exchange rates and european monetary ystem
TRANSCRIPT
FLEXIBLE VERSUS FIXED EXCHANGE
RATES, EUROPEAN MONETARY
SYSTEM, AND MACROECONOMIC POLICY COORDINATION
Savatore, 2015
Patcharawan Ubonloet
19 April 2016 GSPA NIDA
OUTLINE
Fixed and Flexible exchange rates
- Pros and Cons
- Optimum currency areas
European Monetary System and
The creation of the euro and
European Central Bank
Hybrid system
- Adjustable pegs, crawling pegs and managed
floating
International macroeconomic policy
coordination 2
FIXED AND FLEXIBLE EXCHANGE RATES
Pros and Cons
Optimum currency areas
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FIXED AND FLEXIBLE EXCHANGE RATES (ER)
Fixed ER More stability to small opened economy which is
subject to large internal shocks with few trading partners
Not allowing impact on decreasing in the volume of international trade and investment leading to destabilizing speculation and inflationary
Disturbance are monetary (inflation)
Flexible ER Believe that stability of speculation is
automatically adjusted by speculators
Suitable for economy that have diversified trade and
majorly facing disturbances from real sector abroad i.e. Technology
and is subject to large external shocks i.e. Rise in export leads to
appreciation of national currency
To achieve internal and external balance
It was good for control money supply. However, it is reduced today
by international capital flow. 4
FIXED AND FLEXIBLE EXCHANGE RATES (ER)
Pros Stabilizes speculation
Minimizes international trade and investment risks
Achieve price discipline which balance of payment disequilibria is fixed (no inflation) and immediate changes in exchange rate is impossible
Requires discipline in economic management
Cons Large holding of foreign reserve
required
Fixed rates can also be devalue/revalue
Loss of internal policy (interest rates) management freedom
Pros Allowing flexible rates to find its
own equilibrium
Protects economy from other countries’ economic volatility
Minimize policy delay/mistakes in using monetary policy
Prevent gov’t from setting ER at level other than equilibrium to benefit one sector of economy on expenses of others
Cons Greater volatility
Encourages speculation
Day-to-day fluctuation discouraging specialization in production and flow of trade and investment
Fixed ER Flexible ER
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OPTIMUM CURRENCY AREAS/BLOC
Developed by Robert Mundell and Ronald Mckinnon during 1960s
A group of nations whose national currencies are linked through permanently fixed exchange rates and the conditions that would make such an area optimum. The currencies of member nations could then float jointly with respect to the currencies of nonmember nations.
In other words, geographical region in which it would maximize economic efficiency to have entire region share a single currency. 6
OPTIMUM CURRENCY AREAS/BLOC
Advantages
Eliminates the uncertainty
Stimulating specialization in
production, flow of trade and investments
Single market and benefit from greater
economies of scale in production
Greater price stability and
discourage inefficient barter deals under inflationary circumstances
Saves the cost of interventions in foreign exchange markets
Emigration of workers from poorer to richer nations
Conditions
for benefits
1. Mobility of resources
2. Structural similarity
3.Willing to coordinate
fiscal, monetary & related policy
Disadvantages
Each member nation cannot pursue
its own independent stabilization and growth policies adjusted to its particularly circumstance
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EUROPEAN MONETARY SYSTEM AND
THE CREATION OF THE EURO AND EUROPEAN CENTRAL BANK
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EUROPEAN MONETARY SYSTEM AND
THE CREATION OF THE EURO AND EUROPEAN CENTRAL BANK
European Monetary System (EMS)
Main feature of EMS
Creation of European Currency Unit (ECU) weighted average of the currencies of the member nations
Allowing the currency of each EU member to fluctuate by maximum of 2.25 percent on either side of its central rate or parity and jointly floating against the dollar
Establishment of the European Monetary Cooperation Fund (EMCF) to provide short- and medium term balance-of-payment assistance to members
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TRANSITION TO MONETARY UNION
THREE-STAGE TRANSITION
1979
1991
1999
1998
EU to form EMS
Maastricht Treaty Convergence criteria
European Central Bank (ECB)
THREE-STAGE TRANSITION 1. Convergence of economic performance
and cooperation in monetary and fiscal
policy& removal of all restrictions to capital
movement
2. Creating a European Monetary Institute
(EMI) for European Central Bank (ECB)
3. Completion of monetary union by 1999
1989
European Monetary Union (EMU) The euro (€) were trade in financial markets
and common monetary policy by ECB
After 1993 Countries converted more to ECU
Value of ECU = $1.1042
Stability and Growth Pact (SGP) Budget deficit smaller than 3% of GDP to prevent
excessive money creation, inflation and a weak euro. German couldn't’ meet the target.
