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Discussion: Exchange Rate Systems and Currency Crises Discuss the causes of the recent currency crisis in Turkey. What are the implications for the Turkish economy and the global economy? What should be the role of the Turkish Central Bank for stable currency? Directions: Embed course material concepts, principles, and theories, which require supporting citations along with at least one scholarly peer reviewed reference in supporting your answer unless the discussion calls for more. Keep in mind that these scholarly references can be found in the Saudi Digital Library by conducting an advanced search specific to scholarly references.Follow APA 7th edition style guidelines.Every fact need a citation. Required readings: Chapter 14 in International Economics (attached) Kamal, U., Dharmendra, D. & Franklin, M. (2020). Exchange rate volatility and exports: some new estimates from the Asean-5. Journal of Developing Areas, 54(1), 65-73.
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INTERNATIONAL
ECONOMICS
SEVENTEENTH EDITION
ROBERT J. CARBAUGH
© 2019 Cengage. All rights reserved.
1
Chapter 14:
ExchangeRate Systems
and Currency
Crises
© 2019 Cengage. All rights reserved.
2
Chapter Outline
(1 of 2)
Exchange-Rate Practices
Choosing an Exchange-Rate System:
Constraints Imposed by Free-Capital Flows
Fixed Exchange-Rate System
Floating Exchange Rates
Managed Floating Rates
© 2019 Cengage. All rights reserved.
3
Chapter Outline
(2 of 2)
The Crawling Peg
Currency Manipulation and Currency Wars
Capital Controls
Increasing the Credibility of Fixed Exchange
Rates
© 2019 Cengage. All rights reserved.
4
Exchange-Rate Practices (1 of 5)
In choosing an exchange-rate system, a
nation must decide whether to allow its
currency to be determined by market forces
(floating rate) or be fixed (pegged) against
some standard of value
© 2019 Cengage. All rights reserved.
5
Exchange-Rate Practices (2 of 5)
Floating exchange-rate system
Nation must decide whether currency should
float independently, float in unison with other
currencies, or crawl according to
predetermined formula
Pegged exchange-rate system
Fixed against some standard of value; nation
must decide whether to
Anchor to single currency, basket of currencies, or
gold
© 2019 Cengage. All rights reserved.
6
Exchange-Rate Practices (3 of 5)
Members of the IMF
Exchange rates should not be manipulated
To prevent effective balance-of-payments
adjustments
To gain unfair competitive advantage over other
members
Members should act to counter short-term
disorderly conditions in exchange markets
When members intervene in exchange markets,
must take into account interests of other
members
© 2019 Cengage. All rights reserved.
7
Exchange-Rate Practices (4 of 5)
TABLE 14.1 Exchange-Rate Arrangements of IMF Members,* 2015
Exchange Arrangement
Percentage of IMF Members
Hard pegs
No separate legal tender
Currency board
6.8
5.8
Soft pegs
Conventional pegged (fixed) exchange rates
Stabilized arrangement
Crawling peg
Crawling-like arrangement
Pegged exchange rate within horizontal bands
23.0
11.5
1.6
10.5
0.5
Floating
Managed floating
Free floating
Other
19.4
15.7
5.2
100.0
*Includes 188 member countries.
Source: International Monetary Fund, Annual Report on Exchange Arrangements and Exchange Restrictions, 2015. See
also International Monetary Fund, Classification of Exchange Rate Arrangements and Monetary Policy Frameworks,
available at http://www.imf.org/.
© 2019 Cengage. All rights reserved.
8
Exchange-Rate Practices (5 of 5)
TABLE 14.2 Choosing an Exchange-Rate System
Characteristics of Economy
Implication for the Desired Degree of Exchange-Rate Flexibility
Size and openness of the
economy
If trade is a large share of national output, then the costs of currency
fluctuations can be high. This suggests that small, open economies may best be
served by fixed exchange rates.
