1. Fixed Exchange Rate & Foreign Exchange Intervention

2. Fixed exchange rates Fixed exchange rates ? 1.Managed floating Managed floatingManaged floating 2.Regional currency arrangements Regional currency arrangementsRegional currency arrangements 3.Developing countries and countries in transition Developing countries and countries in transitionDeveloping countries and countries in transition 4.Lessons of the past for the future Lessons of the past for the futureLessons of the past for the future

3. Central bank intervention & the money supply central bank transactions in asset markets the central bank balance sheet according to the principles of double-entry bookkeeping

4. double-entry bookkeeping AssetsLiabilities Any acquisition of an asset by the central bank (a positive change) Any increase in the bank’s liabilities (a positive change) + + increase + + – reduce – ++ –

5. assets money supply Changes in the central bank’s assets cause changes in the domestic money supply When the central bank buys an asset from the public, its payment (cash/check) enters the money supply. money supply to expandthe asset purchase → money supply to expand. money supply shrinksthe asset sale →receive cash or check → money supply shrinks

6. upshot same directionChanges in the level of central bank asset holdings cause the money supply to change in the same direction because they require equal changes in the central bank’s liabilities. automatically automaticallyAny central bank purchase of assets automatically results in an increase in the domestic money supply, while any central bank sale of assets automatically causes the money supply to decline.

7. Money multiplier Effect multiple deposit creationWhen the central bank buys assets, the accompanying increase in the money supply is larger than the initial asset purchase because of multiple deposit creation within the private banking system.

8. Central Bank Balance Sheet AssetsLiabilities Foreign assets Foreign assets Foreign assets Foreign assets $1000 Deposits held by private banks Deposits held by private banks Deposits held by private banks Deposits held by private banks $500 Domestic assets Domestic assets $1500 Currency in circulation Currency in circulation Currency in circulation Currency in circulation $2000 $2500

9. Exchange intervention AssetsLiabilities Foreign assets Foreign assets $1000 Deposits held by private banks Deposits held by private banks $500 Domestic assets $1500 Currency in circulation Currency in circulation $2000 $2500 ① sell $100 for ￥ ② pay $100 in ￥

10. Decline in Money Supply AssetsLiabilities Foreign assets $900 Deposits held by private banks Deposits held by private banks $500 Domestic assets $1500 Currency in circulation $1900 $2400 $2400

11. private citizen’s action AssetsLiabilities Foreign assets Foreign assets $900 Deposits held by private banks Deposits held by private banks $500 Domestic assets $1500 Currency in circulation Currency in circulation $1900 $2400 ① buyer of foreign asset pays a $100 check drawn on deposit ② Private bank deposits with the central bank fall by $100

12. result of such action AssetsLiabilities Foreign assets Foreign assets $900 Deposits held by private banks Deposits held by private banks $400 Domestic assets $1500 Currency in circulation Currency in circulation $2000 $2400

13. Sterilization Sterilized foreign exchange intervention: equal foreign and domestic asset transactions in opposite directions domestic money supply Central banks carry out equal foreign and domestic asset transactions in opposite directions to nullify the impact of their foreign exchange operation on domestic money supply.

14. Before Sterilized $ 100 Sale AssetsLiabilities Foreign assets Foreign assets $1000 Deposits held by private banks Deposits held by private banks $500 Domestic assets $1500 Currency in circulation Currency in circulation $2000 减少 check $100→ 货币供应量减少 货币供应量减少 $2500 ① sell $100

15. Sterilized Process AssetsLiabilities Foreign assets Foreign assets $900 Deposits held by private banks Deposits held by private banks $500 Domestic assets $1600 Currency in circulation Currency in circulation $2000 增加 check $100→ 货币供应量增加 货币供应量增加 $2500 ② buy $100 of domestic A ① sell $100

16. After Sterilized $ 100 Sale AssetsLiabilities Foreign assets $900 Deposits held by private banks Deposits held by private banks $500 Domestic assets $1600 $1600 Currency in circulation Currency in circulation $2000 $2500

17. Table 17-2 Summary 简译 本国央行的 行为 货币 供给 对本国货币 供给的影响 本国 资产 对央行本国 资产的影响 外国 资产 对央行外国 资产的影响 不冲销的外 汇购买 +$1000 冲销的外汇 购买 0-$100+$100 不冲销的外 汇购买 -$1000 冲销的外汇 购买 0+$100-$100

18. Balance of Payments & Money Supply Different definition: BOPcurrent account non-reserve component of capital accountBOP is the sum of the current account and the non-reserve component of capital account, that is, the international payment gap that central banks must finance through their reserve transaction.

19. BOPMoney Supply BOP & Growth of Money Supply increase in the home central bank’s foreign assets increased home money supplyIf central banks are not sterilizing and the home country has balance of payments surplus, any associated increase in the home central bank’s foreign assets implies an increased home money supply. Similarly, any associated decrease in a foreign central bank’s claims on the home country implies a decreased foreign money supply.

20. Burden of BOP adjustment goals 1.Macroeconomic goals of the central banks and institutional arrangement governing intervention; sterilizing 2.Central banks may be sterilizing to counter the monetary effects of reserve changes; indirectly help 3.Some central bank transactions indirectly help to finance a foreign country’s BOP deficit.

