3-2fixedexchangeratesandforeignexchangeintervention.pptVIP

Chinese Finance Research Institute * * Content Why Study Fixed Exchange Rates? Intervention and Money Supply Fixing the Exchange Rate Stabilization Policy in a Fixed Rate Balance of Payments Crises Sterilized Intervention Assignments Why Study Fixed Exchange Rates? I. Management Floating II. Regional Currency Arrangements III. Developing Countries and Transition Countries See Table 3-2-1 in the appendix. IV. Lessons of the Past for the Future Pure Fixed Pure Floating Dirty Floating Flexibility Independence Degree of Intervention Theoretical Theoretical Real World Intervention and Money Supply I. The Central Bank Balance Sheet the Money Supply Recall the reduced form of the central bank balance sheet we have learned. II. Intervention and Money Supply e.g. 3-3-1 Suppose a central bank sells $100 worth of foreign bonds for home currency. See Table 3-3-2. Table 3-2-2 Balance Sheet and Intervention Intervention and Money Supply III. Sterilization III.1 What Is Sterilization? “Central banks sometimes carry out equal foreign and domestic asset transactions in opposite directions to nullify the impact of their foreign exchange operations on the domestic money supply. This type of policy is called sterilized foreign exchange intervention (Krugman and Obstfeld, 2003, 488). ” III.2 Impact on Money Supply See Table 3-2-3. Table 3-2-4 summarizes and compares the effects of sterilized and non-sterilized interventions. IV. Balance of Payments and Money Supply Table 3-2-3 Sterilization and Money Supply Table 3-2-4 Summarization Fixing the Exchange Rate I. Exchange Market Equilibrium in a Fixed Rate Suppose the central bank fixes its currency rate at S0. The foreign exchange market will arrive at equilibrium when UIP holds. Hence, i-i*=(EtSt+1-St)/St= (EtSt+1-S0)/S0 Since we assume the target rate S0 will not change under any circumstance, this means that EtSt+1=S0, consequently, i=i* Since home interest rate is determi