Deck 19: Government Policies Toward the Foreign Exchange Market

Question 1

What is the difference between an adjustable peg and a crawling peg

Answer 1

The difference between Adjustable peg and Crawling peg are explained as below:
1. Adjustable Peg System: It is the in which member countries fix the exchange rate of their currencies against one particular currency. The exchange rate is fixed for particular period of time. However, a currency can be repegged at lower rate (known as devaluation) or a higher rate (known as revaluation) under certain circumstances even before the expiry of the fixed period of time.
2. Crawling Peg System: This system is a midway between dirty floating system and the adjustable peg system. According to this system, a country specifies the parity value for its currency and permits a small variation (+/- percent) around that parity. The parity rate is adjusted regularly as required by the international reserve of the country changes in money supply and changes in the prices.

Question 2

"The emergence of expectations that a country in the near future will impose exchange controls will probably result in upward pressure on the exchange rate value of the country's currency." Do you agree or disagree Why

Answer 2

Yes, I agree with the statement that has been mentioned in this question because Every countries government often have other reasons for opting policies toward the foreign exchange market. A government of a country may want to keep the exchange-rate value of its currency low, preventing appreciation or promoting depreciation. This benefits certain activities or groups in the country, including the country's exporters and import-competing businesses.
In a different setting, a country's government may want to the opposite: keep the exchange-value of its currency high, preventing depreciation or promoting appreciation. This can benefit other activities or groups -for instance, buyers of imports. It can also be used as part of an effort to reduce domestic inflation by competitive pressure of low import prices.
The government may believe that it is defending national honor or encouraging national pride by maintaining a steady exchange rate or a strong currency internationally. Devaluation or depreciation may be feared as confirmation of the ineptitude of the government in selecting policies.

Question 3

The Pugelovian government is attempting to peg the exchange rate value of its currency (the pnut, pronounced "p'noot") at a rate of three pnuts per U.S. dollar (plus or minuS₂ percent). Unfortunately, private market supply and demand is putting downward pressure on the pnut's exchange rate value. In fact, it appears that under current market conditions, the exchange rate would be about 3.5 pnuts per dollar if the government did not defend the pegged rate.
a. How could the Pugelovian government use official intervention in the foreign exchange market to defend the pegged exchange rate
b. How could the Pugelovian government use exchange controls to defend the pegged exchange rate
c. How could the Pugelovian government use domestic interest rates to defend the pegged exchange rate

Answer 3

a) Official reserve transaction will be done in the foreign exchange market to defend the pegged exchange basically these are the transaction which has been done by central bank of a nation that cause change in official reserves of the nation. Where a country used to purchase or sale its own currency in the foreign exchange market in the exchange for foreign currencies or other currency denominated assets. In the balance of payments, the purchase of its own currency is to be shown in credit side and while on the other hand a sale is in debit side.
b. The government can impose some form of exchange control to maintain or attract the rate of exchange with the help demand or supply of foreign exchange in the market. Similar to the approach would use trade controls such as tariffs or quotas to attempt to accomplish this result.
c. The government can change domestic interest rates to attract inflow of capital in short-term, thus maintaining or attracting the exchange rate by changing the position of demand and supply in the market.

Question 4

Consider the international currency experience for the period of the gold standard before 1914.
a. What type of exchange rate system was the gold standard and how did it operate
b. What country was central to the system What was the role of this country in the success of the currency system
c. What was the nature of economic shocks during this period
d. What is the evidence on speculation and speculative pressures on exchange rates during this period

Question 5

Consider the international currency experience for the Bretton Woods era from 1944 to the early 1970s.
a. What type of exchange rate system was the Bretton Woods system How did it operate
b. What country was central to the system What was the role of this country in the success of the currency system
c. What is the evidence on speculation and speculative pressures on exchange rates during this period

Question 6

The current exchange rate regime is sometimes described as a system of managed floating exchange rates, but with some blocs of currencies that are tied together.
a. What are the two major blocs of currencies that are tied together
b. What are the major currencies that float against each other
c. Given the discussion in this chapter and the previous chapters of Part III, how would you characterize the movements of exchange rates between the U.S. dollar and the other major currencies since the shift to managed floating in the early 1970s