Solutions – Lecture 7

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Solutions – Lecture 7
  Solutions – Lecture 7 Q1. Read page 311: Pros and Cons of Currency Boards Q2. According to the IMF’s  International Financial Statistics  there are a number of exchange rate arrangements are in operation around the world. Identify and discuss different exchange rate arrangements that are currently in use. Exchange arrangements with no separate legal tender Under this arrangement, the currency of another country circulates as the sole legal tender. Alternatively, the country belongs to a monetary or currency union in which the same legal tender is shared by members of the union. This includes the countries using the euro (see (Textbook) box on page 154) as well as members of other currency unions (for example, Grenada is part of the East Caribbean Currency Union). Currency board arrangements A currency board is an arrangement that is based on an explicit legislative commitment to exchange the domestic currency for a specified foreign currency at a fixed exchange rate, combined with restrictions on the issuing authority to ensure the fulfilment of its legal obligation. Until early 2002, Argentina opted for this arrangement, exchanging the peso for the US dollar on a one-to-one basis. Following the Argentine financial crisis, this arrangement was abolished as the peso was floated. Other conventional fixed peg arrangements These arrangements include pegging to a single currency and pegging to a basket of currencies, such as the SDR. Under these arrangements, the country pegs its currency (formally or de facto) at a fixed rate to a single currency or a basket of currencies, allowing the actual exchange rate to fluctuate within a narrow margin of less than ±1 per cent around a central rate (the rate determined by the arrangement). Pegged exchange rates with horizontal bands This arrangement is similar to the previous one, except that the band within which the exchange rate is allowed to fluctuate is wider than ±1 per cent. Crawling peg Under a crawling peg, the exchange rate is adjusted periodically at a fixed, pre-announced small rate or in response to changes in some quantitative indicators (for example, inflation).  Exchange rates with crawling bands An arrangement of crawling bands requires the exchange rate to be maintained within a certain band around a central rate that is adjusted periodically at a fixed, pre-announced rate or in response to changes in some indicators. Managed floating with no pre-announced path for the exchange rate Under this arrangement, the exchange rate is determined by market forces but the monetary authority intervenes actively in the foreign exchange market without specifying a path for the exchange rate. Independent floating Under independent floating the exchange rate is determined by market forces. Any intervention in the foreign exchange market aims at curbing exchange rate volatility.
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