International Economics

International Economics
国际经济学 Lectured by Yuanfen Tu School of International Trade and Economics

International Economics By Robert J. Carbaugh 13th Edition
Chapter 6: Exchange-Rate Systems and Currency Crises

contents The exchange-rate practices
Nature and operation of actual exchange-rate systems Economic factors influencing the choice of alternative exchange-rate systems Operation and effects of currency crisis 3

Exchange-Rate Practices
Floating exchange-rate system Determined by market forces Float independently Float in unison with a group of other currencies Crawl according to a predetermined formula 4

Pegged exchange-rate system Fixed against some standard of value Anchor to a single currency Anchor to a basket of currencies Anchor to gold – not used since 1971 5

Members of the IMF Exchange rates should not be manipulated To prevent effective balance-of-payments adjustments To gain unfair competitive advantage over other members Members should act to counter short-term disorderly conditions in exchange markets When members intervene in exchange markets Take into account the interests of other members 6

Exchange-rate arrangements of IMF members, 2008
TABLE 6.1 Exchange-rate arrangements of IMF members, 2008 Legal tender:法定货币 Pegged exchange rates within horizontal bands:水平带内盯住汇率制度 7

Choosing an exchange-rate system
TABLE 6.2 Choosing an exchange-rate system 8

Allowing free capital flows
Choosing an Exchange Rate System: Constraints Imposed by Free Capital Flows Allowing free capital flows Constrains a country’s Choice of an exchange-rate system Ability to operate an independent monetary policy Impossible trinity A country can maintain only two of the following three policies: Free capital flows A fixed exchange rate An independent monetary policy 9

The Impossible Trinity
FIGURE 6.1 The Impossible Trinity Countries can adopt only two of the following three policies: free capital flows, a fixed exchange rate, and an independent monetary policy. 10

Fixed Exchange-Rate System
Used primarily by small, developing nations Currencies are anchored to a key currency Key currency Widely traded on world money markets Demonstrated relatively stable values over time Widely accepted as a means of international settlement 11

TABLE 6.3 Key currencies: currency composition of official foreign exchange reserves of the member countries of the international monetary fund, 2008 12

Anchoring to a single currency Developing nations whose trade and financial relations are mainly with a single industrial-country partner Anchoring to the special drawing right (SDR) A basket of four currencies established by the IMF 13

Anchoring to a basket of currencies Developing nations with more than one major trading partner Currency basket Prescribed quantities of foreign currencies In proportion to the amount of trade done 14

Par value In terms of gold or other key currencies Official exchange rate Can be determined by comparing the par values of two currencies Exchange-stabilization fund To defend the official rate Through purchases and sales of foreign currencies 15

Exchange rate systems Fixed Exchange-Rate System Continued Example 1: 1ounce gold=$35 1ounce gold= £12.50 The official exchange rate between dollar and pound is $2.80= £1 Example 2: Bolivian central bank fix their peso at 20peso=US $1 Ecuador’s sucre is set at 10 sucres (苏克雷）=US $1 The official exchange rate between the peso and sucre is 1peso=0.5 sucre

Exchange-rate stabilization under a fixed exchange-rate system
FIGURE 6.2 Exchange-rate stabilization under a fixed exchange-rate system To defend the official exchange rate of $2.80 per pound, the central bank must supply all of the nation’s currency that is demanded at the official rate and demand all of the nation’s currency that is supplied to it at the official rate. To prevent a dollar depreciation, the central bank must purchase the excess supply of dollars with an equivalent amount of pounds. To prevent a dollar appreciation, the central bank must purchase the excess supply of pounds with an equivalent amount of dollars. 17

Fundamental disequilibrium Long term, the official exchange rate and the market exchange rate may move apart Reflecting changes in fundamental economic conditions Income levels, tastes and preferences Technological factors Cost of defending the existing official rate may become prohibitive 18

Balance-of-payments equilibrium By devaluing or revaluing its currency Currency devaluation To cause the home currency’s exchange value to depreciate Counteracting a payments deficit Currency revaluation To cause the home currency’s exchange value to appreciate Counteracting a payments surplus 19

