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Finance in the Global Market

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Finance in the Global Market © Centre for Financial and Management Studies SOAS, University of London First published 2007, revised 2010, revised 2013, 2014 All rights reserved. No part of this course material may be reprinted or reproduced or utilised in any form or by any electronic, mechanical, or other means, including photocopying and recording, or in information storage or retrieval systems, without written permission from the Centre for Financial & Management Studies, SOAS, University of London.

Finance in the Global Market Course Introduction and Overview

Contents 1 Course Content

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2 The Course Author

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3 The Course Structure

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4 Learning Outcomes

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5 Study Materials

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6 Assessment

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Fin an ce in th e G lobal Market

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Un iversity of Lon don

Cou rse In trodu ction an d O verview

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Course Content The starting point for understanding any financial market is that, on a large scale, firms and governments have to turn to institutions (such as banks) and markets (such as bond markets) to finance their core operations. Even if a government or firm currently has no need to borrow or obtain new capital funds, it operates on financial markets to manage its old financial liabilities (such as its outstanding bonds which are traded on markets) or to invest currently surplus funds. At the same time, banks and other financial institutions essentially operate on financial markets as their main business activity. The fundamental fact underlying this course is that such large players’ financial operations take place on financial markets that are international in character. That is especially true now that, since the 1970s, economies have experienced a fast pace of globalisation. For centuries firms’ and governments’ financial operations have generally involved an international dimension, but modern globalisation has been accompanied by changes in both its scale and its character. What do we mean by saying that today ‘financial markets…are international in character’? When firms and governments, or banks, arrange finance or rearrange it, how do international matters come into play? We can list three dimensions: • Much borrowing and lending occurs on markets that have no national home (such as eurodollar – or, more generally, eurocurrency – markets). • National capital, credit, and money markets are highly integrated with other countries’ (for example, variations in the price index or in market returns in the stock markets of Tokyo, London, Frankfurt and New York exhibit significant correlation). • An important element in the costs of financing and the returns on financial assets is exchange rate movement. Firms, banks and investors of all types including individuals have to take account of possible exchange rate movements in calculating the expected yield of their investments or costs of borrowing; that means they have to take account of foreign exchange markets. In this course we give much attention to the third item listed, the great role that exchange rate variations have in financial markets, and the foreign exchange dealing and risk management techniques that relate to that. We first put that in context by studying how the processes of foreign exchange markets and exchange rates are themselves conditioned by government policies towards them – their ‘exchange rate regimes’. And, since exchange rate regimes have evolved over time, we study the main historical episodes. By looking at how exchange rates and foreign exchange markets operate under different exchange rate regimes, your study deals with the question: how did we get to where we are now? You will study a variety of theories throughout the course, which seek to explain the ways in which finance is handled internationally. One question we want you to keep in mind throughout your study of is: ‘Is the theory

Cen tre for Fin an cial an d Man agemen t Stu dies

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true?’ Whatever your answer, your next step should be to consider the related, but different question ‘Is the theory useful?’

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The Course Author Laurence Harris is Professor of Economics in the University of London and is a member of CeFiMS in the Department of Financial and Management Studies, SOAS, University of London. He has previously taught at several universities including London School of Economics; University of California Berkeley; Harvard University; Birkbeck, University of London; the Open University; University of Zimbabwe. He has published nine books and eighty articles. Books include Monetary Theory; New Perspectives on the Financial System; City of Capital and Peculiarities of the British Economy. Additional material for this edition of the course has been written by Norman Williams, he graduated with an MA in Economics from the University of Manchester and worked in a variety of research and advisory roles at the Bank of England, specifically in the areas of monetary policy, financial markets and banking regulation. He moved to H.M. Treasury where he worked on exchange rate policy and implementation, the strategic management of the official reserves and government borrowing. Thereafter, Norman worked for a large global investment bank focusing on European economic and investment research and advice. Norman is now a full-time academic specialising on banking and finance. Parts of the module have also been updated by Zeynep Kacmaz. Dr Kacmaz is a researcher and lecturer in the fields of International Business and Banking and Finance. She is currently working as associate lecturer at the University of Bradford and also tutors on the Centre for Financial & Management Studies distance learning programmes. Zeynep gained a PHd in Banking from Marmara University, Turkey.