Inflation rate
If a country has much higher inflation than its trading partners, its exchange
rate needs to be flexible to prevent its goods from becoming uncompetitive in
world markets. If inflation differentials are more modest, a fixed rate is less
troublesome.
Labor-market flexibility
The more rigid wages are, the greater the need for a flexible exchange rate to
help the economy respond to an external shock.
Degree of financial
development
In developing countries with immature financial markets, a freely floating
exchange rate may not be sensible because a small number of foreign exchange
trades can cause big swings in currencies.
Credibility of policy makers
The weaker the reputation of the central bank, the stronger the case for
pegging the exchange rate to build confidence that inflation will be controlled.
Capital mobility
The more open an economy to international capital, the harder it is to sustain a
fixed rate.
© 2019 Cengage. All rights reserved.
9
Choosing an Exchange-Rate System:
Constraints Imposed by Free Capital Flows
(1 of 2)
Allowing free capital flows
Constrains a countrys
Choice of exchange-rate system
Ability to operate independent monetary policy
Impossible trinity
A country can maintain only two of the
following three policies:
Free capital flows
Fixed exchange rate
Independent monetary policy
© 2019 Cengage. All rights reserved.
10
Choosing an Exchange-Rate System:
Constraints Imposed by Free Capital Flows
(2 of 2)
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11
Fixed Exchange-Rate System
(1 of 9)
Use of fixed exchange rates
Used primarily by small, developing nations
with currencies anchored to key currency
Key currencies
Widely traded on world money markets
Have demonstrated relatively stable values
over time
Widely accepted as means of international
settlement
© 2019 Cengage. All rights reserved.
12
Fixed Exchange-Rate System
(2 of 9)
TABLE 14.3 Key Currencies: Currency Composition of Official Foreign Exchange
Reserves of the Member Countries of the International Monetary Fund, 2016
Key Currency
Composition of Official Foreign Exchange Reserves
U.S. dollar
63.9%
Euro
19.7
British pound
4.4
Japanese yen
4.2
Canadian dollar
2.0
Australian dollar
1.8
Chinese yuan
1.1
Other
2.9
100.0
Source: From Currency Composition of Official Foreign Exchange Reserves (COFER), International Monetary Fund, 2017,
available at www.imf.org.
© 2019 Cengage. All rights reserved.
13
Fixed Exchange-Rate System
(3 of 9)
Anchoring to single currency
Generally done by developing nations whose
trade and financial relations are mainly with a
single industrial-country partner
Some nations anchor to special drawing
right (SDR)
Basket of four currencies established by IMF
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14
Fixed Exchange-Rate System
(4 of 9)
Par value and official exchange rate
In terms of gold or other key currencies
Official exchange rate
Can be determined by comparing par values of two
currencies
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15
Fixed Exchange-Rate System
(5 of 9)
Exchange-rate stabilization
Exchange stabilization fund
Used to defend official rate through purchases and
sales of foreign currencies
Fundamental disequilibrium
Long-term, official exchange rate and the market
exchange rate may diverge, reflecting changes in
fundamental economic conditions like income
levels, tastes, preferences, and technological
factors
© 2019 Cengage. All rights reserved.
16
Fixed Exchange-Rate System
(6 of 9)
Devaluation and revaluation
Devaluation-counteracting payments deficit
Revaluation-counteracting payments surplus
Depreciation and appreciation
Actual impact on market exchange rate
caused by
A redefinition of par value
Changes in exchange rate
Changes in the supply or demand of foreign exchange
© 2019 Cengage. All rights reserved.
17
Fixed Exchange-Rate System
(7 of 9)
Bretton Woods System of Fixed
Exchange Rates
Semi-fixed exchange-rate system
Adjustable pegged exchange rates
Currencies tied to each other
Nation could repeg its exchange rate via
devaluation or revaluation policies
Use fiscal and monetary policies first to
correct payment imbalances
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18
Fixed Exchange-Rate System
(8 of 9)
Bretton Woods System (cont.)