Devaluation and revaluation Legal redefinition of a currency’s par value under a system of fixed exchange rates Depreciation and appreciation Actual impact on the market exchange rate caused by A redefinition of a par value Changes in an exchange rate Changes in the supply of or demand for foreign exchange 20

Bretton Woods system, Semi-fixed exchange-rate system Adjustable pegged exchange rates Currencies were tied to each other Provide stable exchange rates for commercial and financial transactions A nation could repeg its exchange rate via devaluation or revaluation policies Use fiscal and monetary policies first to correct payments imbalances 21

Bretton Woods system, Agree to defend existing par values Correct fundamental disequilibrium by repegging their currencies Up to 10% without permission from the IMF By greater than 10% with the fund’s permission Par value set in terms of gold Or gold content of the U.S. dollar in 1944 22

Double Hook System

Bretton Woods system, Market exchange rates were almost but not completely fixed Market exchange rates are kept within a band of 1 percent on either side of parity. In 1971, the margin were widen to 2.25. 24

Adjustable pegged rates
Bretton woods system Adjustable pegged rates

Operational problems of the Bretton Woods system Adjustments in prices and incomes often conflicted with domestic-stabilization objectives Currency devaluation was considered undesirable Failure of domestic policies Loss of international prestige 26

Operational problems of the Bretton Woods system Currency revaluations were unacceptable to exporters Repegging exchange rates only as a last resort Sizable adjustments Difficult because of adjustable pegged rates Speculators 27

Bretton woods system Adjustable pegged rates The defects in the Bretton Woods system The Triffin dilemma / 特里芬两难 The inherent conflict of the U.S. Dollar being both a national currency and an international currency. Dilemma of liquidity(清偿力) and confidence

Bretton woods system Adjustable pegged rates The defects in the Bretton Woods system 1960年，美国耶鲁大学教授特里芬在其著作《黄金与美元危机》中指出：布雷顿森林制度以一国货币作为主要国际储备货币，在黄金生产停滞的情况下，国际储备的供应完全取决于美国的国际收支状况：美国的国际收支保持顺差，国际储备资产不敷国际贸易发展的需要；美国的国际收支保持逆差，国际储备资产过剩，美元发生危机，危及国际货币制度。这种难以解决的内在矛盾，国际经济学界称之为“特里芬难题”，它决定了布雷顿森林体系的不稳定性。

Bretton woods system Adjustable pegged rates liquidity U.S. run deficits U.S. run surplus confidence Dollar shortage ; dollar glut

Bretton woods system Adjustable pegged rates Dollar value per ounce of gold 1盎司值美元 35 38 脱钩浮动 42.22

Is China a currency manipulator?
China - manipulates the Yuan Yuan - significantly undervalued relative to the dollar U.S. exports to China more expensive Harms U.S. production and employment Chinese goods cheaper for American consumers – more imports Huge trade surplus with the United States Large accumulation of dollar reserves 32

Little or no connection between the Yuan and the health of U.S. manufacturing Transition away from manufacturing in the U.S. is a long-term trend Goes far beyond competition from Chinese exports Jobs have been slashed: technological improvements Each worker more productive U.S. – more competitive workers Reform its educational system 33

Good economic rationale for China’s peg policy Effective monetary anchor for China’s internal price level Positive results for the U.S. economy Large investments in U.S. debt - keep U.S. interest rates low Increase the size of the economy Promotes a lower inflation rate in the United States Foster economic stability 34

Floating Exchange Rates
Floating (flexible) exchange rates Currency prices established daily in the foreign-exchange market Without restrictions imposed by government policy Equilibrium exchange rate Demand for and supply of the home currency Changes in the exchange rate Correct a payments imbalance Shifts in imports and exports of goods, services, and short-term capital movements 35

Market adjustment under floating exchange rates
FIGURE 6.3 Market adjustment under floating exchange rates Under a floating exchange-rate system, continuous changes in currency values restore payments equilibrium at which the quantity supplied and quantity demanded of a currency are equal. Starting at equilibrium point A, an increase in the demand for francs leads to a depreciation of the dollar against the franc; conversely, a decrease in the demand for francs leads to an appreciation of the dollar against the franc. 36