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The Course Structure Unit 1 1.1 1.2 1.3 1.4 1.5 1.5

Unit 2 2.1 2.2 2.3 2.4 2.5

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The International Context of Finance Exchange Rate Regimes Fixed and Floating Exchange Rates Exchange Rate Regimes – a Bipolar Future? Recent Examples of Hard Pegs and Intermediate Regimes A New Bretton Woods System? Summary

The Markets for Foreign Exchange A Global Twenty-Four-Hour Market Developments in Asian Foreign Exchange Markets The Mechanics of the Foreign Exchange Markets How the Foreign Exchange Market Works in the US Conclusion



Unit 3 3.1 3.2 3.3 3.4 3.5 3.6 3.7

Unit 4 4.1 4.2 4.3 4.4 4.5 4.6

Unit 5 5.1 5.2 5.3 5.4 5.5 5.6

Unit 6 6.1 6.2 6.3 6.4 6.5 6.6

Unit 7 7.1 7.2 7.3

Unit 8 8.1 8.2 8.3 8.4

Exchange Rates and Prices Introduction The Balance of Payments A Standard for Measuring Economies Purchasing Power Parity Theory The Big Mac Measure Empirical Evidence – Short-Run Deviations from Purchasing Power Parity Conclusions

Exchange Rates and Interest Rates Introduction to Unit 4 Uncovered Interest Parity – Principles Uncovered Interest Parity – Evidence Interest Rates and Purchasing Power Parity Prices, Interest Rates and Exchange Rates in Equilibrium Conclusion

Managing Foreign Exchange Exposure Introduction to Unit 5 Hedging Techniques Why Firms Hedge with Derivatives Hedging Currency Risk in East Asian Economies Managing Foreign Exchange Exposure – Some More Things for You to Think About Conclusion

International Corporate Finance and Project Finance Introduction to Unit 6 Corporate Finance – Going International Corporate Finance – International Equity Markets International Bond Issues International Project Finance More Reading and a Conclusion

Capital Structure and Cost of Capital in International Financing Introduction How International Financing Affects Firms’ Costs Conclusion

Tax Policies of Multinationals Introduction to Unit 8 International Tax Environment Tax Arbitage Conclusion


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Learning Outcomes When you have completed your study of this course you will be able to • explain the nature of an exchange rate regime, and assess the future evolution of such regimes • identify and discuss drivers of the growth of the global foreign exchange market • explain the nature of exchange rate quotations • discuss the foreign exchange market microstructure • interpret balance of payments accounts • use purchasing power parity measures of gross domestic product (GDP) • explain the law of one price • assess the uses of absolute purchasing power parity and relative purchasing power parity • explain how firms can use currency derivatives to manage risks through hedging • discuss what determines whether firms do use currency derivatives for hedging • discuss models and empirical evidence on the difference between the beta coefficient of multinational enterprises as compared with domestic firms • outline evidence on the connection between agency costs and the capital structure of multinational enterprises • explain the main features of ‘third generation’ models of currency crises • discuss the effects of regulatory regimes on firms’ choice of stock exchange for their foreign listings • explain the differences and relative merits of project finance compared to corporate finance as methods of raising international finance • compare them with the main features of first and second generation models

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Study Materials This Study Guide is your central learning resource as it structures your learning unit by unit. Each unit should be studied within a week. It is designed in the expectation that studying the unit and the associated core readings will require 15 to 20 hours during the week, but this will vary according to your background knowledge and experience of studying.

Textbook In addition to the study guide you will be assigned chapters in the following textbook, which is provided for you: David K Eiteman, Arthur I Stonehill and Michael H Moffett (2013) Multinational Business Finance, Thirteenth edition.

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This is a widely used and authoritative coverage of contemporary international finance, which aims to explain and illustrate the unique features of global markets. It uses real-life cases to illustrate current industry practices, allows you to test yourself with review questions and exercises, and provides appendices throughout the text which add advanced material on the basic topics covered in the chapter.

