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  3. Lecture International finance: An analytical approach (3/e): Chapter 5 - Imad A. Moosa

Lecture International finance: An analytical approach (3/e): Chapter 5 - Imad A. Moosa

Chapter 5 - The international monetary system and exchange rate arrangements. In this chapter, the learning objectives are: To classify international monetary systems, to outline the history of exchange rate arrangements, to outline the pros and cons of fixed and flexible exchange rates, to examine the Australian exchange rate arrangements. Chapter 5 The International Monetary System and Exchange Rate Arrangements Objectives • To classify international monetary systems • To outline the history o

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  1. Chapter 5 The International Monetary System and Exchange Rate Arrangements
  2. Objectives • To classify international monetary systems • To outline the history of exchange rate arrangements • To outline the pros and cons of fixed and flexible exchange rates • To examine the Australian exchange rate arrangements Copyright 2010 McGraw-Hill Australia Pty Ltd PPTs t/a International Finance: An Analytical Approach 3e by Imad A. Moosa Slides prepared by Afaf Moosa 5-2
  3. Definition • The IMS is the framework of rules, regulations and conventions that govern the financial relations among countries Copyright 2010 McGraw-Hill Australia Pty Ltd PPTs t/a International Finance: An Analytical Approach 3e by Imad A. Moosa Slides prepared by Afaf Moosa 5-3
  4. Components of the IMS • A public component consisting of a series of agreements • A private component represented by the banking and finance industry Copyright 2010 McGraw-Hill Australia Pty Ltd PPTs t/a International Finance: An Analytical Approach 3e by Imad A. Moosa Slides prepared by Afaf Moosa 5-4
  5. Classification according to reserve assets • Pure commodity standards (e.g. the gold standard) • Pure fiat standards • Mixed standards (e.g. the Bretton Woods system) Copyright 2010 McGraw-Hill Australia Pty Ltd PPTs t/a International Finance: An Analytical Approach 3e by Imad A. Moosa Slides prepared by Afaf Moosa 5-5
  6. Classification according to flexibility of exchange rates • Several systems may arise by restricting, or otherwise, the exchange rate Copyright 2010 McGraw-Hill Australia Pty Ltd PPTs t/a International Finance: An Analytical Approach 3e by Imad A. Moosa Slides prepared by Afaf Moosa 5-6
  7. Fixed exchange rates • The exchange rate is fixed by the central bank and is not allowed to move • The FX market is likely to be out of equilibrium Copyright 2010 McGraw-Hill Australia Pty Ltd PPTs t/a International Finance: An Analytical Approach 3e by Imad A. Moosa Slides prepared by Afaf Moosa 5-7
  8. Perfectly flexible exchange rates • The exchange rate moves continuously, propelled by market forces, to maintain equilibrium in the FX market • Under this system, currencies appreciate and depreciate Copyright 2010 McGraw-Hill Australia Pty Ltd PPTs t/a International Finance: An Analytical Approach 3e by Imad A. Moosa Slides prepared by Afaf Moosa 5-8
  9. Fixed but adjustable exchange rates • Countries alter the fixed values of their exchange rates • Devaluation and revaluation are implemented to ‘correct’ some economic fundamentals such as the BOP Copyright 2010 McGraw-Hill Australia Pty Ltd PPTs t/a International Finance: An Analytical Approach 3e by Imad A. Moosa Slides prepared by Afaf Moosa 5-9
  10. Fixed exchange rates and flexible within a band • Exchange rates are flexible within upper and lower limits defined by a band around the par value • Central bank intervention is required to keep the exchange rate within the band Copyright 2010 McGraw-Hill Australia Pty Ltd PPTs t/a International Finance: An Analytical Approach 3e by Imad A. Moosa Slides prepared by Afaf Moosa 5-10
  11. Crawling peg • The par value of the exchange rate is revised periodically according to its recent behaviour or economic indicators such as inflation Copyright 2010 McGraw-Hill Australia Pty Ltd PPTs t/a International Finance: An Analytical Approach 3e by Imad A. Moosa Slides prepared by Afaf Moosa 5-11
  12. Dual exchange rates • A commercial (fixed) rate is used for imports and exports • A financial (flexible) rate is used for trading in financial assets Copyright 2010 McGraw-Hill Australia Pty Ltd PPTs t/a International Finance: An Analytical Approach 3e by Imad A. Moosa Slides prepared by Afaf Moosa 5-12
  13. Managed floating • The exchange rate is flexible, but the central bank intervenes to limit the frequency and amplitude of exchange rate fluctuations Copyright 2010 McGraw-Hill Australia Pty Ltd PPTs t/a International Finance: An Analytical Approach 3e by Imad A. Moosa Slides prepared by Afaf Moosa 5-13
  14. Target zones • Major countries establish a set of mutually consistent targets for real effective exchange rates Copyright 2010 McGraw-Hill Australia Pty Ltd PPTs t/a International Finance: An Analytical Approach 3e by Imad A. Moosa Slides prepared by Afaf Moosa 5-14
  15. The classical gold standard • This system operated between approximately 1870 and 1914 • It is remembered with nostalgia because the world economy prospered during that period Copyright 2010 McGraw-Hill Australia Pty Ltd PPTs t/a International Finance: An Analytical Approach 3e by Imad A. Moosa Slides prepared by Afaf Moosa 5-15
  16. Pillars of the gold standard • The monetary authorities fix the price of gold in terms of their currencies, which produces a fixed exchange rate • The market exchange rate can move above or below the fixed rate by certain limits: the gold points Copyright 2010 McGraw-Hill Australia Pty Ltd PPTs t/a International Finance: An Analytical Approach 3e by Imad A. Moosa Slides prepared by Afaf Moosa 5-16
  17. The collapse of the gold standard • The gold standard collapsed in 1914 as the warring countries suspended the convertibility of their currencies and prohibited the export of gold Copyright 2010 McGraw-Hill Australia Pty Ltd PPTs t/a International Finance: An Analytical Approach 3e by Imad A. Moosa Slides prepared by Afaf Moosa 5-17
  18. The inter-war period • Between the end of World War I and 1926 a system of flexible exchange rates was adopted • In 1925, Britain re-established the convertibility of the pound into gold, signalling the creation of the gold exchange standard Copyright 2010 McGraw-Hill Australia Pty Ltd PPTs t/a International Finance: An Analytical Approach 3e by Imad A. Moosa Slides prepared by Afaf Moosa 5-18
  19. The collapse of the gold exchange standard • In 1931 Britain abolished the convertibility of the pound, bringing to an end the era of the gold exchange standard • This was followed by the decade of the Great Depression (1931-1939) Copyright 2010 McGraw-Hill Australia Pty Ltd PPTs t/a International Finance: An Analytical Approach 3e by Imad A. Moosa Slides prepared by Afaf Moosa 5-19
  20. Failure of the inter-war experiment: reasons • The golden age was a myth • The world economy experienced significant changes Copyright 2010 McGraw-Hill Australia Pty Ltd PPTs t/a International Finance: An Analytical Approach 3e by Imad A. Moosa Slides prepared by Afaf Moosa 5-20
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