1. Module Exchange Rate Policy KRUGMAN'S MACROECONOMICS for AP* 43 Margaret Ray and David Anderson

2. What you will learn in this Module : The difference between fixed exchange rates and floating exchange rates Considerations that lead countries to choose different exchange rate regimes This presentation covers Modules 43- 44.

3. Exchange Rate Policy Governments have more power to influence nominal exchange rates than other prices Exchange rates are important to countries where exports and imports are a large fraction of GDP

4. To Float or Not to Float To Float or Not to Float Fixed Target Float Float Team assignment: Define, Example, Pros / Cons

5. Figure 43.1 Exchange Market Intervention Ray and Anderson: Krugman’s Macroeconomics for AP, First Edition Copyright © 2011 by Worth Publishers How can an exchange rate be fixed?

6. How Can an Exchange Rate Be Held Fixed? How Can an Exchange Rate Be Held Fixed? Exchange Market Intervention Foreign Exchange Reserves Foreign Exchange Controls

7. Last Resort Last Resort Devaluation: original fixed exchange rate above market equilbrium. Revaluation: original rate is below market equilibrium.

8. The Exchange Rate Regime Dilemma The Exchange Rate Regime Dilemma Pros of Fixed Exchange Rates Facilitates trade by creating certainty about the exchange rate Acts as a check on inflationary policies Makes borrowing in foreign currency more predictable. Undervalued currencies help exports.

9. The Exchange Rate Regime Dilemma The Exchange Rate Regime Dilemma Cons of Fixed Exchange Rates: Requires large foreign currency reserves May divert monetary policy May lead to uncompetitive exports And to over borrowing.

10. Defending a currency Defending a currency Albernian fixed rate problem Krugman page 454 # 12 Show solution graphically.

11. Floating Rates Floating Rates Let the market determine the FX rate. Most common regime – especially among large economies. No government intervention (officially)

12. Floating Rates – Pros and Cons Floating Rates – Pros and Cons Pros:  Frees up domestic monetary and fiscal policy.  May help export competitiveness. Cons:  Difficult to plan long-term trade or investment.  Companies bear cost of hedging the risk.

13. Managed Float Managed Float Keep FX rate stable within a range. Pros: Many of the benefits of fixed rates at less cost. Cons: Many of the cons of fixed rates. Can break down in times of stress (e.g. Asian debt crisis of 1997).

14. Defending a currency Defending a currency Singaporian dollar intervention – FRQ 2011B.

15. Summary – Pick Your Poison Summary – Pick Your Poison Fixed Float Stable foreign trade and finance, but…. Less domestic flexibility. Unstable foreign trade and finance, but … More domestic flexibility.