Trade Restrictions, Jobs and Floating Exchange Rates Labor unions lobby for import restrictions To save jobs for domestic workers Implementation of import restrictions Help one industry Shift jobs from other industries in the economy to the protected industry No significant impact on aggregate employment Short-term employment gains in the protected industry Offset by long-term employment losses in other industries 37

Arguments for floating exchange rates Simplicity Respond quickly to changing supply and demand conditions Clear the market of shortages or surpluses of a given currency Simplified institutional arrangements that are relatively easy to enact 38

Arguments for floating exchange rates Continuous adjustment in the balance of payments Partially insulate the home economy from external forces Nations have greater freedom to pursue policies that promote domestic balance 39

Arguments against floating exchange rates An unregulated market may lead to wide fluctuations in currency values Discourage foreign trade and investment Inflationary bias Monetary authorities may lack financial discipline Greater freedom for domestic financial management Less resistance to over spending and to its subsequent pressure on prices and wages 40

TABLE 6.4 Advantages and disadvantages of fixed exchange rates and floating exchange rates Advantages Disadvantages Fixed exchange rates Floating exchange rates Simplicity and clarity of exchange-rate target Automatic rule for the conduct of monetary policy Keeps inflation under control Continuous adjustment in the balance of payments Operate under simplified institutional arrangements Allow governments to set independent monetary and fiscal policies Loss of independent monetary policy Vulnerable to speculative attacks Conducive to price inflation Disorderly exchange markets can disrupt trade and investment patterns Encourage reckless financial policies on the part of government 41

Managed Floating Rates
Managed floating system Informal guidelines established by IMF for coordination of national exchange-rate policies Nations might intervene in the exchange markets to avoid exchange-rate alterations that would weaken their competitive position Concern that floats over time might lead to disorderly markets with erratic fluctuations in exchange rates A nation can alter the degree to which it intervenes in the foreign-exchange market 42

Leaning against the wind Intervene to reduce short-term fluctuations in exchange rates Without attempting to adhere to any particular rate over the long term Target exchange rates To reflect long-term economic forces that underlie exchange-rate movements 43

Market intervention - used to stabilize exchange rates in the short term Allows market forces to determine exchange rates in the long term 44

Managed floating exchange rates
FIGURE 6.4 Managed floating exchange rates Under this system, central bank intervention is used to stabilize exchange rates in the short term; in the long term, market forces are permitted to determine exchange rates. 45

Monetary policy To stabilize a currency’s exchange value Expansionary monetary policy Increase the money supply To offset currency appreciation Contractionary monetary policy Decrease the money supply To offset currency depreciation Long-run effectiveness of using monetary policy to stabilize the exchange value of the currency is limited 46

Exchange-rate stabilization and monetary policy
FIGURE 6.5 Exchange-rate stabilization and monetary policy In the absence of international policy coordination, stabilizing a currency’s exchange value requires a central bank to initiate (a) an expansionary monetary policy to offset an appreciation of its currency, and (b) a contractionary monetary policy to offset a depreciation of its currency. 47

Official foreign-exchange intervention May be useful when the exchange rate is under speculative attack May be helpful in coordinating private-sector expectations Some support for the short-term effectiveness No support for the long-term intervention 48

The Crawling Peg The crawling-peg system
Small, frequent changes in the par value of its currency To correct balance-of-payments disequilibrium The process of exchange-rate adjustment Continuous for all practical purposes Used by nations with high inflation rates Combines the flexibility of floating rates with the stability usually associated with fixed rates 49

The crawling peg Exchange rate system alternatives Differences from the system of adjustable pegged rates: Under the adjustable peg, currencies are tied to a par value that changes infrequently (perhaps once every several years) but suddenly, usually in large jumps. Under the crawling peg, a nation can make small frequent changes in par values, perhaps several times a year. IMF view Hard to apply this system to industrialized nations whose currencies serve as a source of international liquidity

Increasing the Credibility of Fixed Exchange Rates
Currency board (货币发行局） Monetary authority that issues notes and coins convertible into a foreign anchor currency at a fixed exchange rate Can operate in place of a central bank or as a parallel issuer alongside an existing central bank Takes over the role of a central bank in strengthening the currency of a developing country 51

