ISSUES IN ECONOMIC POLICY

Issues in Economic Policy

Issues in Economic Policy

Introduction

In this report, we will be discussing the implications of fixed exchange rate and flexible exchange rate on international trade and would focus on the issue that what mode of exchange rate is preferred by countries in this regard, primarily fixed exchange rate. In order to that, we must first understand the basic essence of these two exchange rate methodologies.

Fixed exchange rate

Fixed exchange rate (fixed exchange rate, fixed exchange rate, a fixed exchange rate) is an exchange-rate system in which a country long a fixed exchange ratio to other foreign currency units, gold or a basket of currencies in domestic currency sets. The grades or central bank guarantees this money since it foreign currency at a fixed price on or sold. One way to guarantee a fixed exchange rate is currency boards. A well-known example was the exchange rates of the countries of the CMEA together and - at least officially - to foreign currencies.

Thematic Classification

In principle, the different exchange rate regimes divided into free exchange rates , which exclusively supply and demand in the international financial markets set the value of currencies among themselves and interventions constitute the central banks except bandwidth fixed exchange rates (relatively fixed exchange rates), where the central banks of the participating countries have committed not to let a participating currency fluctuate more than the predetermined frame (example: Exchange Rate Mechanism II ) and fixed exchange rates. The specific exchange rate system arises from the exchange rate targets of such state or the single currency area.  An extreme case of a fixed exchange rate peg, the monetary union. 

 Current Situation

Many countries today are between the extremes of fixed and flexible exchange rates, depending on the current exchange rate objectives. Thus there are, for example, the intermediate forms peg regime, foreign exchange spreads, Adjustable Peg and dirty floating.  In Europe, there were about 1979 to 1998 with the European monetary system, a mechanism that limited the fluctuations between the exchange rates of the participating currencies. With stronger changes in prices, the central banks of the participants were required to support prices. Differences will remain between the voluntary commitment to a reserve currency (e.g. Argentine peso to the U.S. dollar) and a monetary union in which several States have a common currency and a common monetary policy conduct.

As part of the European Economic and Monetary Union with the introduction were euro as book money in 1999, the national currencies participants to "non-decimal subdivisions of the euro" and listened to it, regardless of the Euro exist. Before new countries can adopt the euro, they must within the Exchange Rate Mechanism II fix the rate of their national currencies to the euro within a band.

Crawling Peg

Crawling pegs are exchange rate pegs with regular Increases or decreases in response to a specific index (e.g. divergence in inflation rates between domestic and foreign). Both up-and-downs are previously announced, to provide a reliable basis for exchange rate expectations and counter currency speculation. [SS 1]

Adjustable Peg

Pegs are adjustable exchange rate pegs with irregular previously announced Increases or decreases. Here, for example, structural balance of payments imbalances parity changes are permitted (fixed exchange rate regime with gradual flexibility). [SS 2]

Foreign Exchange Spreads

In foreign exchange spreads (relatively fixed exchange rates, bandwidth fixed exchange rates) are fixed exchange ratios between currencies (parity) ...