Fixed and Floating Exchange Rate.

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LOG
FIXED AND FLOATING
EXCHANGE RATES
INTERNATIONAL FINANCE
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CONTENTS
1 Evolution of IMS
2 Flexible Exchange Rate Regime
3 Role of International
4 Effects of BOP on Exchange Rate System
5 Floating Exchange Rate
6 Fixed Exchange
7 Exchange Arrangements
EVOLUTION OF INTERNATIONAL
MONETARY SYSTEM
BIMETALLISM
v Double standard in that free coinage was
maintained for both gold and silver
v Both gold & silver used as a means of international
payment
v The abundant metal was used as money
E.g. -
When gold poured into the market in 1850s, the
value of gold depressed, causing overvaluation of
gold under the French official ratio, which equated
a gold franc to a silver franc 15.5 times as heavy.
So the franc became a gold currency
CLASSICAL GOLD STANDARD

INTER WAR PERIOD

v Similar to Gold Standard
but now central banks’
reserves consist of gold
and currencies.
v As the gold standard,
the gold exchange
standard restrains
excessive monetary
growth throughout the
world.
v But it allows more
flexibility in the growth
BRETTON WOODS
v U.S. dollar is the reserve currency.
v Every central bank fixes the dollar exchange rate of its
currency through intervention.
v Drawbacks of the Reserve-Currency Standard:
– U.S. occupies a special position because it never has to
intervene in the foreign exchange market
– US can use its monetary policy for macroeconomic
stabilization
– US has the power to affect its own economy, as well as
foreign economies by using monetary policy
– Other central banks have to import the monetary policy
of the US.
– This inherent asymmetry led eventually to policy
disputes within the system
FLEXIBLE EXCHANGE RATE

v 1973 to th e prese nt.
v Aft er th e brea ku p of t he Bre tt on
Woods syste m, th e cu rr enci es o f
th e indust rialize d co untri es’
exch ange rate s were all owed to
fl oat i n Ma rch 1 973.
v Cu rr enci es of U. S., Ja pan,
Ge rma ny and G reat B rit ain
co nti nues to f lo at again st each
oth er to th e prese nt.
ROLE OF IMF
Main goal of the IMF was:
Avoiding repetition of the chaos that occurred
between the wars through a combination of
discipline and flexibility
Discipline Flexibility
Mean that: Meant that:
•Need to maintain a fixed •While monetary discipline was a
exchange rate put a brake central objective of the
on competitive devaluations agreement, a rigid policy of fixed
and brought stability to the exchange rates would be too
world trade environment. inflexible.
•IMF was ready to lend foreign
currencies to members to tide
•fixed exchange rate regime
them over during short periods
imposed monetary of balance-of-payments deficit,
discipline on countries, when a rapid tightening of
thereby curtailing price monetary or fiscal policy would
inflation hurt domestic employment
Rate the government or Determined by the

central bank sets and private market through
maintains as the official supply and demand
exchange rate.
EFFECTS ON BOP OF EXCHANGE RATE
If currency value rises
If currency value falls

FLOATING EXCHANGE RATE

Monetary Policy Autonomy

v Freedom (autonomy) for domestic monetary
policy
v No country is forced to import inflation (or

deflation) from abroad.
v Flexibility and the possibility for the country’s

economy to be quickly adjusted to changing
market conditions.
Symmetry
Floating exchange rates
remove two main asymmetries
of the Bretton Woods system
and allow:
– Central banks abroad to

be able to determine their own
domestic money supplies
– The U.S. to have the
same opportunity as other
countries to influence its
exchange rate against foreign
Exchange Rates as Automatic

Stabilizers
v Floating rates promote swift and relatively
painless adjustment to certain shocks in
the goods market, such as a fall in foreign
demand for the country’s exports.
v Figure 1 shows that a temporary fall in a
country’s export demand reduces that
country’s output more under a fixed rate
than a floating rate.
FIXED EXCHANGE RATE

