Universitas Islam Indonesia – Faculty of Economics

Chapter 6
GOVERNMENT INFLUENCE ON EXCHANGE RATE
 Our Topics Today!

1 Exchange Rate System

3 Government Intervention

5 Intervention as a Policy Tool

Government Influence on Exchange Rate 2

 History of Foreign Exchange
1944-1971
1876-1913
The governments should
intervene to prevent exchange
rates from moving more than 1
Each currency was % above/below their
convertible into gold at a established levels
specified rate (Bretton Woods Agreement)
Government Influence on Exchange Rate
1973
Floating Exchange Rate
The currency were allowed
to fluctuates in accordance
with market forces, and the
official boundaries were
eliminated
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 Exchange Rate System

Fixed Exchange Rate

Freely Floating

Managed Float

Pegged Exchange Rate

Based on the degree of government control

Government Influence on Exchange Rate 4
 Exchange Rate Systems

Requires much central bank intervention in

order to maintain a currency’s value within
Fixed Exchange Rate narrow boundaries by offsetting any
imbalance between demand and supply.

Freely Floating ER Float freely without government intervention.

Lies somewhere between fixed and freely

Managed Float ER floating (system that exists today).

Pegged to one stable currency –dollar- or to

Pegged Exchange Rate an index of currencies, it moves in line with
that currency against other currencies.

Government Influence on Exchange Rate 5

 Which exchange rate
system has the lowest risk
for an MNC?

Government Influence on Exchange Rate 6

 Direct Intervention

Government can affect the domestic currency’s value indirectly

by influencing the factors that determined supply and demand

The effectiveness of a central bank’s direct intervention is the amount of reserves it can use
Government Influence on Exchange Rate 7
 Indirect Intervention

Government can affect the domestic currency’s value indirectly

by influencing the factors that determined supply and demand

Government Influence on Exchange Rate 8

 Reasons for
Government
Intervention

Establish implicit Smooth Respond to

exchange rate exchange rate temporary
boundaries movements disturbances

Government Influence on Exchange Rate 9

 Intervention as a Policy Tool

How Central Bank intervention can

stimulate the US economy

Government Influence on Exchange Rate 10

 Intervention as a Policy Tool (2)

How Central Bank intervention can

reduce inflation

Government Influence on Exchange Rate 11

Government Influence on Exchange Rate 12
 Conclusion

Who can conclude deserve points

Raise your hand!!

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