Agree to defend existing par values
Correct fundamental disequilibrium by
repegging currencies
Up to 10% without permission from IMF
By greater than 10% with the funds permission
Par value set in terms of gold or gold content
of U.S. dollar in 1944
Market exchange rates were almost but not
completely fixed
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19
Fixed Exchange-Rate System
(9 of 9)
Bretton Woods System (cont.)
Operational problems (cont.)
Currency devaluation indicated failure of domestic
policies
Currency revaluations unacceptable to exporters
Repegging exchange rates only as a last resort
Difficult because of adjustable pegged rates
Speculators had incentive to move out of
weakening currency
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20
Floating Exchange Rates (1 of 4)
Floating exchange rates (flexible)
Currency prices established daily in foreignexchange market
Without restrictions imposed by government policy
Equilibrium exchange rate
Demand for and supply of home currency
Changes in exchange rate
Correct a payments imbalance
Shifts in imports and exports of goods, services, and
short-term capital movements
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21
Floating Exchange Rates (2 of 4)
Trade restrictions, jobs, and floating exchange
rates
During economic downturns, labor unions lobby for
import restrictions to save jobs of domestic workers
Implementation of import restrictions
Helps one industry
Shifts jobs from other industries to protected industry
Has no significant impact on aggregate employment
Leads to short-term employment gains in protected
industry being offset by long-term employment losses in
other industries
© 2019 Cengage. All rights reserved.
22
Floating Exchange Rates (3 of 4)
Arguments for floating rates
Respond quickly to changing supply and demand conditions
Clear the market of shortages or surpluses of a given
currency
Simplified institutional arrangements that are relatively easy
to enact
Continuous adjustment in the balance of payments
Partially insulate home economy from external forces
Nations have greater freedom to pursue policies that
promote domestic balance
© 2019 Cengage. All rights reserved.
23
Floating Exchange Rates (4 of 4)
Arguments against floating rates
Unregulated market may lead to wide fluctuations in
currency values and discourage foreign trade and
investment
Inflationary bias; monetary authorities may lack financial
discipline
Greater freedom for domestic financial management
© 2019 Cengage. All rights reserved.
24
Managed Floating Rates
(1 of 6)
Managed floating system
Informal guidelines established by IMF for
coordination of exchange-rate policies
Nations might intervene in exchange markets to
avoid exchange-rate alterations that would weaken
their competitive position
Concern that floats over time might lead to
disorderly markets with erratic fluctuations in
exchange rates
Nation can alter degree to which it intervenes
in foreign-exchange market
© 2019 Cengage. All rights reserved.
25
Managed Floating Rates
(2 of 6)
When U.S. suspended gold convertibility & allowed
overvalued dollar to float, hoped free market
adjustment would result in depreciation of dollar
against undervalued currencies
Clean float
Market solution; but foreign central banks refused
to permit and intervened in exchange market
Dirty float
Interference in market; forces of supply & demand
not allowed to play equilibrating role
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26
Managed Floating Rates
(3 of 6)
Leaning against the wind
Intervene to reduce short-term fluctuations in
exchange rates without attempting to adhere
to any particular rate over long term
Target exchange rates
To reflect long-term economic forces that
underlie exchange-rate movements
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27
Managed Floating Rates
(4 of 6)
Managed floating rates in the short run and long run
Market intervention stabilizes exchange rates in short term; allows
market forces to determine exchange rates in long term
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28
Managed Floating Rates
(5 of 6)
Exchange-rate stabilization & monetary policy
To stabilize a currencys exchange value; expansionary/contractionary
monetary policy
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29
Managed Floating Rates
(6 of 6)
Is exchange-rate stabilization effective?
May be useful when exchange rate is under
speculative attack
May be helpful in coordinating private-sector
expectations
Research provides some support for shortterm effectiveness
Does not support long-term intervention
© 2019 Cengage. All rights reserved.
