1. McGraw-Hill/Irwin Copyright  2009 by The McGraw-Hill Companies, Inc. All rights reserved. Chapter 20: Government Policies toward the Foreign Exchange Market

2. 20-2 Government Policies Toward the Foreign Exchange Market Two Aspects Policy toward the level and variability of the (nominal spot) exchange rate. In simple terms, the choice between a floating exchange rate and a fixed exchange rate. Policy toward the level and variability of the (nominal spot) exchange rate. In simple terms, the choice between a floating exchange rate and a fixed exchange rate. Restrictions (if any) on the use of the foreign exchange market. These restrictions are generally called exchange controls. Restrictions (if any) on the use of the foreign exchange market. These restrictions are generally called exchange controls.

3. 20-3 Decisions for a Government That Has a Fixed Exchange Rate What to peg to? What to peg to?  Gold  U.S. dollar  Other foreign currency  Basket of foreign currencies When to change the fixed rate? When to change the fixed rate?  Never (not credible)  Seldom (adjustable peg)  Often (crawling peg) How to defend the fixed rate? How to defend the fixed rate?  Intervention in the FX market  Exchange control  Alter domestic interest rates  Macroeconomic adjustment

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9. 20-9 International Currency Experience Gold Standard, 1870-1914 Gold Standard, 1870-1914  Gold value of each currency was fixed  Britain was the central country Interwar Instability Interwar Instability Bretton Woods System, 1944-1971 Bretton Woods System, 1944-1971  Adjustable pegged exchange rates  United States and U.S. dollar were at the center  Eventual dollar crisis Current System Current System  A “nonsystem”—countries can choose almost any exchange rate policy  Many countries use managed floating exchange rates

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