TOPIC 1.3 - Fixed vs Floating ER Flashcards
What is a Managed Floating ER?
Where central banks reserve the right to intervene at anytime to obtain desirable rate levels
What is a Crawling Peg ER?
The rate is adjusted periodically in small amounts. Slowly re/devalued. (fixed ER)
What is a Crawling Band ER?
The rate is maintained within fluctuation margins around a central rate which is adjusted periodically. (fixed ER)
Managed Floating ER is what?
The CB intervenes in the exchange market with no pre-announced path for the ER. A mix between floating and fixed.
Independently Floating ER is what?
The rate is market determined.
What is an argument in favour of Floating ERs?
A country can follow domestic macroeconomic policies independent from other countries.
What is an argument in favour of Fixed ERs?
They impose international discipline on the inflationary policies of countries.
Three problems with floating ERs?
- ER can move for many other reasons than changes in the domestic IR
- Subject to large fluctuations which require large movements in IR that could be economically destabilising.
- increases foreign exchange volatility.
What are the Three aspects of the impossible trinity?
Free Capital Flows, Fixed ER, Independent Monetary Policy
Why can’t you have IMP with a Fixed ER and Free Capital Flows?
If the government increases MS to decrease IR,
then there would be an excess supply of NZD due to the low IR as people don’t want NZD,
so to keep the fixed rate the CB buy this excess NZD
which increases demand thus decreasing MS due to CB taking money out of circulation and increasing IR back to the original rate.
Therefore its impossible to have IMP with a Fixed ER and FCF.
If NZ wants a Fixed ER and IMP then they must enforce what and why?
Capital Controls, so that people are unable to get rid of NZD in the first place, however, this discourages FDI.
If NZ wants Free Capital Flows and IMP then they must forfeit what?
Fixed ER
If trade is a large share of national output and openness of the economy is a major factor, what choice of ER system would be best?
Fixed ER with Free Capital Flows, The costs of currency fluctuations can be high therefore a very open economy with a fixed ER may be best.
A country with one major trading partner may peg their currency against what compared to a country with diversified trade patterns.
A country with one trading partner may peg their currency to that of its trading partner
while…
A country with diversified trade may be better suited to peg its currency to a market basket of currencies.
Countries that cannot control Inflation may prefer what ER Rate System?
A Fixed ER