30
The Crawling Peg
Crawling peg system
Small, frequent changes in par value of currency
to correct balance-of-payments disequilibrium
Process of exchange-rate adjustment is
continuous for all practical purposes
Used by nations with high inflation rates
Combines flexibility of floating rates with stability
usually associated with fixed rates
© 2019 Cengage. All rights reserved.
31
Currency Manipulation and
Currency Wars (1 of 3)
Currency manipulation
Purchase or sale of currency by fiscal or
monetary authority to influence its value
In 2000s, U.S. accused Japan, China, South
Korea, Singapore, and other countries of
keeping the exchange values of their
currencies artificially low in order to boost
international competitiveness and trade
surpluses.
U.S. has been doing the same thing
© 2019 Cengage. All rights reserved.
32
Currency Manipulation and
Currency Wars (2 of 3)
Is China a currency manipulator?
U.S.: China manipulates the yuan
Yuan significantly undervalued relative to dollar
U.S. exports to China more expensive
Harms U.S. production and employment
Chinese goods cheaper for American consumers
More imports
Huge trade surplus with United States
Large accumulation of dollar reserves
© 2019 Cengage. All rights reserved.
33
Currency Manipulation and
Currency Wars (3 of 3)
Is China a currency manipulator?
Others say theres little or no connection
between yuan and health of U.S.
manufacturing
Other analysts contend that Chinas currency
intervention yields positive results for the U.S.
economy
© 2019 Cengage. All rights reserved.
34
Currency Crises
(1 of 4)
Major currency crises have been common in
recent years
Currency crisis (speculative attack)
Weak currency experiences heavy selling
pressure
Some reasons: sizable losses in foreign reserves
held by countrys central bank
Depreciating exchange rates in forward market
Currency crisis can decrease growth of GDP
by 6% or more
© 2019 Cengage. All rights reserved.
35
Currency Crises
(2 of 4)
Crisis ends when selling pressure stops; ways to
end pressure include:
Devaluation: establish new exchange rate at
sufficiently depreciated level
Adoption of floating exchange rate
Imposition of restrictions on ability of people to buy
and sell foreign currency
Use of loan to bolster foreign reserves of monetary
authority
Restoration of confidence in existing rate
Crisis ending in devaluation: currency crash
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36
Currency Crises
(3 of 4)
Sources of currency crises
Currency speculators
Budget deficits financed by inflation
Weak financial systems
Recently deregulated financial systems
A weak economy
Political factors
External factors
Choice of an exchange-rate system
© 2019 Cengage. All rights reserved.
37
Currency Crises
(4 of 4)
Speculators attack East Asian currencies
July 1997: Thai abandoned bahts peg to USD
October 1997: Baht depreciated by 60%
against USD
Triggered wave of speculation against other
Southeast Asian currencies
Some economists argue abandoning fixed
exchange rates not in long-term interest
© 2019 Cengage. All rights reserved.
38
Capital Controls (1 of 5)
Capital controls (exchange controls)
Government-imposed barriers
To foreign savers investing in domestic assets
To domestic savers investing in foreign assets
Government directly bypasses market forces
Direct controls on international transactions
Government allocates foreign exchange among
traders and investors
Government sets prices
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39
Capital Controls (2 of 5)
Advantages
Enables government to influence its payments
position by regulating amount of foreign
exchange allocated to imports or capital outflows
Enables government to encourage or discourage
certain transactions by offering different rates for
foreign currency for different purposes
Gives domestic monetary and fiscal policies
greater freedom in their stabilization roles
© 2019 Cengage. All rights reserved.
40
Capital Controls (3 of 5)
Disadvantages
Capital outflows may further increase after
controls are implemented
Result in evasion
Provide government officials false sense of
security that they do not have to reform their
financial systems to ameliorate crisis
© 2019 Cengage. All rights reserved.