Course Reader In your Course Reader, you are provided with a selection of academic articles and extracts from books, which you are expected to read as part of your study of this course. You will note from reading them that the topics covered in these articles often vary widely from the Study Guide. The Course Reader articles are often more technical or adopt a more in-depth approach. This should not put you off, as many were written with an academic audience in mind. These articles were selected so that the central arguments and concepts could be understood and appreciated at a level appropriate to this course.

Optional Reading You are provided with all the reading essential for this course, and we do not expect you to undertake extra reading on your own, partly because not all students have ready access to good libraries or bookshops. However, the reference section of each unit lists academic articles, book chapters or web based sources that you can choose to read if you wish to further investigate a particular topic. Many of these readings can be accessed on the Internet, but it is important to note that they will not be assessed in examination or assignments. Although not required, we think that you will enrich your study of this course by looking at such articles. Indeed, you are encouraged to choose your own additional reading on topics related to global finance. You can do this through searching the Internet and by making use of the online academic journals through the Library resources on the CeFiMS Online Study Centre. You are also recommended to browse through your textbook for additional coverage of the topics studied in this course.

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Assessment Your performance on each course is assessed through two written assignments and one examination. The assignments are written after week four and eight of the course session and the examination is written at a local examination centre in October. The assignment questions contain fairly detailed guidance about what is required. All assignment answers are limited to 2,500 words and are marked using marking guidelines. When you receive your grade it is accompanied by comments on your paper, including advice about how you might improve, and any clarifications about matters you may not have understood.


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These comments are designed to help you master the subject and to improve your skills as you progress through your programme. The written examinations are ‘unseen’ (you will only see the paper in the exam centre) and written by hand, over a three hour period. We advise that you practice writing exams in these conditions as part of you examination preparation, as it is not something you would normally do. You are not allowed to take in books or notes to the exam room. This means that you need to revise thoroughly in preparation for each exam. This is especially important if you have completed the course in the early part of the year, or in a previous year.

Preparing for Assignments and Exams There is good advice on preparing for assignments and exams and writing them in Sections 8.2 and 8.3 of Studying at a Distance by Talbot. We recommend that you follow this advice. The examinations you will sit are designed to evaluate your knowledge and skills in the subjects you have studied: they are not designed to trick you. If you have studied the course thoroughly, you will pass the exam.

Understanding assessment questions Examination and assignment questions are set to test different knowledge and skills. Sometimes a question will contain more than one part, each part testing a different aspect of your skills and knowledge. You need to spot the key words to know what is being asked of you. Here we categorise the types of things that are asked for in assignments and exams, and the words used. All the examples are from CeFiMS examination papers and assignment questions. Definitions Some questions mainly require you to show that you have learned some concepts, by setting out their precise meaning. Such questions are likely to be preliminary and be supplemented by more analytical questions. Generally ‘Pass marks’ are awarded if the answer only contains definitions. They will contain words such as:

Describe Define Examine Distinguish between Compare Contrast Write notes on Outline What is meant by List

Reasoning Other questions are designed to test your reasoning, by explaining cause and effect. Convincing explanations generally carry additional marks to basic definitions. They will include words such as:

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Interpret Explain What conditions influence What are the consequences of What are the implications of

Judgment Others ask you to make a judgment, perhaps of a policy or of a course of action. They will include words like:

Evaluate Critically examine Assess Do you agree that To what extent does

Calculation Sometimes, you are asked to make a calculation, using a specified technique, where the question begins:

Use indifference curve analysis to Using any economic model you know Calculate the standard deviation Test whether

It is most likely that questions that ask you to make a calculation will also ask for an application of the result, or an interpretation. Advice Other questions ask you to provide advice in a particular situation. This applies to law questions and to policy papers where advice is asked in relation to a policy problem. Your advice should be based on relevant law, principles, evidence of what actions are likely to be effective. Advise Provide advice on Explain how you would advise Critique In many cases the question will include the word ‘critically’. This means that you are expected to look at the question from at least two points of view, offering a critique of each view and your judgment. You are expected to be critical of what you have read. The questions may begin

