Term
| What happens when a central bank purchases domestic currency? |
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Definition
Sell foreign assets (international reserves)
- Leads to an equal decline in the money supply |
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Term
| What happens when a central bank sells domestic currency? |
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Definition
| Increase in foreign assets, and an equal increase in the money supply (expansionary) |
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Term
| Unsterilized Foreign Exchange Market |
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Definition
| When domestic currency is sold to purchase foreign assets leads to a gain in international reserves/money supply, and the domestic currency depreciates |
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Term
| Whats the effect of an unsterilized purchase of domestic currency? |
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Definition
| Decreases money supply, appreciates currency, raises domestic interest rates |
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Term
| Sterilized Foreign Exchange Intervention |
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Definition
When a central bank conducts an open market operation to offset the effect of foreign exchange interventions
- There is no effect on the monetary base or on the exchange rate
- for example, purchase of government bonds to counteract a purchase of domestic currency
- China always sterilizes, but it is costly |
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Term
| Fixed Exchange Rate Regime |
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Definition
| Value of a currency is pegged relative to the value of one other currency (anchor currency) |
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Term
| Floating Exchange Rate Regime |
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Definition
| Value of a Currency is allowed to fluctuate against all other currencies (US) |
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Term
| Managed Float Regime (dirty float) |
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Definition
| Attempt to influence exchange rates by buying and selling currencies (China) |
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Term
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Definition
- Fixed Exchange Rate Regimes- Currency was convertible directly into gold at fixed rates
- Country had no control over monetary policy (supply was determined by gold flows)
- Influenced heavily by the production and discovery of gold
- Left this when we went to war |
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Term
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Definition
- Fixed Exchange Rates using the US dollar as the anchor currency
- Led to the creation of the IMF
- World Bank was also created
- General Agreement on Tariffs and Trade (GATT) |
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Term
| IMF (International Monetary Fund) |
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Definition
| Provided loans to countries to keep their currencies stable- countries had to give up control of monetary policy to the IMF |
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Term
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Definition
| Provided long term loans to countries for economic development (raised funds by issuing bonds) |
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Term
| General Agreement on Tariffs and Trade |
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Definition
| Set up and monitor rules for conduct of trade between countries (evolved into the WTO) |
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Term
| Why did the US leave the Bretton Woods System |
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Definition
| In 1971, the Us was facing inflation and a growing trade deficit and countries refused to let their currency appreciate |
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Term
| When a currency is overvalued in a fixed rate regime, what will a country do? |
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Definition
Purchase domestic currency in order to lessen the money supply and appreciate its currency
- Contractionary
- Or Devaluation |
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Term
| What type of intervention takes place in a fixed rate regime when a currency is undervalued? |
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Definition
Central bank sells domestic currency to increase international reserves and increase the money supply, depreciating the currency
- Expansionary
- Or Revalue their currency if they don't want any more international reserves |
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Term
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Definition
| When a countries CB runs out of international reserves and can't keep its currency from depreciating |
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Term
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Definition
If a CB doesn't want to gain international reserves, it will set its par value higher, appreciate the currency
- Will happen because reserves often gain no return |
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Term
| 3 options in the policy trilemma |
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Definition
1. A country chooses to have capital mobility and independent monetary policy, but no fixed exchange rate (US, Eurozone)
2. When a country has capital mobility and fixed exchange rate, but no independent monetary policy (Hong Kong, Belize)
3. When a country has a fixed exchange rate and independent monetary policy but no capital mobility (China) |
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Term
| Control on Capital Outflows (negatives) |
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Definition
It can promote financial instability by forcing a devaluation
- Controls are seldom effective and may increase capital flight
- Leads to corruption - government officials look the other way when residents move funds abroad
- Lose opportunity to improve economy |
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Term
| Control on capital inflows |
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Definition
Lead to a lending boom and excessive risk of financial intermediaries
- Controls may block funds for production uses
- Produce substantial distortion and misallocation
- Lead to corruption
- However, it does make a case for improving bank regulation and supervision |
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Term
| Advantages of Exchange-Rate Targeting (pegging) |
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Definition
- Contributes to keeping inflation under control
- Automatic rule for conduct of monetary policy
- Simplicity and clarity |
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Term
| Disadvantages of Exchange-Rate Targeting |
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Definition
- Cannot respond to domestic shocks and shocks to anchor country are transmitted
- Open to speculative attacks on currency
- Weakens the accountability of policymakers as the exchange rate loses value as a signal of how expansionary the monetary policy has become |
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Term
| When is exchange rate targeting desirable in industrialized countries? |
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Definition
- If domestic monetary and political institutions are not conducive to good policy making
- Other important benefit such as integration of monetary policy arise from this strategy |
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Term
| When is exchange rate targeting desirable in emerging market countries? |
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Definition
| Political and monetary institutions are weak (strategy becomes the stabilization policy of last resort) |
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Term
| What does a currency board present a solution to? |
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Definition
| Lack of transparency and commitment to target |
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Term
| Details of Currency Board |
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Definition
- Domestic currency is backed 100% by a foreign currency
- Note issuing authority establishes a fixed exchange rate and stands ready to exchange currency at this rate
- Money supply can expand only when foreign currency is exchanged for domestic currency (can't print more) |
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