Chapter 18 Global Edition Fixed Exchange Rates and Foreign Exchange Intervention International Economics THEORY POLICY Ninth Edibon Paul R.Krugman Maurlce Obstfeld Marc J.Melltz PEARSON PEARSON Copyright 2012 Pearson Education.All rights reserved
Copyright © 2012 Pearson Education. All rights reserved. Chapter 18 Fixed Exchange Rates and Foreign Exchange Intervention
Preview Balance sheets of central banks Intervention in the foreign exchange markets and the money supply How the central bank fixes the exchange rate Monetary and fiscal policies under fixed exchange rates Financial market crises and capital flight Types of fixed exchange rates: reserve currency and gold standard systems Copyright 2012 Pearson Education. All rights reserved 18-2
Copyright © 2012 Pearson Education. All rights reserved. 18-2 Preview • Balance sheets of central banks • Intervention in the foreign exchange markets and the money supply • How the central bank fixes the exchange rate • Monetary and fiscal policies under fixed exchange rates • Financial market crises and capital flight • Types of fixed exchange rates: reserve currency and gold standard systems
Introduction Many countries try to fix or peg"their exchange rate to a currency or group of currencies by intervening in the foreign exchange markets Many with a flexible or floatingexchange rate in fact practice a managed floating exchange rate The central bank "manages the exchange rate from time to time by buying and selling currency and assets, especially in periods of exchange rate volatility How do central banks intervene in the foreign exchange markets? Copyright G 2012 Pearson Education. All rights reserved 18-3
Copyright © 2012 Pearson Education. All rights reserved. 18-3 Introduction • Many countries try to fix or “peg” their exchange rate to a currency or group of currencies by intervening in the foreign exchange markets. • Many with a flexible or “floating” exchange rate in fact practice a managed floating exchange rate. – The central bank “manages” the exchange rate from time to time by buying and selling currency and assets, especially in periods of exchange rate volatility. • How do central banks intervene in the foreign exchange markets?
Central Bank Intervention and the money Supply To study the effects of central bank intervention in the foreign exchange markets first construct a simplified balance sheet for the central bank This records the assets and liabilities of a central bank Balance sheets use double-entry bookkeeping each transaction enters the balance sheet twice Copyright 2012 Pearson Education. All rights reserved 18-4
Copyright © 2012 Pearson Education. All rights reserved. 18-4 Central Bank Intervention and the Money Supply • To study the effects of central bank intervention in the foreign exchange markets, first construct a simplified balance sheet for the central bank. – This records the assets and liabilities of a central bank. – Balance sheets use double-entry bookkeeping: each transaction enters the balance sheet twice
Central bank's balance Sheet Assets Liabilities Foreign Assets(official Deposits of domestic banks international reserves) Currency in circulation Foreign government bonds Foreign currency deposits Gold (official international reserves Domestic assets Domestic government bonds Loans to domestic banks Copyright 2012 Pearson Education. All rights reserved
Copyright © 2012 Pearson Education. All rights reserved. Central Bank’s Balance Sheet Assets Liabilities ◼ Foreign Assets (official international reserves) ◼ Foreign government bonds ◼ Foreign currency deposits ◼ Gold (official international reserves) ◼ Domestic Assets ◼ Domestic government bonds ◼ Loans to domestic banks ◼ Deposits of domestic banks ◼ Currency in circulation