Currency board Has no discretionary powers Sole function: to exchange its notes and coins for the anchor at a fixed rate The government can finance its spending only by taxing or borrowing Not by printing money and thereby creating inflation 52

Currency board Monetary policy on autopilot When the anchor currency flows in The board issues more domestic currency Interest rates fall When the anchor currency flows out Interest rates rise 53

Major benefits of the currency-board system: Making a nation’s currency and exchange-rate regimes more rule-bound and predictable Placing an upper bound on the nation’s base money supply Arresting any tendencies in an economy toward inflation Forcing the government to restrict its borrowing to what foreign and domestic lenders are willing to lend it at market interest rates 54

Major benefits of the currency-board system: Engendering confidence in the soundness of the nation’s money Assuring citizens and foreign investors that the domestic currency can always be exchanged for some other strong currency Creating confidence and promoting trade, investment, and economic growth 55

Currency boards vs. dollarization (cont’d)
Stabilizing developing country currencies Currency boards vs. dollarization (cont’d) 1983年10月15日，港英政府对港币发行和汇率制度作出的安排：要求发钞银行（汇丰银行和渣达银行，1993年中国银行香港分行也成为发钞银行）在增发港元纸币时，必须按1美元兑7.8港元的比价向外汇基金缴纳等值美元，以换取港元的负债证明书，作为发钞的法定准备金，这一安排标志着香港联系汇率制的诞生。因此，香港的联系汇率制实质上是美元汇兑本位制。

Stabilizing developing country currencies Currency boards vs. dollarization (cont’d) 当港元现钞从流通中回笼后，发钞行可以用同样的比价向外汇基金换回美元，同时赎回负债证明书；发钞行以同样的方式为其他银行提供和收回港元现钞；1美元兑换7.8港元的固定比价只适用于发钞行和外汇基金之间，发钞行和其他银行之间以及银行同业、银行与客户之间的港元交易全部按市场汇率进行。

Stabilizing developing country currencies Currency boards vs. dollarization (cont’d) ★ 香港的联系汇率制以美元为锚货币；官方汇率 1美元：7.8港元商业银行发行港元，100%美元发行准备发行汇率与市场汇率并存商业银行发钞银行（汇丰、渣打、中银）外汇基金管理局负债证明书 1:7.8000上缴US$ 市场汇率 HK$

Stabilizing developing country currencies Currency boards vs. dollarization (cont’d) 联系汇率制两个内在的自我调节机制 1）套利机制因为每当市场汇率有波动，偏离联系汇率，三间发钞银行可透过7.8港元兑1美元的联系汇率向金管局买入或卖出负债证明书图利。举例说，假设港元的市场汇率贬值至8港元兑1美元，发钞银行可以持负债证明书向金管局以7.8港元兑1美元的联系汇率换取美元，每换取1美元便可从中获利0.2港元。而又假设港元的市场汇率升值至7.5港元兑1美元，发钞银行可以持美元向金管局以7.8港元兑1美元的联系汇率购入负债证明书发行港元，每退换1美元便可从中获利0.3港元。在三间银行的竞争下，确保了发钞银行会在当港元市场汇价波动时入市干预。

Stabilizing developing country currencies Currency boards vs. dollarization (cont’d) 联系汇率制两个内在的自我调节机制 2）美元流动均衡机制。在资金流入时，市场人士买入港元，港元市场汇率面临升值压力，三家发钞银行会以美元向金管局购买负债证明书，发行港元获利。这使香港的货币基础得以扩张，经过货币扩张的过程，市场上货币供应会增加，逼使利率下调，资金继而流出。而港元市场汇价回到联系汇率的水平。资金流出时的情况亦相似，三家银行会收回港元，以负债证明书换回美元获利。这使货币基础收缩，利率上升，吸引资金为赚取利息而流入，港元市场汇价回到联系汇率的水平。

香港联系汇率制的两个内在的自我调节机制：
1. 国际收支的自动调节机制 2. 套利机制国际收支发行准备货币供应量物价、利率美元升值美元贬值退美元买港元退港元买美元美元供给增加美元供给减少美元贬值美元升值