41
Capital Controls (4 of 5)
Controls on capital inflows receive more
support
If speculative capital cannot enter country, it
cannot suddenly leave and create crisis
But problematic
Can prevent funds that would be used to finance
productive investment opportunities from entering
Are seldom effective because private sector finds
ways to evade them and move funds into country
© 2019 Cengage. All rights reserved.
42
Capital Controls (5 of 5)
Should foreign-exchange transactions be
Taxed?
A tax would increase cost of these transactions
Discourage massive responses to minor changes
Dampen volatility of exchange rates
Drawbacks:
We do not know how much volatility is excessive or
irrational
Tax could impose burden on countries rationally
borrowing overseas
Difficult to implement
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43
Increasing the Credibility of
Fixed Exchange Rates (1 of 8)
Currency board
Monetary authority that issues notes and
coins convertible into foreign anchor currency
at fixed exchange rate
Can operate in place of central bank or as a
parallel issuer alongside central bank
Takes over role of central bank in
strengthening currency of developing
countries
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44
Increasing the Credibility of
Fixed Exchange Rates (2 of 8)
Currency board (cont.)
Has no discretionary powers
Sole function: to exchange its notes and coins for
the anchor at fixed rate
Does not lend to government, which can
finance spending only by taxing or borrowing,
not by printing money and thereby creating
inflation
Results from stipulation that backing of domestic
currency must be 100%
© 2019 Cengage. All rights reserved.
45
Increasing the Credibility of
Fixed Exchange Rates (3 of 8)
Currency board (cont.)
Monetary policy on autopilot
When anchor currency flows in, Board issues more
domestic currency
Interest rates fall
When anchor currency flows out,
Interest rates rise
© 2019 Cengage. All rights reserved.
46
Increasing the Credibility of
Fixed Exchange Rates (4 of 8)
Benefits of currency board system
Making nations currency & exchange-rate regimes more
rule bound & predictable
Placing upper bound on nations base money supply
Arresting inflationary tendencies
Forcing government to restrict borrowing to what foreign
and domestic lenders are willing to lend at market interest
rates
Engendering confidence in soundness of nations money
Creating confidence & promoting trade, investment, &
economic growth
© 2019 Cengage. All rights reserved.
47
Increasing the Credibility of
Fixed Exchange Rates (5 of 8)
Objections to currency board system:
Prevents country from pursuing a
discretionary monetary policy
Reduces economic independence
Renders country susceptible to financial
panics
Lacks lender of last resort
Creates colonial relation with anchor currency
Example=Argentina
© 2019 Cengage. All rights reserved.
48
Increasing the Credibility of
Fixed Exchange Rates (6 of 8)
Dollarization
When residents of foreign country use dollar alongside
or instead of domestic currency; can be full or partial
Benefits of dollarization
Credibility and policy discipline
Avoids capital outflows
Decreased transaction costs
Lower rate of inflation
Greater openness
Balance-of-payments crises minimized
© 2019 Cengage. All rights reserved.
49
Increasing the Credibility of
Fixed Exchange Rates (7 of 8)
Effects of dollarization on foreign country
Country must be treated like one of 50 states
Monetary policy of Federal Reserve national in scope
Federal Reserve
Not a lender of last resort for foreign nations
?
No seigniorage from its monetary system
?
State expenditures not affected
Can establish own trade policies
Cannot print more domestic currency to finance budget
deficits; must exercise caution in spending
?
?
© 2019 Cengage. All rights reserved.
50
Increasing the Credibility of
Fixed Exchange Rates (8 of 8)
Effects of dollarization on U.S.
For each dollar sent abroad, Americans enjoy onetime increase in amount of goods and services
they can consume
U.S. gets an interest-free loan from foreign country
Might hinder formulation and execution of
monetary policy by Federal Reserve
Could result in more pressure on Federal Reserve
to conduct policy according to interests of foreign
country
© 2019 Cengage. All rights reserved.
51
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