries). * This can be seen on an international scale as well as on a local scale. For example, environments in a city will experience tremendous benefits from the common currency, while less-integrated and/or unequal countries tend to face huge costs.
See also
References
(11) Feenstra, Robert C., and Alan M. Taylor. International Macroeconomics. New York: Worth, 2012. Print.
External links
- http://internationalecon.com/Finance/Fch80/F80-1.php
- http://www.wellesley.edu/Economics/weerapana/econ213/econ213pdf/lect213-05.pdf
- Gavin, F. J. (2002). "The Battle of Gold in the Cold War: American Monetary Policy and European Defense, 1960-1963". Diplomatic History . 26 (1): 61-94. doi: 10.1111/1467-7709.00300.
- http://people.ucsc.edu/~mpd/InternationalFinancialStability_update.pdf
- http://www.polsci.ucsb.edu/faculty/cohen/inpress/bretton.html
- http://www.imf.org/external/pubs/ft/issues13/index.htm
- http://www.imf.org/external/pubs/ft/issues/issues38/ei38.pdf
- http://www.cato.org/pubs/bp/bp100.pdf
- http://econ.la.psu.edu/~bickes/goldstd.pdf
- Currency, Current and Future Currency Rate Regulations in Wayback Engines (archived April 11, 2010)
- Reinhart, C. M.; Rogoff, K. S. (2004). "Modern History of Exchange Rate Arrangement: Reinterpretation". Economic Journal of the Quarter . 119 (1): 1-48. doi: 10.1162/003355304772839515.
- "International Exchange Rate and Reserve Regime" (PDF) . Archived from the original on July 26, 2011 . Retrieved September 12, 2011 . CS1 maint: The URL is not feasible
News articles
- https://www.washingtonpost.com/wp-dyn/content/article/2005/07/26/AR2005072600681.html
- http://www.forexrealm.com/forex-analytics/exchange-rates/exchange-rate-regimes.html
- http://www.gold-eagle.com/greenspan011098.html
- https://www.washingtonpost.com/wp-dyn/content/article/2005/07/21/AR2005072100351.html
Source of the article : Wikipedia
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