1. Slide 1 of Slides developed by Jeff Madura, with additions and enhancements by Tim Richardson

2. Slide 2 of Slides developed by Jeff Madura, with additions and enhancements by Tim Richardson Government Influence on Exchange Rates Chapter 6

3. Slide 3 of Slides developed by Jeff Madura, with additions and enhancements by Tim Richardson Overview u u Examine exchange rate systems u u Explain how governments intervene to influence exchange rates u u Describe how intervention in exchange market can affect economic conditions

4. Slide 4 of Slides developed by Jeff Madura, with additions and enhancements by Tim Richardson Why Do We need to know Government involvement u u Internal u u National governments do things which have a domestic effect on the value of their own currency u u External u u Internationally, other governments do things which can effect the value of your currency

5. Slide 5 of Slides developed by Jeff Madura, with additions and enhancements by Tim Richardson Why Do We need to know Government involvement u u Internal u u By doing a bad job with inflation, or unemployment a National governments can be seen to be not operating effectively, and this will create negative confidence among currency traders and international business people

6. Slide 6 of Slides developed by Jeff Madura, with additions and enhancements by Tim Richardson Why Do We need to know Government involvement u u Internal u u By doing a bad job … the value of the currency will decline u u If it declines it makes it very difficult for consumers in that country to afford imported products u u therefore standard of living will decline

7. Slide 7 of Slides developed by Jeff Madura, with additions and enhancements by Tim Richardson Why Do We need to know Government involvement u u External u u Internationally, other governments do things... u u By using trade barriers and import taxes and other impediments which make it difficult for a country to export - this can deprive it of situations which can effect the value of its currency

8. Slide 8 of Slides developed by Jeff Madura, with additions and enhancements by Tim Richardson Why Do We need to know Government involvement u u External u u If currency is pegged then it can go up or down according to the rise and fall of the situation in another country

9. Slide 9 of Slides developed by Jeff Madura, with additions and enhancements by Tim Richardson Exchange Rate Systems u u Classified according to the degree by government controls them u u Fixed u u Freely floating u u Managed float u u Pegged

10. Slide 10 of Slides developed by Jeff Madura, with additions and enhancements by Tim Richardson Exchange Rate Systems u u Fixed – –currency fluctuation limited to narrow bands – –Bretton Woods Agreement (1944-1971) F F valued each currency in terms of gold F F permitted fluctuations of 1% from original rates F F meant you also had to have gold on hand – –lessened currency risk for MNCs

11. Slide 11 of Slides developed by Jeff Madura, with additions and enhancements by Tim Richardson Exchange Rate Systems u u Freely floating exchange rates – –market forces determine exchange rates – –advantages F F increases stability in global economy F F reduces maintenance of exchange rates by central banks – –disadvantages   may exacerbate a country’s economic problems

12. Slide 12 of Slides developed by Jeff Madura, with additions and enhancements by Tim Richardson Exchange Rate Systems u Managed Float exchange rates –a mix of fixed and freely floating characteristics –exchange rates fluctuate freely –government intervenes directly to manage the exchange rate

13. Slide 13 of Slides developed by Jeff Madura, with additions and enhancements by Tim Richardson Exchange Rate Systems u Pegged exchange rates –ties a currency’s value to a foreign currency or to some unit of account F examples include European Economic Community and the European Currency Unit –produces dependency upon the movement of the foreign currency

14. Slide 14 of Slides developed by Jeff Madura, with additions and enhancements by Tim Richardson Exchange Rate Systems u Potential barriers to a single European currency –meeting specified economic targets –impact of monetary policy F consolidation of European monetary policy

15. Slide 15 of Slides developed by Jeff Madura, with additions and enhancements by Tim Richardson Government Intervention u Reasons for intervention –smoothing exchange rates –establishing implicit exchange rate boundaries –responding to temporary disturbances

16. Slide 16 of Slides developed by Jeff Madura, with additions and enhancements by Tim Richardson Government Intervention Direct Intervention u Central bank actively trades on exchange market to influence currency values –attempt to weaken home currency F trade home currency for foreign currency –places downward pressure on home currency –attempt to strengthen home currency F exchange foreign currency for home currency –places upward pressure on home currency

17. Slide 17 of Slides developed by Jeff Madura, with additions and enhancements by Tim Richardson Government Intervention Direct Intervention u Nonsterilized intervention –intervention in exchange market without adjusting for the change in money supply F money supply increases with attempts to weaken home currency F money supply decreases with attempts to strengthen home currency

18. Slide 18 of Slides developed by Jeff Madura, with additions and enhancements by Tim Richardson Government Intervention Direct Intervention u Sterilized intervention –intervention in exchange market while making adjustments to avoid change in money supply F transact simultaneously in exchange markets and Treasury securities markets –strengthen home currency by: F 1) exchange home currency for foreign currency F 2) sell holdings of Treasury securities for home currency

19. Slide 19 of Slides developed by Jeff Madura, with additions and enhancements by Tim Richardson Government Intervention Indirect Intervention u Central banks affect currency values by influencing factors that determine exchange rates –increase or decrease money supply to move interest rates in desired direction

20. Slide 20 of Slides developed by Jeff Madura, with additions and enhancements by Tim Richardson Exchange Rate Target Zones u Proposed to reduce volatility in exchange rates of major currencies –suggest creating a central rate with specific boundaries –governments would be responsible for maintaining currencies within the zones –Louvre Accord established acceptable ranges F US intervention quickly declined over time

21. Slide 21 of Slides developed by Jeff Madura, with additions and enhancements by Tim Richardson Intervention as a Policy Tool u Impact of weak currency on economy –may stimulate foreign demand for products –may reduce imports –may boost exports and jobs u Impact of strong currency on economy –encourages greater demand for imports –constrains price increases through competition

22. Slide 22 of Slides developed by Jeff Madura, with additions and enhancements by Tim Richardson Summary u Exchange rate systems: –fixed rate, freely floating, managed and pegged u Direct intervention –buy or sell currencies on exchange market u Indirect intervention –influence economic factors that affect exchange rates