Exchange Rate System

Foreign Exchange Control – Definition and Objectives

Exchange controls, like currency devaluations, form a part of expenditure-switching policy package. Because, they, too, like devaluation, aim at directing domestic spending away from foreign supplies and investment. Exchange controls try to divert domestic spending into consumption of domestically produced goods and services on the one hand and into domestic investment on the other.

Exchange controls represent the most drastic means of BOP adjustment. A full-fledged system of exchange controls establishes a complete government control over the foreign exchange market of the country. Foreign exchange earned from exports and other sources must be surrendered to the government authorities. The available supply of foreign exchange is then allocated among the various buyers (importers) according to the criterion of national needs and established priorities.… Read the rest

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Balance of Payments (BOP) and Exchange Rates

The International Monetary Fund (IMF) defines the BOP as a statistical statement that systematically summarizes, for a specific time period, the economic transactions of an economy with the rest of the world. BOP data measures economic transactions include exports and imports of goods and services, income flows, capital flows, and gifts and similar €•one-sided transfer payments. The net of all these transactions is matched by a change in the country‘s international monetary reserves.

The significance of a deficit or surplus in the BOP has changed since the advent of floating exchange rates. Traditionally, BOP measures were used as evidence of pressure on a country‘s foreign exchange rate.… Read the rest

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Ideal currency and a sound currency system

Attributes of the Ideal Currency:

If the ideal currency existed in today‘s world, it would possess three attributes:

  • Fixed value. The value of the currency would be fixed in relationship to other major currencies so that trades and investors could be relatively certain of the foreign exchange value of each currency in the present and into the near future.
  • Convertibility. Complete freedom of monetary flows would be allowed, so that traders and investors could willingly and easily move funds from one country and currency to another in response to perceived economic opportunities or risks.
  • Independent monetary policy. Domestic monetary and interest rate policies would be set by each individual country so as to pursue desired national economic policies, especially as they might relate to limiting inflation, combating recessions, and fostering prosperity and full employment.
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Global Scenario of Exchange Rate Arrangements

Firms engaged in international business must have an idea about the exchange rate arrangement prevailing in different countries as this will facilitate their financial decisions. In this context, it can be said that over a couple of decades, the choice of the member countries has been found shifting from one form of exchange rate arrangement to the other, but, on the whole, preference for the floating rate regime is quite evident. At present as many as 35 of a total of 187 countries have an independent float, while the other 51 countries have managed floating system. The other 7 countries have a crawling peg, while 53 countries have pegs of different kinds.… Read the rest

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An Eclectic Currency Arrangement, 1973-Present

Since March 1973, exchange rates have become much more volatile and less predictable than they were during the €•fixed €– exchange rate period, when changes occurred infrequently. In general the dollar has been volatile and has weakened somewhat over the long run. On the other hand, the Japanese yen and German mark have strengthened. The emerging market currencies have been exceptionally volatile and have generally weakened.

In the wake of the collapse of the Bretton Woods exchange rate system, the IMF appointed the Committee of Twenty which suggested various options for the exchange rate arrangement. These suggestions were approved at Jamaica during February 1976 and were formally incorporated into the text of the Second Amendment to the Articles of Agreement, which came into force from April 1978.… Read the rest

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Fixed Exchange Rates, 1945-1973

Fixed Exchange Rates, 1945-1973

The currency arrangement negotiated at Bretton Woods and monitored by the IMF worked fairly well during the post-World War II period of reconstruction and rapid growth in world trade. However, widely diverging national monetary and fiscal policies, differential rates of inflation, and various unexpected external shocks eventually resulted in the system‘s demise. The U.S. dollar was the main reserve currency held by central banks and was the key to the web of exchange rate values. Unfortunately, the United States ran persistent and growing deficits on its balance of payments. A heavy capital outflow of dollars was required to finance these deficits and to meet the growing demand for dollars from investors and businesses.… Read the rest

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