What is the cause of today’s inflation?

Cost-push inflation

Exchange rates: fixed exchange rates and floating exchange rate

Let’s see how they work.

Another term for fixed exchange rate is pegged exchange rate; you peg your
currency against another currency. When you fix exchange rate you determine
the parity of exchange rate. You need to have enough stocks of US dollars in your
central bank. Whenever AZN depreciates you need to prevent that depreciation.
In the foreign exchange market when there is increased demand of US dollar
what should US dollar do? It should appreciate. But how do you prevent that?
You constantly provide dollars into the market. That is what happened in the
first devaluation (2015). At the period a lot of people began turning to banks to
buy US dollars. Because previously devaluation process had taken place in Russia
and there were sanctions against Russia and oil price was falling fundamentally.
So, everyone understood that sooner or later in this country devaluation is going
to take place. So, Central Bank suddenly loses all reserves. But Central Bank has
to make sure that it supplies enough dollars. Then it was supplying a lot of
dollars all of a sudden because of increasing demand. What is the problem with
it? It was at the time getting less dollars and supplying less dollars. Before it was
getting a lot of dollars from the oil fund. In other words, Central Bank is receiving
less and it has to supply more and more. In order to keep the parity, it constantly
needs to supply. If it doesn’t, it will appreciate. And in that process Central Bank
realizes that if it continues that way it is going to lose all its reserves. What is the
way out? Devaluation (I’m going to devalue so that I give you less dollars now as
I have to supply less dollars)

Why do countries actually prefer to fixed exchange rate? Most currencies are
floating exchange rates (US dollar, euro, japan yen) because they are powerful
currencies. What makes currency powerful? Export of the country

But is US actually exporting that much? Trump constantly keeps tracing about
trade deficit. But current account deficit in US is balanced and is adjusted to
capital account surplus. In other words, it (not to export) is not a problem for US
because there is so much interest in exponential sector, into buying its bonds
into buying its debts. It is the largest financial sector/market in the world. And it
is too big and reliable to fail. So, it is not a problem in the case of US.

But in the case of Azerbaijan, if you don’t export anything, your currency can
never stay the same level. Capital account and current account must always be
balanced. Current account surplus meets capital account deficit.

So why would countries prefer fixed exchange rate? It is primarily those

countries mono exporters, oil dependent countries because they stability.
Without fixed exchange rate the Dutch disease would have been much worse in
the case of Azerbaijan. The AZN would have appreciated fundamentally. Central
Bank didn’t allow it through its intervention into the foreign exchange market.
How? The Central Bank was constantly supplying extra AZN into the foreign
exchange market. Where does the oil fund change that money? Oil fund needed
to transfer money into the state budget. The oil fund is exchanging it in the
foreign exchange market. When oil fund brings so much money into the foreign
exchange market AZN must appreciate. But in order to keep the parity Central
Bank has to supply extra money.

Fixed but adjustable exchange rate

The exchange rate is fixed but if you have serious problems in your economy you
can adjust it. This was the system in European countries. Was our system fixed
but adjustable? NO

In this system if you have serious balance of payment problem, which means
that terms of trade are in serious decline and there is a lot pressure on your
currency, you can adjust it. Fixed exchange rate gives more stability to an
investor in particular. It is very similar to gold standard.

In the floating exchange rate central bank does nothing. It is the value of the
currency that is determined by the market (foreign exchange market; supply and
demand primarily). Floating exchange rate can also have manageable float. In
managed float, the currency is left applaud but the central bank having right to
intervene. From time to time, it intervenes, it manages. If things go very badly,
central bank may intervene from time to time. That is manageable float.

And there is a fourth one, which is crawling peg- a currency is pegged to another
one. In other words, you say that my currency is 1 equals 0.78 and it is fixed
exchange rate. But there can be changes/fluctuations within 10% or 15%. There
I’m not going to intervene. That is called crawling peg. 10-15% changes may
occur. There I’m not going to intervene. But when it is broader than that then I’m
going to intervene.

Managed float is easier to understand in the case of Azerbaijan.