21. How the central bank fixes the exchange rate? interventionThrough foreign exchange intervention. asset marketCondition: only if its financial transactions ensure the asset market remain in equilibrium when the exchange rate is at its fixed level. exchange market 1.Foreign exchange market equilibrium 2.Money market 2.Money market equilibrium

22. Exchange market equilibrium Interest rate parity must hold Expectation of domestic currency is zero!

23. Money market equilibrium R* equates aggregate real domestic money demand and real money supply. PY R* Given P and Y, the above equilibrium condition tells what the money supply must be if a permanently fixed exchange rate is consistent with asset market equilibrium at foreign exchange rate of R*.

24. A rise in output raises the demand for domestic money… This foreign asset purchase (by the central bank) eliminates the excess demand for domestic money because the central bank issues money to pay for the foreign assets it buys.

25. RE ●● ● ● ● 维持固定汇率 实际货币供给 外币储蓄的本币收益 实际国内货币持有 ①产出增加 ②货币供应增加

26. Stabilization Policies Alternatives: 1.Monetary policy 2.Fiscal policy 3.An abrupt change in the exchange rate’s fixed level, E 0

27. Two alternatives under the fixed Fiscal policy becomes a more potent toolBy fixing the exchange rate, the central bank gives up its ability to influence the economy through monetary policy. Fiscal policy becomes a more potent tool for affecting output and employment.

28. Analysis approaches DD-AADD-AA model E e equalsE 0Add the assumption that the expected future exchange rate ( E e ) equals the rate E 0 at which the central bank is pegging.

29. 1. Monetary Policy monetary policy tools are powerlessUnder a fixed exchange rate, central bank monetary policy tools are powerless to affect the economy’s money supply or its output.

30. E Y DD AA 1 AA 2 E0E0E0E0 E2E2E2E2 Y1Y1Y1Y1 Y2Y2Y2Y2 ① ② 中央银行通过购 买国内资产扩大 国内货币供给来 增加产出 维持固定汇率 央行不得不出 售外国资产来 换回本币 在固定汇率制下货币扩张是无效的

31. 2. Fiscal Policy can be used to affect outputFiscal policy can be used to affect output under a fixed exchange rate. appreciation of domestic currencyIn comparison with under a floating rate, fiscal expansion is accompanied by an appreciation of domestic currency and the central bank is forced to expand the money supply through foreign exchange purchases.

32. E Y DD 1 AA 1 AA 2 E0E0E0E0 E2E2E2E2 Y1Y1Y1Y1 Y2Y2Y2Y2 ① ② DD 2 Y3Y3Y3Y3 ③ 财政扩张政策移动 DD 为了避免过度的 货币需求造成利 率上升, 引起本币 升值, 央行购买外 国资产, 从而增加 了本币的供给, 这 种干预移动了 AA 曲线 本币升值压力 干预结果产出增加而汇率不变

33. 3. Changes in the exchange rate last resortDevaluation (or revaluation) is a last resort for the central bank… output official outflowDevaluation causes a rise in output, a rise in official reserves, and an expansion of the money supply. A private capital inflow matches the central bank’s reserve gain (an official outflow ) in the balance of payments account. official outflow official outflow

34. E Y DD AA 1 AA 2 E1E1E1E1 E0E0E0E0 Y1Y1Y1Y1 Y2Y2Y2Y2 ① ② 本币贬值 Both output & money supply expand

35. Why choose to devaluate? fight domestic unemployment 1.Devaluation allows the government to fight domestic unemployment despite the lack of effective monetary policy. boosting aggregate demand 2.Devaluation is the most convenient way of boosting aggregate demand. (government spending and budget deficit unpopular) running low on reserves 3.Central bank is running low on reserves, devaluation is a kind of tax on holders of government bonds and money.

36. Balance of payments crises & capital flight impending change balance of payments crisisThe market’s belief in an impending change in the exchange rate gives rise to a balance of payments crisis, a sharp change in official foreign exchange reserves sparked by a change in expectations about the future exchange rate.

37. RE ● ● ●● 实际货币供给 外币储蓄的本币收益 实际国内货币持有 ① ② ⑴⑵ 本币贬值预期右移 外币储蓄的本币收 益曲线 央行必须出售外汇储 备, 紧缩国内货币供 给。

38. Upshot expectation of a future devaluation a sharp fall in reservesa rise in the home interest rateThe expectation of a future devaluation causes a balance of payment crisis marked by a sharp fall in reserves and a rise in the home interest rate above the world interest rate and vice versa.

39. Capital flight capital flight debt private capital outflowThe reserve loss accompanying a devaluation scare is often labeled capital flight because the associated debt in the balance of payments accounts is a private capital outflow.

40. currency crises What causes currency crises ? Central bank is compelled to buy bonds form the domestic government to allow the government to run continuing fiscal deficits. Central bank’s purchases of domestic assets cause losses of foreign exchange reserves. Central bank can not support of rise of domestic interest rate.

