Fixed FX Regimes FNCE 4070 – Financial Markets and Institutions

Floating FX Regimes The value of a currency is allowed to fluctuate against all other currencies. The USD floats against most major currencies

Fixed FX Regimes In a fixed FX regime a currency is pegged relative to the value of another currency (the anchor currency) or basket of currencies

Recent Headlines Danish Central Banker: Negative Deposit Rate Successful So Far (1 September 2012 WSJ) RBC Offers Negative Interest Rates on Danish Krone, Swiss Franc (9 October 2012 Bloomberg)

Intervention in a Fixed Exchange Rate System

Monetary Policy for a Pegged Currency Generally speaking a country that ties its exchange rate to a currency of a larger country loses control of its monetary policy. – If the larger country purses a more contractionary monetary policy and decreases its money supply then the smaller country will have to do the same.

The Euro – Convergence Criteria In order to join the Euro there were strict criteria – A debt to GDP ratio of less than 60% – Government budget deficits had to under control – Inflation within a certain band – Interest rates had to be close to European average – Exchange rate stability

Gross Government Debt in Europe

European Government Surpluses

Greek Trade Deficit 1988 to present

German and Greek Interest Rates

Greek Drachma vs Deutsche Mark

Greek 10 year Government Bond Yields

Germany 10 year Government Bond Yields

Present Value of $2,000 paid monthly for 30 years

Greece Balance of Trade 2001-present

Greece Current Account – includes foreign aid

House Prices In Greece (1997 – prices are 100)

Greek Government External Debt

Target Balances - Europe