Critically analyse Critically consider Critically assess Critically discuss the argument that

Examine by argument Questions that begin with ‘discuss’ are similar – they ask you to examine by argument, to debate and give reasons for and against a variety of options, for example Discuss the advantages and disadvantages of


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Discuss this statement Discuss the view that Discuss the arguments and debates concerning

The grading scheme Details of the general definitions of what is expected in order to obtain a particular grade are shown below. Remember: examiners will take account of the fact that examination conditions are less conducive to polished work than the conditions in which you write your assignments. These criteria are used in grading all assignments and examinations. Note that as the criteria of each grade rises, it accumulates the elements of the grade below. Assignments awarded better marks will therefore have become comprehensive in both their depth of core skills and advanced skills.

70% and above: Distinction As for the (60-69%) below plus: • shows clear evidence of wide and relevant reading and an engagement with the conceptual issues • develops a sophisticated and intelligent argument • shows a rigorous use and a sophisticated understanding of relevant source materials, balancing appropriately between factual detail and key theoretical issues. Materials are evaluated directly and their assumptions and arguments challenged and/or appraised • shows original thinking and a willingness to take risks

60-69%: Merit As for the (50-59%) below plus: • shows strong evidence of critical insight and critical thinking • shows a detailed understanding of the major factual and/or theoretical issues and directly engages with the relevant literature on the topic • develops a focussed and clear argument and articulates clearly and convincingly a sustained train of logical thought • shows clear evidence of planning and appropriate choice of sources and methodology

50-59%: Pass below Merit (50% = pass mark) • shows a reasonable understanding of the major factual and/or theoretical issues involved • shows evidence of planning and selection from appropriate sources, • demonstrates some knowledge of the literature • the text shows, in places, examples of a clear train of thought or argument • the text is introduced and concludes appropriately

45-49%: Marginal Failure • shows some awareness and understanding of the factual or theoretical issues, but with little development • misunderstandings are evident • shows some evidence of planning, although irrelevant/unrelated material or arguments are included

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0-44%: Clear Failure • fails to answer the question or to develop an argument that relates to the question set • does not engage with the relevant literature or demonstrate a knowledge of the key issues • contains clear conceptual or factual errors or misunderstandings [approved by Faculty Learning and Teaching Committee November 2006]

Specimen exam papers Your final examination will be very similar to the Specimen Exam Paper that you received in your course materials. It will have the same structure and style and the range of question will be comparable. For students enrolled on FFL108, the examination paper will differ from the specimen examination here in that you will have two hours to answer two questions from a choice of six. The paper is also divided into A and B sections. CeFiMS does not provide past papers or model answers to papers. Our courses are continuously updated and past papers will not be a reliable guide to current and future examinations. The specimen exam paper is designed to be relevant to reflect the exam that will be set on the current edition of the course.

Further information The OSC will have documentation and information on each year’s examination registration and administration process. If you still have questions, both academics and administrators are available to answer queries. The Regulations are available at www.cefims.ac.uk/regulations.shtml, setting out the rules by which exams are governed.


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UNIVERSITY OF LONDON Centre for Financial and Management Studies MSc Examination Postgraduate Diploma Examination for External Students 91DFMC242 91DFMC342 FINANCE FINANCE & FINANCIAL LAW FINANCIAL MANAGEMENT

Finance in the Global Market Specimen Examination This is a specimen examination paper designed to show you the type of examination you will have at the end of the year for Finance in the Global Market. The number of questions and the structure of the examination will be the same as on this one, but the wording and the requirements of each question will be different. Best wishes for success on your final examination. This examination must be completed in THREE hours. You must answer THREE questions, at least ONE from EACH section. The examiners give equal weight to each question; therefore, you are advised to distribute your time approximately equally between the three questions. DO NOT REMOVE THIS PAPER FROM THE EXAMINATION ROOM. IT MUST BE ATTACHED TO YOUR ANSWER BOOK AT THE END OF THE EXAMINATION.

© University of London, 2007


PLEASE TURN OVER

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Answer THREE questions, at least ONE from EACH section.

