BMS 1B

NAME : SHREYA GUPTA

ROLL NO: 21216

Exchange Rates and the Market for Foreign Exchange :

Foreign Exchange is a term that refers to an aggregate of foreign currencies.
Demand for foreign currencies by domestic residents is called the demand for foreign
exchange. The foreign exchange market is the market in which national currencies are
traded for one another.

EXCHANGE RATE DETERMINATION:

FLEXIBLE EXCHANGE RATES

A system of exchange rate determination, in which there is no central bank intervention, is a
flexible exchange rate system or, as it is sometimes called, a
floating rate system. An exchange rate system or regime is a set of international rules
governing the setting of exchange rates. A completely flexible or floating rate system is
a particularly simple set of rules for the central banks to follow; they do nothing to
directly affect the level of their exchange rate. The exchange rate is market determined.

FIXED EXCHANGE RATES:

An international monetary system is a set of rules organizing exchange rate determina-
tion and agreeing on which assets will be official reserve assets. An example of a fixed
exchange rate system is the post-World War I Bretton Woods system. The international
monetary agreements that made up this system were negotiated near the end of the war
(at Bretton Woods, New Hampshire). The IMF was set up to administer the Bretton
Woods system. According to IMF rules, the United States was to set a parity, or par
value, for its currency in terms of gold. Other nations would set parities for their curren-
cies in terms of dollars, which with the dollar tied to gold also fixed the gold value of
these other currencies. The United States agreed to maintain convertibility between the
dollar and gold at the fixed price (originally $35 per ounce). Other countries agreed to
maintain convertibility (after a period of postwar adjustment) with the dollar and other
currencies but not with gold. The other countries agreed to maintain their exchange
rates vis-à-vis the dollar within a 1 percent range on either side of the parity level. The
differential responsibility of the United States compared to other IMF members con-
cerning convertibility into gold seemed sensible because, at the time, the United States
had approximately two-thirds of the official world gold reserves.The Bretton Woods System
included 44 countries. These countries were brought together to help regulate and promote
international trade across borders. As with the benefits of all currency pegging regimes,
currency pegs are expected to provide currency stabilization for trade of goods and services as
well as financing All of the countries in the Bretton Woods System agreed to a fixed peg against
the U.S. dollar with diversions of only 1% allowed. Countries were required to monitor and
maintain their currency pegs which they achieved primarily by using their currency to buy or sell
U.S. dollars as needed. The Bretton Woods System, therefore, minimized international currency
exchange rate volatility which helped international trade relations. More stability in foreign
currency exchange was also a factor for the successful support of loans and grants
internationally from the World Bank.