Refers to set of rules, regulations, policies, practices, instruments, institutions and mechanisms that determine exchange rates between currencies

   Gold Specie standard: the actual currency in circulation consists of gold coins with fixed gold content Gold Bullion standard: currency in circulation consists of paper notes but a fixed weight of gold remains the basis of the money (Fixed conversion ratio) Gold Exchange Standard: Paper currency can be converted at a fixed rate into the paper currency of the other country.(Followed post Bretton Woods Era) . if it is operating a gold specie or gold bullion standard.

The US & some other countries returned to gold as to achieve financial stability. gold standard were finally abandoned.5 billion) in Dec 1923. Hyperinflation in Germany-Price index rapidly shot from 262 in 1919 to 126160000000000 (481. . but following the Great depression in 1930.   Gold Standard was suspended following World War I in 1914 & governments financed massive military expenditure by printing money. This led to sharp rise both in supply of money & market prices.

   July 1944. representatives of 44 allied nations agreed to a fixed rate monetary system & setting up of IMF & IBRD in a conference held in Bretton Woods. Countries required to establish a parity of their national currencies in terms of the US dollar and to maintain exchange rates within 1% of parity (a band) by intervening in their foreign exchange market (i. . buying or selling foreign money) The US dollar was the only strong currency to meet the rising demands for international currency transactions and so US agreed both to link the dollar to gold at rate of $35 per ounce of gold and convert dollars into gold at that price.e.

but then March 1973 Fixed exchange rate system abandoned. Due to concerns about America’s rapidly deterioting payments situation and massive flight of liquid capital from the US. Smithsonian agreement called for devaluation of US dollar by 8% against other currencies and pegging the official price of gold to US$38 per ounce. . President Richard Nixon suspended the convertibility of the dollar into gold on 15th Aug 1971.

The Central bank of a country remains committed at all times to buy and sell its currency at a fixed price.  Is a currency system in which governments try to keep the value of their currencies constant against one another. The Central bank provides foreign currency needed to finance payments imbalances .

PROS  Reduced Risk in international trade  Introduces discipline in economic Management  Fixed rates should eliminate destablishing speculation. . CONS  No automatic BOP adjustments  Large holdings of foreign Exchange Reserve required  Loss of freedom in internal policy  Fixed rates are inherently unsatble.

As floating exchange rates automatically adjust. they enable a country to dampen the impact of shocks and foreign business cycles.  . and to preempt the possibility of having a balance of payments crisis. Currency Prices are determined by market demand & supply conditions without the intervention of Government.

adding to uncertainty Leaves the international competitiveness of a country’s goods to a market that is often affected by speculative money flows. these may have little to do with the underlying state of the economy and its balance of payments .Pros    Cons   Requires no foreign currency reserves The exchange rate adapts to changes in trade patterns Reflects market forces Firms cannot predict future rates.

Japan. Tanzania. Such exchange rate arrangements prevail in about 48 countries including India. Switzerland. . Kenya. Such a system is known as “Managed” or “Dirty Float”. For instance. New Zealand. a government may weaken its currency to attract foreign demand with an objective to stimulate its stagnant economy. UK. France. Bangladesh and Mauritius. Thailand. Singapore. The system is criticized on the ground that it allows governments to manipulate exchange rates for the benefit of their countries at the expense of others. Australia. Canada and Brazil have adopted this system  Managed Float with no Pre-determined path for the Exchange rate: Although currencies are allowed to fluctuate on a daily basis with no official boundaries national governments may sometime intervene so as to prevent their currencies from moving too fare in a certain direction. Mexico. Clean Float: About 35 Countries including US. the Russian Federation. Indonesia. Malaysia.

. IMF classifies pegging exchange rate system as soft and hard pegs. Pegging value of home currency to a foreign currency or a basket of currencies is known as pegged exchange rate system.

or capital flows. The monetary authority stands ready to maintain the fixed parity through direct intervention (i.  Conventional Fixed Peg: The currency fluctuate for at least three months within a band of less than 2% or +1 % against another currency or a basket of currencies. via sales or purchase of foreign exchange in the market) or indirect intervention (i. services. imposition of foreign exchange regulations.) .e.e. The basket of currencies is formed from the geographical distribution of trade. exercise of moral suasion that constrains foreign exchange activity etc. via aggressive use of interest policy.

Saudi Arab. The UAE. Egypt.   About 70 countries follow this-out of which 63 countries are pegged against one currency whereas seven countries are pegged against other currency composites. Kuwait. Argentina. Vietnam etc… Nepal & Bhutan peg their currencies to the Indian rupee . Syria. Ethiopia. Qatar. Oman. Venezuela.

Azerbaijan. Iraq. Slovak Republic and Cyprus follow such an exchange System Crawling Peg: Currency is pegged to a basket of currencies. China is among the six countries following such an exchange rate system. Denmark. Nicaragua and Sierra Leone.  Pegs with Horizontal bands: Currencies are not allowed to fluctuate beyond +1 % of the Central parity. but the peg is periodically adjusted with a range of less than 2% in response to changes in selective micro-economic indicators. apart from Botswana. such as inflation differentials vis-à-vis major trading partners. .