1997
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MAASTRICHT TREATY
Convergence Criteria to the Monetary Union
1998,most members countries met the most of the Maastricht criteria
Price stability
Inflation rate
< 1.5% point average of the three nations with
the lowest rate
Sustainable
public finance Gov’t debt
< 60% of GDP
Durability of convergence
Long-term interest rates < 2 points more than the
average interest rates of the three countries with the lowest
inflation rates
Sound public
finance
Budget deficit
< 3% of GDP
Exchange rate stability
Average exchange rate not falling by more than
2.25% of the average of the EMS for the 2 years
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THE CREATION OF THE EURO,
EUROPEAN CENTRAL BANK AND THE COMMON MONETARY POLICY
EMU have 12 members of EU that have adopted
the euro as their common currency and have
established the ECB to conduct their common
monetary policy. Euro notes and coin became
the sole legal tender. Even though the euro
fluctuated in relation to other currencies, the
exchange rate of the participating currency
remained rigidly fixed in terms of euros as
earlier decided in 1998.
ECB
The institution similar to the Federal Reserve
System in the U.S. that would not control the
money supply and issue the single currency of
the EU. It is responsible for the common EMU
monetary policy. It aims to pursue price
stability and political free.
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ECB VERSUS FED
European Parliament
has no power to
influence ECB’s decision
to prevent excessive
monetary stimulus and
thus inflation
Maastricht Treaty can
be amended by
legislations/voters in
member countries for ECB’s statute to change
Congress can pass laws
to reduce independency of FEB board
ECB FED
Criticized for being
undemocratic and
unresponsive to
economic needs of citizens
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CURRENCY BOARD ARRANGEMENTS (CBAS) AND DOLLARIZATION
CBA is the most extreme form of a fixed exchange rate system.
Adopted when in a financial crisis and to combat inflation. i.e. Hong Kong 1983 and Argentina 1991-2001
The exchange rate arrangement whereby the nation rigidly fixes the exchange rate of its currency to a foreign currency or basket of currencies. i.e. adopting the dollars as the nation’s currency.
Its central bank loses its ability to
1) Conduct an independent monetary policy by allowing the nations supply to increase or decrease only in response to balance-of- payments surpluses or deficits.
2) Act as lender of last resort
3) Collect seignorage from issuing own currency
Dollarization is further than CBA. It is the situation whereby a nation adopts another nation’s currency as its legal tender i.e. Panama&Ecuador
Advantages are
1) Avoiding cost of own currency to dollars and hedge foreign exchange risks
2) Inflation and interest rate similar to the U.S.
3) Avoid foreign exchange crises and the need for foreign exchange and trade controls
4) Fostering budgetary discipline and promote more rapid and full international financial integration
Disadvantages
1) Cost of replacing the domestic currency with the dollar
2) Loss of monetary and exchange rate policies independency
3) Loss of central bank as a lender of last resort to bail out domestic banks in case of crisis
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HYBRID SYSTEM
Adjustable pegs, crawling pegs and managed floating
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Nations monetary authority intervene in foreign exchange markets to smooth out short-run fluctuations in exchange rates without attempting to affect their long-run trend.
The monetary authority supply, out of international reserves, a proportion of any short-run excess demand for foreign exchange in the market (thus moderating the tendency of the currency depreciation) and absorb (to add to its reserves) a portion of any short-run excess supply of foreign exchange in the market (moderating the tendency of the currency appreciation)
HYBRID SYSTEM ADJUSTABLE PEGS, CRAWLING PEGS AND MANAGED FLOATING
The system which exchange rates or par values are periodically changed to correct bop disequilibria. The band of allowed fluctuation is very narrow.
Adjustable pegs
The system under which par values or exchange rates are changed by very small preannounced amounts at frequent and clearly specified intervals until the equilibrium exchange rate is reached.
Nation set par value preventing destabilizing speculation by manipulate short-term interest rates so as to neutralize profit from scheduled change in exchange rate.
Crawling pegs
Managed floating (Dirty float)
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INTERNATIONAL
MACROECONOMIC POLICY COORDINATION
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INTERNATIONAL MACROECONOMIC POLICY COORDINATION
The modifications of national economic policies in
recognition of international interdependence.
Obstacles
Lack of consensus about the functioning of
international monetary system i.e. Whether money
expansion leads to increased output and employment
or only inflation
Lack of agreement on policy mix required
because of identifying gains from the cost of
coordination and perhaps they are not very large or it
maybe of that inability to capture full benefits. 18
THANK YOU
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