Section A (Answer at least ONE question from this section) 1. Changes in exchange rates have important effects on firms engaged in foreign trade and investment. Discuss how far knowledge of purchasing power parity theory would enable them to understand the causes of exchange rate changes.

2. Answer all three parts of the question (each part contributes the indicated amount to the total grade for the question): a. A foreign exchange trader in Tokyo wants to invest US$2,000,000 or its yen equivalent in a covered interest arbitrage between US$ and Japanese yen. He faces exchange rate and interest rate quotes: Spot exchange rate: ¥110.20/$ 180-day forward exchange rate: ¥109.80/$ 180-day dollar interest rate: 3.000% per year 180-day yen interest rate 1.800% per year The bank does not calculate transaction costs on any individual transaction, because these costs are part of the overall operating budget of the arbitrage department. Explain and diagram the specific steps the foreign exchange trader in Tokyo must take to make a covered interest arbitrage profit. b. Explain the role that currency derivatives can, in principle, play in hedging currency risk. c.

Discuss whether companies’ actual use of derivatives takes full advantage of that potential.

[35% of marks] [35% of marks] [30% of marks]

3. Explain the role that changes in relative interest rates may have in causing changes in exchange rates.

4. Are there any valid reasons for thinking that shareholders in companies engaged in foreign trade or foreign investment face greater risk than shareholders in domestic companies? Explain your answer using theoretical and empirical reasoning.

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Section B (Answer at least ONE question from this section) 5. In the light of Paul Krugman’s ‘third generation’ model, explain how a currency crisis may be preceded by ‘overinvestment’. Discuss the implications of the model for policymakers seeking to avoid a repeat of the 1997-8 Asian Crisis.

6. Discuss the factors influencing a multinational company’s choice of capital structure.

7. ‘The continued attractiveness of ADRs as a means of raising capital depends on changes in emerging markets, the United States, and international capital markets.’ Explain and discuss

8. Explain the differences between international project financing and international corporate finance. Discuss the reasons for the growth of the former.

[END OF EXAMINATION]


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Finance in the Global Market Unit 1 The International Context of Finance

Contents Unit Content

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Learning Outcomes

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1. 1 Exchange Rate Regimes

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1. 2 Fixed and Floating Exchange Rates

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1. 3 Exchange Rate Regimes – a Bipolar Future?

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1. 4 Recent Examples of Hard Pegs and Intermediate Regimes 14 1. 5 A New Bretton Woods System?

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1. 6 Summary

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References and Websites

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Unit Content In Unit 1, by studying the evolution of today’s international monetary system, you will examine the major operating principles, or ‘rules of the game’, of alternative international exchange rate regimes. You will see how the rules of the game for the classical gold standard, the Bretton Woods system, and the Euro system have operated in practice. You will also study the pros and cons of fixed, intermediate and floating exchange rate regimes. The overall question, which is the main learning objective of this unit, may be expressed as follows: • What is likely to be the future evolution of exchange rate regimes?

Learning Outcomes When you have completed your study of this unit and its readings, you will be able to • explain the nature of an exchange rate regime • describe the exchange rate regime of the Bretton Woods system until 1973 • discuss the difference between ‘hard peg’, fully ‘independent floating’ and intermediate regimes • define the ‘bipolar view’, and discuss the reasoning supporting it and some arguments against it • outline the modern history of the euro, of China’s exchange rate regime, and of Argentina’s exchange rate regime.

Reading for Unit 1 Textbook David Eiteman, Arthur Stonehill and Michael Moffett (2013) Multinational Business Finance, Thirteenth Edition: Chapter 3 ‘The International Monetary System’, and Chapter 5, ‘The U.S. and European Financial Crises’

Course Reader Your core reading includes two valuable articles, looking both backward and forward, and describing the exchange rate systems that exist at the start of the twenty-first century: Stanley Fischer (2001) ‘Exchange Rate Regimes: Is the Bipolar View Correct?’ Vijay Joshi (2003) ‘Financial Globalisation, Exchange Rates and Capital Controls in Developing Countries’.

