Flexible exchange rate arrangements. The topic for study in International finance.

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308FIN-INTERNATIONAL FINANCE
Dr. Mital Bhayani
Flexible Exchange rate system: 1973- Present
1
SanjivaniCollegeofEngineering,Kopargaon
DepartmentofMBA
www.sanjivanimba.org.in

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At the End of this video you should be able to:
ü Explain the fundamental “Trilemma” that affects the design of any
exchange rate system.
ü Distinguish between a free float, a managed float, a target-zone
arrangement, and a fixed-rate system of exchange rate determination
ü Describe how equilibrium in the foreign exchange market is achieved
under alternative exchange rate systems, including a gold standard
ü Identify the three categories of central bank intervention under a
managed float
Session Learning Outcome

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1. Bimetallism: Before 1875
2. Classical gold standard: 1875-1914
3. Interwar period: 1915-1944
4 .Bretton Woods System: 1945-1972
- Smithsonian Agreement
5. Flexible exchange rate regime: 1973
- Jamaica Agreement
Recap

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“Followed by Smithsonian agreement - European and
Japanese currencies were allowed to float marking end of
Brettons woods”
• 1976- Jamaica Agreement
- Market determined exchange rate with government
intervention
- Gold was demonetized
- Preference to least developed countries for IMF assistance.
Flexible Exchange rates: 1973-Present

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Volatility in Exchange rates aftermath Jamaica Agreement

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‘‘Impossible trinity’’ of
international finance:
1. A Stable exchange rate
2. An independent monetary
policy
3. Capital market integration
The Trilemma and Exchange Rate Regime Choice
Stability
Independence Integration

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“Impossible Trinity”: Select any one side of triangle

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Emerging economies capital controls

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1. Exchange arrangements with no separate legal tender.
- Using Currency of another country. Ex: Panama
2. Currency Board arrangements
- Commitment to exchange domestic currency for a specified
foreign currency at a fixed exchange rate.
- Domestic currency is usually fully backed by foreign assets,
eliminating traditional central bank functions.
- Combined with restrictions on the issuing authority to ensure the
fulfillment of its legal obligation. Ex: Hong Kong (USD), Estonia
(Euro)
Current Exchange rate Arrangements ( IMF)

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3. Conventional Peg:
- Country formally pegs its currency at a fixed rate to another
currency (Anchor) or a basket of currencies.
- Direct Intervention by central authorities.
- No irrevocable commitment to keep the parity, ± 1%
fluctuation allowed around central rate. Ex: Morocco, Saudi
Arabia.

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4. Stabilized arrangement:
- Classification as a stabilized arrangement entails a spot
market exchange rate that remains within a margin of 2
percent for 6 months or more and is not floating.
- The required margin of stability can be met either with
respect to a single currency or a basket of currencies.
- Ex: Cambodia, Angola, and Lebanon

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5. Crawling peg
- The currency is adjusted in small amounts at a fixed rate or in
response to changes in selected quantitative indicators, such
as past inflation differentials
- Ex: Bolivia and Nicaragua.
6. Crawl-like arrangement: The exchange rate must remain
within a narrow margin of 2 percent relative to a statistically
identified trend for six months or more Ex: Ethiopia, China,
and Croatia.

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7. Pegged exchange rate within horizontal bands:
- The value of the currency is maintained within certain
margins of fluctuation of at least 61 percent around a fixed
central rate, or the margin between the maximum and
minimum value of the exchange rate exceeds 2 percent.
- Tonga is the only example.

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8. Other managed arrangement:
- This category is a residual, and is used when the exchange
rate arrangement does not meet the criteria for any of the
other categories.
- Arrangements characterized by frequent shifts in policies may
fall into this category.
- Examples are Costa Rica, Switzerland, and Russia.

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9. Floating: ( Managed Float)
- A floating exchange rate is largely market determined,
without an ascertainable or predictable path for the rate.
- Foreign exchange market intervention may be either direct or
indirect, and serves to moderate the rate of change and
prevent undue fluctuations in the exchange rate, but policies
targeting a specific level of the exchange rate are
incompatible with floating rate:
- Examples include Brazil, Korea, Turkey, and India.

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10. Free floating:
- A floating exchange rate can be classified as free floating if
intervention occurs only exceptionally and aims to address
disorderly market conditions.
- Examples are Canada, Mexico, Japan, Israel, U.K., United States,
and euro zone.

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Free Float, 31
Managed Float,
35
No legal tender,
13Pegged to Hard
currencies, 12
Mixure of fixed
and float, 104
Exchange rate regimes At present

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Thank You!!