Stabilizing developing country currencies Currency boards vs. dollarization (cont’d) 2、香港联系汇率制的利弊联系汇率制的最大优点有利于香港金融的稳定，而市场汇率围绕联系汇率窄幅波动的运行也有助于香港国际金融中心，国际贸易中心和国际航运中心地位的巩固和加强，增强市场信心。

Stabilizing developing country currencies Currency boards vs. dollarization (cont’d) 2、香港联系汇率制的利弊联系汇率制度的弱点联系汇率使香港的经济行为以及利率货币供应量等指标过分依赖和受制于美国，从而严重削弱了运用利率和货币供应量杠杆调节本地区经济的能力。同时，联系汇率也使通过汇率调节国际收支的功能无从发挥。

Objections to the currency-board system: Prevents a country from pursuing a discretionary monetary policy Reduces its economic independence Susceptible to financial panics It lacks a lender of last resort Creates a colonial relation with the anchor currency 64

Dollarization When residents of a foreign country use the U.S. dollar alongside or instead of the domestic currency Full dollarization Elimination of the domestic currency and its complete replacement with the U.S. dollar U.S. Virgin Islands, Marshall Islands, Puerto Rico, Guam, Ecuador, other Latin American countries 65

Benefits of dollarization Credibility and policy discipline Avoid the capital outflows that often precede or accompany an embattled currency situation Decrease in transaction costs Lower rate of inflation Tied to inflation rate of the issuing country Greater openness Balance-of-payments crises are minimized 66

Effects of dollarization for the foreign country Monetary policy of the Federal Reserve Federal Reserve Not a lender of last resort for the foreign nation The country No seigniorage from its monetary system State expenditures are not affected Can establish its own trade policies Constraint on fiscal policy: Cannot print more domestic currency to finance budget deficits 67

Effects of dollarization for the U.S. For each dollar sent abroad, Americans enjoy a one-time increase in the amount of goods and services they are able to consume The U.S. gets an interest-free loan from the foreign country 68

Effects of dollarization for the U.S. Might hinder the formulation and execution of monetary policy by the Federal Reserve Could result in more pressure on the Federal Reserve to conduct policy according to the interests of the foreign country 69

Currency Crises Currency crisis, speculative attack
A weak currency experiences heavy selling pressure Sizable losses in the foreign reserves held by a country’s central bank Depreciating exchange rates in the forward market Widespread flight out of domestic currency Into foreign currency Into goods that people think will retain value Can decrease GDP growth by 6% 70

Examples of currency crises
TABLE 6.5 Examples of currency crises Mexico, December 1994–1995. Mexico’s central bank maintained the value of the peso within a band that depreciated four percent a year against the U.S. dollar. In order to reduce interest rates on its debt, the Mexican government in April 1994 began issuing debt linked to the dollar. The amount of this debt soon exceeded the central bank’s falling foreign-exchange reserves. Unrest in the province of Chiapas led to a speculative attack on the peso. Although the government devalued the peso by 15 percent by widening the band, the crisis continued. The government then let the peso float; it depreciated from 3.46 per dollar before the crisis to more than 7 per dollar. To end the crisis, Mexico received pledges for $49 billion in loans from the U.S. government and the IMF. Mexico’s economy suffered a depression and banking problem that led to government rescues. Russia, The Russian government was paying high interest rates on its short-term debt. Falling prices for oil, a major export, and a weak economy also contributed to speculative attacks against the ruble, which had an official crawling band with the U.S. dollar. Although the IMF approved loans for Russia of about $11 billion and the Russian government widened the band for the ruble by 35 percent, the crisis continued. This crisis led to the floating of the ruble and its depreciation against the dollar by about 20 percent. Russia then went into recession and experienced a burst of inflation. Many banks became insolvent. The government defaulted on its ruble-denominated debt and imposed a moratorium on private-sector payments of foreign debt. 71