41. Solution to the currency crises The central bank should stop bankrolling the government deficit, hopefully forcing the government to live within its means. Independence of central bankIndependence of central bank.

42. Self-fulfilling currency crises currency speculationAn economy can be vulnerable to currency speculation without being in such bad shape that a collapse of its fixed exchange regime is inevitable. liabilities are mainly short- term depositsAn economy in which domestic commercial banks’ liabilities are mainly short- term deposits. The central bank has to lend money to the commercial banks.

43. Managed floating & sterilized intervention Under managed floating, monetary policy is influenced by exchange rate changes without being completely subordinate to the requirements of a fixed rate. trade-off between domestic objectivesThe central bank faces a trade-off between domestic objectives (employment or the inflation rate) and exchange rate stability. sterilization or nullificationSuch efforts are usually ended in sterilization or nullification.

44. Intervention=sterilization? money supply interest rateTools of intervention: money supply & interest rate. Empirical studies confirm that such intervention are sterilized throughout the 20 th century and earlier.

45. Perfect asset substitutability & Ineffectiveness of sterilized intervention money supply interest rate exchange rateWithout change in the domestic money supply, any intervention by the central bank will not affect the domestic interest rate and therefore will not affect the exchange rate.

46. Mexico’s 1994 Balance of Payments Crisis 利率被迫拉升 储备不断减少

47. Sterilization is fruitless under the fixed exchange rate The ineffectiveness of monetary policy under a fixed exchange rate implies that sterilization is a self-defeating policy.

48. Perfect Perfect asset substitutability perfect substitutes in portfoliosAll interest-bearing (non-money) assets denominated in the same currency, whether illiquid time deposits or government bonds, are perfect substitutes in portfolios.The single term “bonds” will generally be used to refer to all assets. Interest Parity ConditionInterest Parity Condition holds Nothing a central bank can do through intervention.

49. Imperfect Imperfect asset substitutability RiskRisk in the foreign exchange market. Risk preferenceRisk preference is different to investors.

50. returnPerfect asset substitutability: expected rate of return that matters returnriskImperfect asset substitutability: both return s and risk that matters.

51. imperfect Exchange market equilibrium under imperfect asset substitutability Comparison: 利率平价论成立Perfect asset substitutability: 利率平价论成立 附加风险贴水Imperfect asset substitutability: 附加风险贴水 本国政府债务存量 中央银行的本国资产

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53. sterilized purchases depreciateWith imperfect asset substitutability, even sterilized purchases of foreign exchange cause the home currency to depreciate. Similarly, sterilized sales of foreign exchange cause the home currency to appreciate.

54. signaling The signaling effect of intervention give an indication of where the central bank expectsIf market participants are unsure about the future direction of macroeconomic policies, sterilized intervention may give an indication of where the central bank expects (desires) the exchange rate to move.

55. crying ‘wolf!’Is the signaling effect “ crying ‘wolf!’ ”? If governments do not follow up on their exchange market signals with concrete policy moves, the signals soon become ineffective.

56. Reserve currencies in the world monetary system Reserve currencyReserve currency : the currency central banks hold in their international reserves, and each nation’s central banks fixes its currency’s exchange rate against the reserve currency by standing ready to trade domestic money for reserve assets at that rate.

57. The mechanics of a reserve currency standard Even though each central bank tied its currency’s exchange rate only to dollar, market forces automatically held all other exchange rates (cross rates) constant at the values implied by the dollar rate.

58. Fixed Exchange Rates under currency-circulation system 纸币流通下的布雷顿森林体系。 1944 Bretton Woods agreement 双挂钩 英国向美国妥协的结果 “ 双挂钩 ” 体系。 金块 美元 dollar 各国货币 日元 … 里拉 … 1 盎司 =35 美元 1% 幅度波动

59. The asymmetric position of the reserve center never has to interveneThe country whose currency is held as reserves occupies a special position because it never has to intervene in the foreign exchange market.

60. NN N-1If there are N countries with N currencies in the world, there are only N-1 exchange rates against the reserve currency, there is no exchange rate for the reserve center to fix. Thus the center countries need never intervene and bears none of the burden of financing its balance of payments. 各国货币钉住美元, 而美元钉住什么 ? 美国用不 着干预外汇市场 各国货币钉住美元, 而美元钉住什么 ? 美国用不 着干预外汇市场。

61. Reserve center’s privilege The reserve center is the one country in the system that can enjoy fixed exchange rates without the need to intervene, it is still able to use monetary policy for stabilizing purposes.

62. The Gold Standard An international gold standard avoids the asymmetry inherent in a reserve currency standard by avoiding the “Nth currency” problem. Under a gold standard, each country fixes the price of its currency in terms of gold by standing ready to trade domestic currency for gold whenever necessary to defend the official price.

63. Two kinds of the fixed exchange rates 1. 金本位制度下的固定汇率制 金本位制度下的固定汇率制 2. 纸币流通制度下的固定汇率制 Gold Standard: 规定货币单位的含金量。 含金量的的对比决定汇率 含金量的的对比决定汇率。 自由自由自由 金币可以自由铸造；自由兑换；自由输出 入。

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