International Economic II

1. International Economic II Lecture 05 Government Policies toward the Foreign Exchange Market （政府的外汇市场政策）

2. Objectives The first half of this chapter examines types of government policies toward the foreign exchange market and provides analysis of government intervention and exchange controls. (Part I) The second half examines the actual policies that governments have adopted during the past 130 years. (Part II)

3. Part I Concepts and Analysis of the Foreign Exchange Policies 对外汇政策的理论分析

4. Why will the government intervene in the foreign exchange market?

5. Why will the government intervene in the foreign exchange market? • To reduce variability in exchange rates. • To keep its currency’s value high or low. • To reduce domestic inflation. • To defend national honor or encourage national price by maintaining a steady exchange rate or a strong currency internationally.

6. Framework of Government’s FX Policies Government’s FX Policies Policies towards the Exchange Rate itself (Price) Policies that permit or restrict access to the foreign exchange market (Quantity) Floating Exchange Rate Fixed Exchange Rate • No Restriction • Exchange Control • Clean Float • Dirty Float • (Managed Float) • Pegged Exchange Rate • Adjustable Peg • Crawling Peg

7. 1. Floating Exchange Rate • Clean Float: The government permits private market demand and supply to set the exchange rate with no direct involvement by government officials 自由浮动汇率（清洁浮动汇率）――市场的供给和需求完全是私人（非官方）活动决定，浮动汇率将随着私人市场的供给与需求变化而变化，这是一种具有完全灵活性的极端情况

8. 1. Floating Exchange Rate • Managed Float/Dirty Float: The monetary authorities buy or sell foreign currency (in exchange for domestic currency) to alter the configuration of supply and demand, and thus influence the exchange rate. 管理浮动汇率（肮脏浮动汇率）货币当局进入外汇市场买入和卖出外汇（或与本币进行交换），从而影响均衡汇率水平。

9. 1. Floating Exchange Rate Thinking about the following Questions: • Tell me the possible reasons of supporting or opposing the floating exchange rate system? • Do import restrictions lead to rising total employment in one country?

10. Possible Reasons of Supporting or Opposing Floating Exchange Rate • The Case for Floating Exchange Rate --Monetary Policy Autonomy --Symmetry --Exchange Rate as Automatic Stabilization

11. Possible Reasons of Supporting or Opposing Floating Exchange Rate • The Case against Floating Exchange Rate （Ad hoc System) --Discipline (“Inflation Bias”) --Destabilizing Speculation and Money Market Disturbances --Injury to International Trade and Investment --Uncoordinated Economic Policies --The illusion of Greater Autonomy

12. Do import restrictions lead to rising total employment in one country? As long as this country maintains a floating exchange rate, the implementation of import restrictions to help one industry will gradually shift jobs from other industries in the economy to the protected industry, with no significant impact on aggregate employment.

13. 2. Fixed Exchange Rate 2.1 What to Fix to? 2.2 When to Change the Fixed Rate? 2.3 How to Defend the Fixed Value?

14. 2.1 What to Fix to? • Gold (a century ago) • The U.S. Dollar/ One Single Currency （Since the end of World War II） • The Average Value of a Number of Other Currencies

15. Gold • Disadvantages of Gold --Limited Output --Unbalanced Allocation --Fluctuating Price --Extra Costs • Advantages of Gold --Ideal hedging measure --”War-chest” Motive

16. The U.S. Dollar/ One Single Currency • The U.S. Dollar --The Bretton Woods Era (1944-1971) • Pegging to a single currency is generally done by developing nations whose trade and financial relationships are mainly with a single industrial country partner.

17. The Average Value of a Number of Other Currencies • Why would a country choose to fix to a “basket” of other currencies? • What basket of currencies might the country fix to? -- Special Drawling Rights (SDR) -- A country can create its own basket

18. Special Drawling Rights (SDR) • SDR--a basket of the four major currencies in the world • With effect from Jan 1, 2008, the IMF has determined that four currencies in the SDR valuation basket will be assigned the following Weights based on their roles in international Trade and Investment: U.S. dollar (44%), euro (34%), Japanese yen (11%), Pound Sterling (11%) • SDR and International Settlement

19. 2. Fixed Exchange Rate 2.1 What to Fix to? 2.2 When to Change the Fixed Rate? 2.3 How to Defend the Fixed Value?

20. 2.2 When to Change the Fixed Rate？ • Pegged Exchange Rate (Never, not Credit) • Adjustable Peg (Seldom) • Crawling Peg (Often) • What factors can influence the issue of when to change the pegged rate?

21. Pegged Exchange Rate (Never)钉住汇率 • Never is a polar case, but it probably is not completely credible (and we often then speak of a pegged exchange rate instead of a fixed exchange rate)

22. Adjustable Peg (Seldom)可调整的固定汇率（可调整的钉住汇率） • In the fact of a substantial or “fundamental” disequilibrium in the country’s international position, the government may change the pegged-rate value, this approach is called an adjustable peg • The Bretton Woods System (1944-1971)

23. Crawling Peg (Often)蠕动钉住汇率下（爬行钉住汇率） • With a crawling peg, the peg value is changed often (for instance, monthly) according to a set of indicators or according to the judgment of the government monetary authority. 在蠕动钉住汇率下（爬行钉住汇率），钉住汇率值常常（例如每个月）根据一组数据或政府货币当局的意图进行调整。

24. What factors can influence the issue of when to change the pegged rate? • The choice of the width of the allowable band is closely related to the issue of when to change the pegged rate.

25. 2. Fixed Exchange Rate 2.1 What to Fix to? 2.2 When to Change the Fixed Rate? 2.3 How to Defend the Fixed Value?