Discipline
v When central banks are free
from the obligation to fix their
exchange rates, they might
embark on inflationary policies.
v A stable (fixed) currency acts
as a discipline on producers to
keep their costs and prices
down and may lead to greater
pressure for exporters
Destabilizing speculation and

money market disturbances
v Floating exchange rates allow
destabilizing speculation.
§ Countries can be caught in a “vicious circle” of
depreciation and inflation.
v Floating exchange rates make a

country more vulnerable to money
market disturbances.
International Trade and

Investment
v Trade and Investment:
– Currency stability can help to promote trade and
investment because of lower currency risk.
– Exporters and importers face lower exchange risk.
– International investments face lower uncertainty
about their payoffs.
v Reductions in the cost of currency
hedging
– With fixed exchange rates, businesses have to spend
less on currency hedging if they know that the currency will
hold its value in the foreign exchange markets (hedging
involves risk)
The illusion of greater autonomy

v Floating exchange rates
increase the uncertainty in
the economy without really
giving macroeconomic
policy greater freedom.
– A currency depreciation raises
domestic inflation due to higher wage
settlements.
Who Uses Fixed and Float

List of exchange arrangements
§ Floating rates are used by many countries

• Rich & poor
• Large & small
• All over the world
§ Pegged rates are used mostly by small
countries
§ Largest number of countries are between fixed
and floating
Exchange Arrangements
Exchange Rate Regimes In

Practice
Currently:
v14% of IMF members follow a free float policy
v26% of IMF members follow a managed float

system
v28% of IMF members have no legal tender of

their own
vRemaining countries use less flexible systems

such as pegged arrangements, or adjustable pegs
Exchange Rate Regimes In

Practice
Exchange Rate Policies, IMF Members,
2006
Exchange Rate System in India
v Rupee linked to GBP till 1975
v In 1975, Rupee was delinked from GBP and

pegged to a multi currency basket of
currencies
v Devaluation of Re in 1991
v 1992 –India moved from fixed regime of

currency to a more controlled flexi regime,
initiating liberalisation & globalisation.
v Partial convertibility of Re, 40% to be sold

to RBI and 60% at market rates
v 1st March 1993 – Re came to be traded

freely in the market, subject to exchange
control and trade control regulations
v USD became the intervention currency

EXCHANGE RATES AT 16.50

Conclusion
v Replacement of new factors by new ones in
the era of Globalization, Informatization
and technical progress play the leading role.
v Need of greater flexibility.
v In case of poor economical policy and non-

balanced government management of the
economy can reduce all the advantages of
flexibility.
v Liberalization of financial markets exceed

the risks of instability, and the future is
promising greater perspectives for the
countries whose financial system is based
on the floating exchange rate system
v Flexible exchange rate system offers better

opportunities for successful economical
development than fixed exchange rate
system.
LOG
Thank You !

Fixed and Floating Exchange Rate.

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Fixed and Floating Exchange Rate.

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www.themegallery.

2 Flexible Exchange Rate Regime

4 Effects of BOP on Exchange Rate System

5 Floating Exchange Rate

CLASSICAL GOLD STANDARD

INTER WAR PERIOD

FLEXIBLE EXCHANGE RATE

Rate the government or Determined by the

EFFECTS ON BOP OF EXCHANGE RATE

If currency value rises

If currency value falls

FLOATING EXCHANGE RATE

Monetary Policy Autonomy

v No country is forced to import inflation (or

v Flexibility and the possibility for the country’s

– Central banks abroad to

Exchange Rates as Automatic

FIXED EXCHANGE RATE

Destabilizing speculation and

v Floating exchange rates make a

International Trade and

The illusion of greater autonomy

Who Uses Fixed and Float

§ Floating rates are used by many countries

Exchange Rate Regimes In

v14% of IMF members follow a free float policy

v26% of IMF members follow a managed float

v28% of IMF members have no legal tender of

vRemaining countries use less flexible systems

Exchange Rate Regimes In

Exchange Rate System in India

v Rupee linked to GBP till 1975

v In 1975, Rupee was delinked from GBP and

v 1992 –India moved from fixed regime of

v Partial convertibility of Re, 40% to be sold

v 1st March 1993 – Re came to be traded

v USD became the intervention currency

EXCHANGE RATES AT 16.50

v Need of greater flexibility.

v In case of poor economical policy and non-

v Liberalization of financial markets exceed

v Flexible exchange rate system offers better

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