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Shambaugh, Jay C. Bibliography Illustrated. Live circulation data is not available. Displaying live circulation data. Includes bibliographical references and index. Description based on print version record. Related item. Print version: ; ISBN: Summary This work provides an analysis of the operation and consequences of exchange rate regimes in an era of increasing international interdependence.

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King's College London Library. LSE Library. This mechanism was originally introduced by Richard Cantillon and later discussed by David Hume in to refute the mercantilist doctrines and emphasize that nations could not continuously accumulate gold by exporting more than their imports. Under the gold standard, each country's money supply consisted of either gold or paper currency backed by gold. Money supply would hence fall in the deficit nation and rise in the surplus nation.

Consequently, internal prices would fall in the deficit nation and rise in the surplus nation, making the exports of the deficit nation more competitive than those of the surplus nations. The deficit nation's exports would be encouraged and the imports would be discouraged till the deficit in the balance of payments was eliminated.

In a reserve currency system, the currency of another country performs the functions that gold has in a gold standard. To maintain this fixed exchange rate, the Reserve Bank of India would need to hold dollars on reserve and stand ready to exchange rupees for dollars or dollars for rupees on demand at the specified exchange rate. In the gold standard the central bank held gold to exchange for its own currency , with a reserve currency standard it must hold a stock of the reserve currency. Currency board arrangements are the most widespread means of fixed exchange rates.

Under this, a nation rigidly pegs its currency to a foreign currency, special drawing rights SDR or a basket of currencies. The central bank's role in the country's monetary policy is therefore minimal as its money supply is equal to its foreign reserves. Currency boards are considered hard pegs as they allow central banks to cope with shocks to money demand without running out of reserves CBAs have been operational in many nations including:.

The new Exchange Market Pressure Index

The fixed exchange rate system set up after World War II was a gold-exchange standard, as was the system that prevailed between and the early s. Its characteristics are as follows:. Unlike the gold standard, the central bank of the reserve country does not exchange gold for currency with the general public, only with other central banks.

The current state of foreign exchange markets does not allow for the rigid system of fixed exchange rates. At the same time, freely floating exchange rates expose a country to volatility in exchange rates. Hybrid exchange rate systems have evolved in order to combine the characteristics features of fixed and flexible exchange rate systems. They allow fluctuation of the exchange rates without completely exposing the currency to the flexibility of a free float.

Mod-01 Lec-05 Floating and Fixed Exchange Rate Regimes

Countries often have several important trading partners or are apprehensive of a particular currency being too volatile over an extended period of time. They can thus choose to peg their currency to a weighted average of several currencies also known as a currency basket. For example, a composite currency may be created consisting of Indian rupees, Japanese yen and one Singapore dollar.

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The country creating this composite would then need to maintain reserves in one or more of these currencies to intervene in the foreign exchange market. In a crawling peg system a country fixes its exchange rate to another currency or basket of currencies. This fixed rate is changed from time to time at periodic intervals with a view to eliminating exchange rate volatility to some extent without imposing the constraint of a fixed rate. Crawling pegs are adjusted gradually, thus avoiding the need for interventions by the central bank though it may still choose to do so in order to maintain the fixed rate in the event of excessive fluctuations.

A currency is said to be pegged within a band when the central bank specifies a central exchange rate with reference to a single currency, a cooperative arrangement, or a currency composite. It also specifies a percentage allowable deviation on both sides of this central rate. Depending on the band width, the central bank has discretion in carrying out its monetary policy. The band itself may be a crawling one, which implies that the central rate is adjusted periodically. Bands may be symmetrically maintained around a crawling central parity with the band moving in the same direction as this parity does.

Alternatively, the band may be allowed to widen gradually without any pre-announced central rate.

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A currency board also known as 'linked exchange rate system" effectively replaces the central bank through a legislation to fix the currency to that of another country. The domestic currency remains perpetually exchangeable for the reserve currency at the fixed exchange rate. As the anchor currency is now the basis for movements of the domestic currency, the interest rates and inflation in the domestic economy would be greatly influenced by those of the foreign economy to which the domestic currency is tied.

The currency board needs to ensure the maintenance of adequate reserves of the anchor currency. It is a step away from officially adopting the anchor currency termed as currency substitution. This is the most extreme and rigid manner of fixing exchange rates as it entails adopting the currency of another country in place of its own.

Their exchange rates are effectively fixed to each other. There are similar examples of countries adopting the U. See ISO for a complete list of territories by currency. Monetary co-operation is the mechanism in which two or more monetary policies or exchange rates are linked, and can happen at regional or international level. Various forms of monetary co-operations exist, which range from fixed parity systems to monetary unions.

source site Monetary co-operation is closely related to economic integration , and are often considered to be reinforcing processes. A monetary union is considered to be the crowning step of a process of monetary co-operation and economic integration. This arrangement is categorized as exchange rate co-operation. The EMS evolves over the next decade and even results into a truly fixed exchange rate at the start of the s. In , the Thai government established the Exchange Equalization Fund EEF with the purpose of playing a role in stabilizing exchange rate movements.

It linked to the U. Over the course of the next 15 years, the Thai government decided to depreciate the baht in terms of gold three times, yet maintain the parity of the baht against the U. Due to the introduction of a new generalized floating exchange rate system by the International Monetary Fund IMF that stretched a smaller role of gold in the international monetary system in , this fixed parity system as a monetary co-operation policy was terminated.

The Thai government amended its monetary policies to be more in line with the new IMF policy. One main criticism of a fixed exchange rate is that flexible exchange rates serve to adjust the balance of trade. That in turn makes the price of foreign goods less attractive to the domestic market and thus pushes down the trade deficit. Under fixed exchange rates, this automatic rebalancing does not occur.

Another major disadvantage of a fixed exchange-rate regime is the possibility of the central bank running out of foreign exchange reserves when trying to maintain the peg in the face of demand for foreign reserves exceeding their supply. This is called a currency crisis or balance of payments crisis, and when it happens the central bank must devalue the currency. When there is the prospect of this happening, private-sector agents will try to protect themselves by decreasing their holdings of the domestic currency and increasing their holdings of the foreign currency, which has the effect of increasing the likelihood that the forced devaluation will occur.

A forced devaluation will change the exchange rate by more than will the day-by-day exchange rate fluctuations under a flexible exchange rate system. Moreover, a government, when having a fixed rather than dynamic exchange rate, cannot use monetary or fiscal policies with a free hand. For instance, by using reflationary tools to set the economy growing faster by decreasing taxes and injecting more money in the market , the government risks running into a trade deficit. This might occur as the purchasing power of a common household increases along with inflation, thus making imports relatively cheaper.

Additionally, the stubbornness of a government in defending a fixed exchange rate when in a trade deficit will force it to use deflationary measures increased taxation and reduced availability of money , which can lead to unemployment.