The commitment to maintain the exchange rate within the band imposes constraints on monetary policy making. Crawling Bands: The currency is adjusted periodically at a fixed rate in response to changes in selective quantitative macroeconomic indicators. Costa Rica is the only country following the Crawling Bands . with the degree of policy independence being a function of the bandwidth. with a range of fluctuations of 2% or more.

. Estonia. Djibouti and Dominica have such arrangements with US dollar. Bulgaria. The Board must maintain foreign currency reserves for all the currency that it has printed About 13 countries have such arrangements For instance.     Currency board arrangements: refers to a monetary regime based on an explicit legislative commitment to exchange domestic currency for a specified foreign currency at a fixed exchange rate. Lithuania & Bosnia have such arrangements with euro. & Brunei Darussalam with Singapore dollars. Honkong. The currency board of a country maintains a reserve of the US dollar for every unit of home currency circulated.

and Australian dollar in Kiribati. Euro is used in Montenegro and San Marino. Marshall Islands.  Adopting such an exchange rate regime implies the complete surrender of the monetary authority’s independent control over domestic policies.  Ecuador. El Salvador. . Palau.Arrangements with no separate legal tender: Replacement of a country’s local currency with US dollars is termed as “dollarization”. Micronesia. Panama and Timor-Leste do not have their own separate legal tender and instead use US dollars.

e. pound sterling (15%).3% of total foreign currency transactions in the world. Swiss franc (6. whereas the Indian rupee comprises merely 0.5%).8%) and Australian dollar (6.5%.7%). .7% and the Chinese Yuan 0. followed by euro (37%). The US dollar is most widely traded currency in the world as it comprises at least on aspect (i. yen (16. buy or sell) of the 86.

    Used as a reserve currency by several central banks Used as a currency for intervention by central banks in foreign exchange markets. Used widely as a currency for invoicing in international trade contracts Used as a currency of transaction in the international commodity market. .

detusche mark deposited outside Germany as euro mark and Yen outside Japan as euro yen. . dollars deposited in banks outside the UK are called euro sterling. Banks trading in markets for eurocurrencies are known as eurobanks and international bonds in countries other than the country of the currency dominating the bond are known as eurobonds. It is used as a generic term rather than being confined to the geographical boundary of Europe.    A currency deposited in a bank outside the country of its origin is known as euro currency. Thus.

Purchasing Power parity Theory: Assuming non-existence of tariffs and other trade barriers and zero cost of transport. converted to a common currency. the law of one price.  The equilibrium price rate between 2 currencies.  Therefore. prices of goods sold in different countries. and Px & Py indicate the price level in two different countries x and y. Based on PPP. according to the PPP theory. Where Se stands for Spot exchange rate. should be identical. would be equal to the ratio of the price levels in two countries : Se=Px/Py. the simplest concept of PPP states that identical goods should cost the same in all nations. the cross-country comparison of the exchnage rates of the currencies may be carried out using the Big Mac Index and Commsec iPod index. .

 Big Mac is considered a global product that involves similar inputs and processes in its preparation across the world.Mc Donald's prices its products in international markets depending upon the country’s purchasing power.  The Big Mac Index was invented in September 1986 as a light-hearted guide for cross-country comparison of currencies based on prices of McDonald’s Big Mac Produced locally and simultaneously in almost 120 countries.  The Purchasing power parity is calculated as: PPP = Big Mac prices in local currency Big Mac Prices in the US The over and under-valuation of currency may be arrived as:  .

 Over(+)/Under (-) valuation of currency = 1-(implied PPP of the US dollar/Actual dollar exchange rate) *100 .

96 70.5 Yen 280 Ringgit 5.50 78.In Local Currency In Dollars (at current exchange rate) 3.08 121 .0 7.08 1.70 6.2 5.57 Peso 11.83 106.54 10.4 1.97 Implied PPP of the dollar Actual Exchange Rate Under()/over(+) valuation against the dollar 2 14 -49 -27 -52 79 -45 US Argentina Canada China Japan Malaysia Sweden Pakistan $3.37 1.6 39.2 5.00 3.64 4.8 11.57 3.90 Norway Kroner40.0 C$4.09 Yuan 12.02 1.22 3.08 1.15 3.8 3.50 SKr 38.83 2.00 6.0 Rupee 140.62 1.

it presents a modern-day variant of Big Mac index. Both the indices work on the theory of “Same goods. same price” This index too represents a light-hearted approach to assessing the pricing of a standard product sold worldwide.    Launched in January 2007. . This index is based on the price variation of 4 gigabytes Apple iPod across countries.

labour laws. There remain several limitations in both these indices as a variety of factors such as transportation costs.  The key difference between the iPod and Big Mac approaches is that Big Macs are made in a host of countries across the globe whereas iPods are predominantly made in china. tariffs and taxes have distorting effects .

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