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C HAPT E R 6

Government Influence on
Exchange Rates
Chapter Overview
A. Exchange Rate Systems

B. A Single European Currency

C. Government Intervention

D. Intervention as a Policy Tool


Chapter 6 Objectives
This chapter will:
A. Describe the exchange rate system used
by various governments
B. Explain how governments can use direct
intervention to influence exchange rates
C. Explain how governments can use
indirect intervention to influence
exchange rates
D. Explain how government intervention in
the foreign exchange market can affect
economic conditions
A. Exchange Rate Systems
1. Fixed Exchange Rate System

a. Bretton woods Agreement


b. Smithsonian Agreement
c. Advantages of a Fixed Exchange Rate
System
d. Disadvantages of a Fixed Exchange
Rate System
A. Exchange Rate Systems
2. Freely Floating Exchange Rate System
a. Advantages of a Freely Floating
Exchange Rate System
1.) a country is more insulated from the
inflation of other countries
2.) a country is more insulated
from unemployment problems in other
countries
A. Exchange Rate Systems
b. Disadvantages of a Freely Floating
Exchange Rate System
can adversely affect a country that has high
unemployment.
A. Exchange Rate Systems
3. Managed Float Exchange Rate
System
a. Criticism of a Managed Float
System
A. Exchange Rate Systems
4. Pegged Exchange Rate System
a. Limitations of a Pegged System
b. Creation of Europes Snake
Arrangement
c. Creation of the European
Monetary System (EMS)
d. Demise of the European
Monetary System
A. Exchange Rate Systems
5. Currency Boards
a. Exposure of a Pegged Currency
to Interest Rate Movements

b. Exposure of a Pegged
Currency to Exchange Rate
Movements
A. Exchange Rate Systems
6. Dollarization
a. the
t replacement of a foreign currency with U.S.
dollars.

b. This process is a step beyond a currency board


because it forces the local currency to be replaced by
the U.S. dollar.

c. Although dollarization and a currency board both


attempt to peg the local currencys value, the currency
board does not replace the local currency with dollars.

7. Classification of Exchange Rate Arrangements


B. A Single European Currency
1. Membership

2. Impact on European Monetary


Policy
a. European Central Bank
b. Implications of a European
Monetary Policy

3. Impact on Business within Europe


B. A Single European Currency
4. Impact on the Valuation of
Businesses in Europe

5. Impact on Financial Flows

6. Impact on Exchange Rate Risk

7. Status Report on the Euro


C. Government Intervention
1. Reasons for Government
Intervention
a. Smooth Exchange Rate
Movements
b. Establish Implicit Exchange Rate
boundaries
c. Respond to Temporary
Disturbances
Effects of Direct Central Bank Intervention
in the Foreign Exchange Market

Exhibit 6.2
C. Government Intervention
2. Direct Intervention
a. Reliance on Reserves
b. Nonsterilized versus Sterilized
Intervention
c. Speculating on Direct
Intervention
Forms of Central Bank Intervention
in the Foreign Exchange Market

Exhibit 6.3
C. Government Intervention
3. Indirect Intervention
a. Government Adjustment of
Interest Rates
b. Government Use of Foreign
Exchange Controls
D. Intervention as a Policy Tool
1. Influence of a Weak Home Currency
on the Economy

2. Influence of a Strong Home


Currency on the Economy
Impact of Government Actions on Exchange Rates

Exhibit 6.4

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