Examples of currency crises
TABLE 6.5 Examples of currency crises Turkey, The Turkish lira had an IMF-designed official crawling peg against the U.S. dollar. In November 2000, rumors about a criminal investigation into ten government-run banks led to a speculative attack on the lira. Interbank interest rates rose to 2,000 percent. The central bank then intervened. Eight banks became insolvent and were taken over by the government. The central bank’s intervention had violated Turkey’s agreement with the IMF, yet the IMF lent Turkey $10 billion. In February 2001, a public dispute between the president and prime minister caused investors to lose confidence in the stability of Turkey’s coalition government. Interbank interest rates rose to 7,500 percent. Thus, the government let the lira float. The lira depreciated from 668,000 per dollar before the crisis to 1.6 million per dollar by October The economy of Turkey stagnated and inflation skyrocketed to 60 percent. 72

Currency Crises Crisis ends when selling pressure stops
Continued Crisis ends when selling pressure stops Ways to end pressure Devalue the currency Adopt a floating exchange rate Currency crashes: Crises that end in devaluations or accelerated depreciations Avoiding a currency crash Impose restrictions on the ability of people to buy and sell foreign currency Obtain a loan to bolster the foreign reserves Restore confidence in the existing exchange rate

Currency Crises Sources of currency crises Currency speculators
Budget deficits financed by inflation Weak financial systems Recently deregulated financial systems A weak economy Political factors External factors Choice of an exchange-rate system 74

Speculators Attack East Asian Currencies
Southeast Asian currency decline led by the Thai Baht Resistance offered to the depreciation pressure and raising interest rates to make the Baht attractive Abandoning the dollar peg in July 1997 Long-term effects of abandoning the fixed rate

Capital Controls Capital controls, exchange controls
Government-imposed barriers To foreign savers investing in domestic assets To domestic savers investing in foreign assets 76

Capital Controls Capital controls, exchange controls Advantages
Government can influence its payments position Regulating the amount of foreign exchange allocated to imports or capital outflows Government - encourage or discourage certain transactions Different rates for foreign currency for different purposes Can give domestic monetary and fiscal policies greater freedom in their stabilization roles 77

Capital Controls Controls on capital outflows – problems:
Capital outflows may further increase after the controls are implemented Result in evasion Provide government officials the false sense of security that they do not have to reform their financial systems to ameliorate the crisis 78

Capital Controls Controls on capital inflows Support Problems
If speculative capital cannot enter a country, then it cannot suddenly leave and create a crisis Problems Can prevent funds that would be used to finance productive investment opportunities from entering Are seldom effective because the private sector finds ways to evade them and move funds into the country 79

Capital Controls Taxing foreign-exchange transactions
A tax would increase the cost of these transactions Discourage massive responses to minor changes Dampen volatility in exchange rates Drawbacks: We do not know how much volatility is excessive or irrational A tax could impose a burden on countries that are quite rationally borrowing overseas Would be difficult to implement 80

The global economic crisis of 2007–2009
General factors causing economic crises An overshooting of markets Excessive leveraging of debt Credit booms Miscalculations of risk Rapid outflows of capital from a country Unsustainable macroeconomic policies 81

Bursting of the U.S. housing market bubble Increase in foreclosures Global financial and economic crisis The U.S. - major center of the financial world Main guarantor - international financial system Provider of dollars: currency reserves, international medium of exchange Financial capital - moves around the world 82

Spreading of the financial crisis Industrial countries Emerging market Developing economies Economies deteriorated Investors pulled capital from countries Plunging values of stocks, domestic currencies Slumping exports and commodity prices Recession or slow economic growth 83

Global crisis played out at two levels Among the industrialized nations of the world Losses from subprime mortgage debt, excessive leveraging of investments, and inadequate capital backing financial institutions Among emerging market and other economies Innocent bystanders to the crisis - weak economies 84

Cope with the global financial crisis Control the contagion Minimize losses to society Restore confidence in financial institutions and instruments Lubricate the wheels of the economy 85

Measures Injecting capital Loans or stock purchases Prevent bankruptcy of financial institutions Increasing deposit insurance limits To limit withdrawals from banks Purchasing toxic debt of financial institutions on the verge of failure So that they would start lending again 86

Measures Coordinating interest-rate reductions by central banks To inject liquidity into the economy Enacting stimulative fiscal policies To bolster sagging aggregate demand 87

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