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Flashcards in Introduction to foreign exchange Deck (15)
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Types (3)

-Freely convertible
-Externally convertible
-Non convertible


Why limit convertibility? Preserve foreign exchange reserves to: (3)

- payback international debt
- make international purchases on behalf of the government
- prevent capital flight
- make imports more difficult to make


Exchange rate regimes about peg (2)

- Fixed/hard peg
Eliminate the foreign exchange rate risk
(Does not work in long term)

Make trade more "fair"

Easier for consumer and businesses to compare prices

- Crawling/Adjustable peg
The rate is revalued/devalued at regular intervals to align with fundamentals


Gold standards 1870-1914 :

When countries to agree to buy or sell gold for an established number of currency units (fixed value of exchange)

Also a government could not create money not backed by gold


Why did Gold standards break down? (2)

-Failed resumption after WW1
-Great Depression


General consensus of Bretton Woods (3)

-Stable exchange rate were desirable
-Floating or fluctuating exchange rate had proved unsatisfactory
-The government controls of trade, exchange and production that developed through WW2 were wasteful and discriminatory


The original role of IMF

- historically worked to help countries to maintain fixed echang rate
- now lending money, technical assistance and surveillance consultations
- loans come with conditions


Some currencies have fixed exchange rates. What are the benefits of having a fixed exchange rate?

- Remove foreign exchange risk
- Make trade more fair


Draw a chart over time for one of the following exchange rate regimes.
- fixed/pegged exchange rate
- crawling peg
- managed/dirty float
- floating

Fucking look it up youself.


Who or what determines the exchange rate?
Fixed/Pegged Exchange Rates:
Crawling Peg:
Managed/Dirty Float:

Fixed/Pegged Exchange Rates: The issuing government sets the exchange rate

Crawling Peg: The issuing government sets the exchange rate

Managed/Dirty Float: The government + supply & demand in the forex market

Floating: supply & demand in the forex market


What role does the government play in this exchange rate regime? (You may need to consider the role of the government in a broader context.)

Fixed/Pegged Exchange Rate:
The government plays the primary role. It sets the exchange rate, and manages the economy in an effort to "support" the rate.

Crawling Peg Exchange Rate:
The government plays the primary role. It sets the exchange rate, and makes adjustments at intervals of time that it determines.

Managed/Dirty Float Exchange Rate:
The government intervenes (buy & sells), as needed in the currency markets when a destabilizing event occurs. Governments typically justify their interventions in terms of “smoothing market irregularities” or “assuring orderly markets”.

Free Floating/Floating Exchange Rate:
The government focuses on management of the economy rather than directly intervening in the market or setting exchange rates. (For some currencies given the volume and value of the currency traded in the forex market it might be impossible for the government to really intervene even if it wanted to.)


Why is law of one price not very accurate?

- one product approach is flawed, there may be special/valid reasons why a certain product is cheaper in one country vis a vis the other
- cultural differences
- government interventions


Why is the IMF lender of last resort?

- Loans of the IMF come with conditions which have consequences for the flexibility and decision making of loan taking country


Controversies of the IMF

- crises keep happening
-moral hazard: stop acting as the lender of the last resort
- lack of accountability: executive board is not responsible and does not face that many checks; too less consultation with taking countries
- Power divide/ voting power allocation: need 85 % to vote for some major actions; US has more than 15 %, nothing can be passed without US


Causes of asian financial crisis

- capital flight "contagion" origination in Thailand fanned the crisis to adjacent markets
- market lost faith in fixed exchange rate as it was artificially high
- loans taken in foreign currency to fuel growth
--->weak financial institutions to regulate lending practices
-Thailand lacked sufficient reserves to pay back foreign dept