26. 2.3 How to defend the Fixed Value? • Official Intervention • Exchange Control • Alter domestic interest rates • Adjust the country’s whole macroeconomic position • Switch to a floating exchange rate

27. 2.3.1 Official Intervention a. Defense against Depreciation b. Defense against Appreciation c. Temporary Disequilibrium d. Disequilibrium That is Not Temporary

28. a. Defense against Depreciation • Mechanism: If the country's currency is experiencing pressure toward depreciation, the country's monetary authority can defend the fixed rate by entering the foreign exchange market to buy domestic currency and sell foreign currency.

29. Figure 6.1 Intervention to Defend a Fixed Rate:Preventing Depreciation of the Country’s Currency

30. a. Defense against Depreciation • Effects: Through intervention, the monetary authority is financing the deficit in its official settlement balance. • Where does the country’s monetary authority get the dollars to sell into the FX market? • What is the implication of buying domestic currency from the foreign exchange market?

31. Where does the country’s monetary authority get the dollars to sell into the FX market? • Official International Reserve Assets --Foreign Exchange Assets --Reserve Position with the IMF --Special Drawling Rights --Gold • Borrows the Dollars -- Official (Swap Lines) -- Private (Secret) • Reserve Currency (Deficits without Tears) 国际储备： 各国中央政府为了弥补国际收支逆差和保持汇率稳定而持有的国际间可以接受的一切资产 外汇资产： 一国政府所持有的可以自由兑换的外币以及短期金融资产 SDR实际上是一种允许各国借入美元的信贷额度，但SDR被当作储备是因为一国可以自动从信贷额度内提取贷款。 储备头寸（普通提款权）： 国际货币基金组织的会员国按规定从基金组织提取一定数额款项的权利，是IMF中最基本的一项贷款。

32. What is the implication of buying domestic currency from the foreign exchange market? By buying domestic currency, the monetary authority is removing domestic money from the economy, which tends to lower the domestic money supply unless the authority separately takes action of sterilization to restore the domestic money back into the economy.

33. 2.3.1 Official Intervention a. Defense against Depreciation b. Defense against Appreciation c. Temporary Disequilibrium d. Disequilibrium That is Not Temporary

34. b. Defense against Appreciation • Mechanism: Buying the U.S. dollars and Selling Domestic Currencies

35. Figure 6.3 Intervention to Defend a Fixed Rate:Preventing Appreciation of the Country’s Currency

36. b. Defense against Appreciation • Effects: It will result in an official settlements balance surplus • What does the country’s monetary authority do with the dollars that it obtains from the FX market? It adds these dollars to its official international reserve holdings (or, if appropriate, repays prior official borrowings of dollars)

37. b. Defense against Appreciation • What is the implication of selling domestic currency into the FX market? This will expand the domestic money supply unless the authority separately takes another action to remove the additional domestic money from the economy.

38. 2.3.1 Official Intervention a. Defense against Depreciation b. Defense against Appreciation c. Temporary Disequilibrium d. Disequilibrium That is Not Temporary

39. c. Temporary Disequilibrium • Key Issue of Official Intervention: The length of time for which the intervention must continue. • Financing temporary deficits and surpluses is better than letting the exchange rate float around • Conditions to meet

40. Temporary disequilibrium

41. 2.3.1 Official Intervention a. Defense against Depreciation b. Defense against Appreciation c. Temporary Disequilibrium d. Disequilibrium That is Not Temporary

42. d. Disequilibrium That is Not Temporary If the disequilibrium is ongoing or fundamental rather than temporary, then intervention alone is not likely to be able to sustain the fixed exchange rate. Instead, the government must shift to one of the other defenses or devalue. • Pressure toward depreciation (deficit imbalance) • Pressure toward appreciation (surplus imbalance)

43. d. Disequilibrium That is Not Temporary Pressure toward Appreciation Ongoing Deficit Speculator or investor’s one-way speculative gamble facing pressure toward depreciation sell domestic currency and buy foreign currency official intervention to sell foreign currency hastening the loss of reserves official reserves will run low losing ability to borrow foreign exchange shift to one of the other three defenses or surrender (devaluate)

44. d. Disequilibrium That is Not Temporary Pressure toward Appreciation • Mechanism: Ongoing Surplus Pressures toward appreciation buy foreign currency accumulates large international reserves

45. d. Disequilibrium That is Not Temporary Pressure toward Appreciation • Problems of large international reserves: --The basic rate of return on this particular form of national wealth tends to be low --the value of foreign exchange assets will decline if the country eventually must “retreat” by revaluating its own currency.

46. d. Disequilibrium That is Not Temporary • Fundamental Disequilibrium calls for adjustment, not merely financing. Unfortunately, it is not easy to judge whether an imbalance is temporary or not.

47. 2.3 How to defend the Fixed Value? • Official Intervention • Exchange Control • Alter domestic interest rates • Adjust the country’s whole macroeconomic position • Switch to a floating exchange rate

48. 2.3.2 Exchange Control

49. 2.3.2 Exchange Control • Mechanism: Exporters are required to turn over all the revenues from foreign buyers to the U.S. government, the government, in turn, givers them $1 for each pound • Ration the right to buy foreign Exchange (e.g. public auction-by-mail ) • Earning Allocation :DCAF • A loss of well-being on society as a whole :CEA

50. 2.3.2 Exchange Control • Other Social Effects and Costs: --Government may allocate the right to buy foreign currency at the low official rate according to more complicated rules rather than public foreign currency auctions --Efforts to evade the exchange control is predictable • What Good Purpose are the exchange controls intended to serve?