Ques5: Explain various exchange rate regimes in international

market with example?

An exchange rate regime is the way an authority manage its currency in
relation to other currencies and the foreign exchange market. It is closely
related to monetary policy and the two are generally dependent on many of
the same factors. the basic type are a floating exchange rate, where the
market dictates movements in the exchange rate; a pegged float, where a
central bank keeps the rate ,which ties the currency to another currency ,
mostly more widespread currencies such as the Indian rupees or euro or a
basket of currencies.
Features
1. Show financial condition of country:
It is show the financial condition of the particular country
2. Show the condition of money market:
It is define and express the condition of the money market that which type of
trend come in market.
3. Show the condition about economy:
In country, which type of cycle come in economic like inflation and deflation.
It is very closely express the condition.
4. Control on the exchange rate:
It is help in control on the exchange rate for good economy of our country.
Advantages
1 Easy to analyses the market condition
2 It can control the condition
Flexible oriented regimes:
Those rate which is flexible not fixed. flexible oriented regimes mean those
rate which is flexible or changed. Most exchange rates are determined by
the foreign exchange market, known as foreign exchange. For this reason,
exchange rates vary on a moment-by-moment basis, depending on
what foreign exchange traders think the currency is worth. This depends on a
lot of factors, including central bank interest rates, the country's debt levels,
and the strength of its economy. Most countries allow their currencies to be
determined by the foreign exchange market. This is known as a flexible
exchange rate.
Advantages:
1. Exchange rate risk: The main disadvantage of flexible exchange
rates is their volatility. In the postBretton Woods era, one of the
characteristics of flexible exchange rate is their excess volatility.
2. Potential for too much use of expansionary monetary policy.
3. Questionable stabilizing effects: Previously, automatic stabilizing
was mentioned as an advantage of the flexible exchange rate system.
Exchange rates change in the appropriate direction when the countrys
inflation rate, output, and current account balance change. Especially
in terms of current account imbalances.

4. Flexible exchange rates as automatic stabilizers.

Features
Automatic correction of payments imbalances
Governments have policy independence can choose any domestic inflation
rate
1. Free float:
This extreme kind of regime has been rarely seen in the world economy. In
this regime, government has no effects on the currency market. The market
agents determine the rate. This regime provides elasticity. Monetary policy is
very efficient. There is no need to keep large amount of reserve .the change
in rate adsorb all of the internal and external shocks.
A free floating exchange rate increases foreign exchange volatility. There are
economists who think that this could cause serious problems, especially in
emerging economies.
These economies have a financial sector with one or more of following
conditions:

high liability

financial fragility

strong balance sheet effects

Example: some country name where exist free float are:
Inflation-targeting framework
 Australia (AUD)

Canada (CAD)

Chile (CLP)

Japan (JPY)

Mexico (MXN)

Norway (NOK)

Poland (PLN)

Sweden (SEK)

United Kingdom (GBP)

2 Managed float regime

Mainly the free market determine the rate, but central bank is ready to
intervene to the market without anchored .in other words, there is no
determined rate but policy maker may intervene according to the economic
conditions. Intervention are generally indirect. Relative to free float, volatility
of exchange rate is rates is less than that of free float.
Example: some country where exist managed float regime are:
Rupees as exchange rate:
India
US dollar as exchange rate

Cambodia (KHR)

Liberia (LRD)

Features
1. Not risky
 2. Easily managed
3. Not Speedily increase or decrease
3 Floating within band:
Floating within band means exchange rate fluctuate with some specify rate
which is decide by reserve bank of India but some time or few time take fixed
or same rate. It means the international financial environment in which
exchange rate increase or decrease but changed with in growth.
Example: In starting 1rs = 65 then after some time 10rs=65 then this second
term continue with some period then come fluctuation.
Features:
Not suddenly change in exchange rate

Good impact on economics compare than free floating

Rate is decide by reserve bank of India.

4 Sliding Band
Sliding band means firstly band decide that what is rate fixe for exchange
rate with in between some rate but after sometime, this band has changed
with the growth.
Example: like 10 -15 is the band rate , exchange rate is used within rate as
like 23 or 23 .after some time the rate changed with increase or growth rate
like as 17 or 18.
Advantages:

It is increase growth of economy.

It is increase value of money.

