EXCHANGE-RATE TARGETING IN MONETARY POLIC

What is fixed (pegged) exchange-rate system?

is a currency system in which the main goal of the monetary policy (thus the central bank) is to keep currency value constant against some external target

What are external targets in this system?

a fixed weight of gold, or a fixed amount of another currency, or a basket of other currencies.

What is the relation between central bank and currencies?

The central bank of a country remains committed at all times to buy and sell its currency at a fixed price, i.e. the central value or par value of a given currency. The central bank provides foreign currency needed to finance payments imbalances.

What are exchange rate regimes?

Hard pegs regimes; floating regimes; soft pegs

What is the market equilibrium exchange rate?

is the rate at which supply and demand will be equal, i.e., markets will clear. In a flexible exchange rate system, this is the spot rate.

Why the foreign central banks maintain reserves of foreign currencies?

hey can sell in order to intervene in the foreign exchange market to make up the excess demand or take up the excess supply.

Types of fixed exchange rate systems?

The gold standard; Gold exchange standard; Reserve currency standard; Currency board; Dollarization/euroization; Hybrid exchange rate systems; Mixed-target monetary policy systems

What types of pegs do we recognise?

Fixed single-currency peg; Basket-of-currencies peg; Pegged within a band; Crawling band/crawling peg

what is a pure gold standard?

a country’s government declares to exchange its currency for a certain weight in gold.

What is the rule of exchange?

anyone may go to the central bank and exchange coins or currency for with pure gold or vice versa at the designated exchange rate.

what are the assumptions and conditions of the gold standard?

assumptions: there are no restrictions on capital movements or export of gold by private citizens across countries; conditions: central bank maintains sufficient gold reserves

What is the gold exchange standard?

it is a mixture of a reserve currency standard and a gold standard. In this system there was a reserve currency country, which fixed its currency value to a fixed weight in gold and agreed to exchange its own currency for gold with other central banks upon demand. All non-reserve countries agreed to fix their exchange rates to the chosen currency reserve at some announced rate.

What are the assumptions and conditions of exchange gold standard?

assumptions: there are no restrictions on capital movements or export of gold by private citizens across countries; conditions: currency reserve central bank maintains sufficient gold reserves and non-reserve central banks hold sufficient stock of reserve currency assets

What is the reserve currency system?

In a reserve currency system, a country fixes its own currency value to a unit of another currency (currencies), most often a currency that is prominently used in international transactions or is the currency of a major trading partner.

What are the assumptions and conditions of reserve currency system?

assumptions: there are no restrictions on capital movements by private citizens across countries. conditions: central bank maintains sufficient foreign (reserve) currency reserves in one or more currencies

What is a currency board?

the most widespread means of fixed exchange rates, effectively replaces the central bank through a legislation to fix the currency to that of another country

What are assumptions and conditions of a currency board?

assumprtions: interest rate parity conditions: maintenance of adequate reserves of the anchor currency, perceptible actual access to exchange of the domestic currency at the fixed rate

WHat is dollarization/euroization?

This is the most extreme and rigid manner of fixing exchange rates as it entails adopting the currency of another country in place of its own.

What are hybrid exchange rate systems?

They combine the characteristics features of fixed and flexible exchange rate systems. They allow fluctuation of the exchange rates without completely exposing the currency to the flexibility of a free float?

What are mixed-target monetary policy systems?

are systems where the inflation target is maintained by a central bank alongside the exchange-rate target, the exchange rate target is defined either as a fixed rate or as a fluctuation band

What is pegged within a band?

In this regime the central bank specifies a central exchange rate as a reference (to a single currency or a currency composite), but also specifies a percentage allowable deviation on both sides of this central rate (fixed or crawling band). Depending on the band’s size, the central bank has discretion in carrying out its monetary policy.

What is a currency basket?

is a portfolio of selected currencies with different weightings. A currency basket is commonly used to minimize the risk of currency fluctuations. An example of a currency basket is the European Currency Unit (ECU) that was used by the European Community member states as the unit of account before being replaced by the euro.

What is crawling band/peg?

A system of exchange rate adjustments in which a currency with a fixed exchange rate is fixed (peg) or allowed to fluctuate within a band of rates. The par value of the stated currency is also adjusted frequently due to market factors such as inflation.

What crawling band/peg is done for?

is done as an alternative to a sudden and significant revaluation of the currency (and helps to avoid excessive intervening in the market).

What is ERM?

was a system introduced by the European Community in March 1979, as part of the European Monetary System (EMS), to reduce exchange rate variability and achieve monetary stability in Europe, in preparation for Economic and Monetary Union and the introduction of a single currency, the euro, which took place on 1 January 1999.

What ERM is based on?

is based on the concept of fixed currency exchange rate margins, but with exchange rates variable within those margins. This is also known as a semi-pegged system. Before the introduction of the euro, exchange rates were based on the European Currency Unit(ECU), the European unit of account, whose value was determined as a weighted average of the participating currencies.

What is the parity grid?

A grid of bilateral rates calculated on the basis of the central rates expressed in ECUs, and currency fluctuations had to be contained within a margin of 2.25% on either side of the bilateral rates.

What was the problem with the parity grid?

In August 1993, the margin had to be expanded to 15% to accommodate speculation against the French franc and other currencies.

What protected the participating currencies from greater exchange rate fluctuations?

Determined intervention and loan arrangements

What any currency is allowed to in ERM(II)?

any currency in ERM (II) is allowed to float within a range of ±15% with respect to a central rate against the euro.

What is the main requirement before adopting the euro?

At least two years in the ERM II before joining the Eurozone

What is the earliest date when Hungary will adopt euro?

2015

What is convertible mark?

operating also under a currency board, is the currency of Bosnia and Herzegovina and it was fixed to 1 German mark when it was introduced on the basis of the Dayton agreement