2 ) FIXED ORIENTED REGIMES:

Those rate which is fixed not flexible. This type of rate is more risky. it is not
good for economic. One country that has traditionally had a fixed exchange
rate is China. It pegs its currency, the Yuan, to a fixed value against the
dollar. As of June 7, 2016, one dollar was worth 6.57 Chinese Yuan. The dollar
has weakened against the Yuan since February 7, 2003, when a dollar could
be exchanged for 8.28 Yuan.
Feature
 Exchange-rate stability promotes globalization more trade and
investment.
Fixing value of currency to the currency of a low inflation country forces
govt to keep prices in line.
Advantages:
1. Avoid Currency Fluctuations.
2. Stability encourages investment.
3. Keep inflation Low.
4. A rapid appreciation in the exchange rate will badly effect
manufacturing firms
Export, this may also cause a worsening of the current account.
5. Joining a fixed exchange rate may cause inflationary expectations to
be lower.
Disadvantage of Fixed Exchange Rates:
1. Conflict with other objectives. To maintain a fixed level of the
exchange rate may conflict with other macroeconomic objectives.
2. Less Flexibility. It is difficult to respond to temporary shocks. For
example an oil importer may face a balance of payments deficit if oil
price increases, but in a fixed exchange rate there is little chance to
devalue.
3. Join at the Wrong Rate. It is difficult to know the right rate to join at.
If the rate is too high, it will make exports uncompetitive. If it is too
low, it could cause inflation.
4. Current Account Imbalances. Fixed exchange rates can lead to current
account imbalances. For example, an overvalued exchange rate could cause
a current account deficit.

1. Fixed but adjusted exchange rate:

Nominal exchange rate is fixed but central bank is not restricted by strict
rules . Sometime it may intervene to the market. This regime provide
macroeconomic discipline, because expectation of risk decreases especially
exchange rate risk in foreign trade. Devaluation chance causes elascity in
the economy. On other hand, if the devaluation rate is too high, that will
cause uncertainity. uncertainity increase the inflation expectation.
features
Requires heavy govt involvement.
BOP deficits are much more troublesome than BOP surpluses
Example: BOP surplus indian central bank simply sells rupees-which it
can print freely--and exchanges them for foreign exchange (U.S. dollars)
This alleviates the shortage of rupees in the FOREX market, causing the
rupeess value to depreciate back to the promised rate.
2 Full Dollarization:
Country uses another countrys currency. That means its monetary policy is
dependent on the other country . the credibility level is at maximum .some
of the latin American countries implemented this regime. On the contrary ,
system does not have elasticity . external shocks can only be absorbed by
unemployment and recession.
A foreign currency acts as legal tender. Monetary policy is delegated to the
anchor country.
Other currency as exchange rate:

Brunei (BND)

Benefits:
The time-inconsistency problem is reduced (subject to the perceived
probability that the regime is abandoned) and real exchange rate volatility is
diminished.
Drawback:
External shocks cannot be buffered by exchange rate movements, imposing
costs if business cycles are asynchronous. The scope for lender of last resort
activity is restricted to excess reserve holdings and fiscal mechanisms.
Requires high reserve holdings.
4 Crawling Peg:
Crawling peg means change exist with minor base. It means change in
exchange rate with minor rate like10 is rate if changes come then rate will
be 10.2. Nominal exchange rate is adjusted periodically according to some
economic indicators. The band is very narrow. Market expectation are
corrected according to this system. Credibility of policies is higher.
Example:
US dollar as exchange rate
 Country name: Nicaragua (NIO)
Composite exchange rate

Country name: Botswana (BWP)

Feature:
A rule-based system for altering the par value, typically at a predetermined
rate or as a function of inflation differentials.
Benefits:
An attempt to combine flexibility and stability. Often used by (initially) high
inflation countries pegging to low inflation countries in an attempt to avoid
trend real appreciation.
5 Crawling Band:
It refers to those band which is decided by a fixed rate like 10-15 and rate is
change with this rate .it means rate fluctuate with slowly- slowly. Not change
suddenly like firstly take 10 then take 10.5.
Example: firstly Decide 10 to 15 is exchange rate then in starting take 10
then if changes come in rate then take 10.5.
Some country name where crawling band follow are:
US dollar as exchange rate
Honduras (HNL)

Jamaica (JMD)
Euro as exchange rate

Croatia (HRK)