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University of London

Unit 1 The International Context of Finance

1.1 Exchange Rate Regimes As noted in the course introduction, in exploring problems of corporate strategies within the international financial system, you need to understand the main features of the international financial system. In Unit 1, you study the international financial system. It is the structure within which foreign exchange rates are determined and international trade and capital flows are accommodated. The international financial system has evolved historically through the policies of governments and their interaction with the market forces generated by banks, firms and individuals. Governments’ efforts to set the framework for the international financial structure have required international cooperation of three types: • Multilateral organisation: Since it was founded in 1945 the International Monetary Fund, which is an organisation of member states, has been the main institution through which governments have influenced how exchange rates are determined, although its significance and role have changed since 1973. • Specific cooperation: Governments of leading economies have also attempted to negotiate major shifts between themselves. The most famous example is the 1985 Plaza Accord between the US, Japan, West Germany, the UK and France, which agreed to engineer a devaluation of the US dollar against the German and Japanese currencies. In the twenty-first century, the clearest example is the effort of the US to persuade China to change the trading system of its currency. • Regional organisation: Governments have also negotiated on a regional basis between themselves to achieve changes affecting the whole international financial system. The outstanding successful example of such a change has been the adoption of the euro in 1999 by eleven European nations. Those examples of nations’ different types of projects to reshape the international financial system are characterised by different types of exchange rate regimes: • Pegged exchange rates (fixed but adjustable rates) underpinned the system supervised by the International Monetary Fund until 1973. • Managed floating exchange rates between the major currencies were the subject of the Plaza Accord. • Adopting the euro created a currency union, uniting economies with a single shared currency – creating an irrevocably fixed exchange rate with each country’s old, and vanished, currency. In this unit we shall focus on exchange rates as the central feature of international financial systems; within each system different exchange rate regimes are prevalent. We have mentioned three regimes – pegged rates, managed floating rates, currency union – but soon you will see that there is a wider spectrum of regimes. To examine the role of exchange rate regimes in international finance, we usually assume that an individual country has to choose its exchange rate regime and then look at the costs and benefits of the alternatives. And, in reality, individual countries do face such choices from time to time. Since the

Centre for Financial and Management Studies

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IMF-supervised formal system of pegged exchange rates ended in 1973 countries have adopted numerous different types of exchange rate regimes. Moreover, from time to time, individual countries face difficult choices about whether to change their regime. For example, a country with pegged exchange rates might find the regime too costly and face the difficult issue of whether to switch to floating exchange rates. Or a country that says it has pure (independent) floating rates might, when faced with exchange rate volatility, decide to switch to a regime of managed floating rates. Let us take a look at the range of exchange rate regimes that different countries operate, and see which countries use which regime. Although the IMF no longer regulates a universal regime of pegged exchange rates, it does have continuing responsibility for overseeing the world’s financial system and annually records the exchange rate regimes of its member states. Box 1.1 shows its list of countries’ exchange rate regimes effective on 31 April 2008 (it is published on the IMF website). Box 1. 1 Classification of Exchange Rate Arrangements and Monetary Policy Frameworks This classification system is based on members’ actual, de facto, arrangements as identified by IMF staff, which may differ from their officially announced arrangements. The scheme ranks exchange rate arrangements on the basis of their degree of flexibility and the existence of formal or informal commitments to exchange rate paths. It distinguishes among different forms of exchange rate regimes, in addition to arrangements with no separate legal tender, to help assess the implications of the choice of exchange rate arrangement for the degree of monetary policy independence. The system presents members’ exchange rate regimes against alternative monetary policy frameworks with the intention of using both criteria as a way of providing greater transparency in the classification scheme and to illustrate that different exchange rate regimes can be consistent with similar monetary policy frameworks. The following explains the categories. Exchange Rate Regimes Exchange Arrangements with No Separate Legal Tender The currency of another country circulates as the sole legal tender (formal dollarization), or the member belongs to a monetary or currency union in which the same legal tender |is shared by the members of the union. Adopting such regimes implies the complete surrender of the monetary authorities’ independent control over domestic monetary policy. Currency Board Arrangements A monetary regime based on an explicit legislative commitment to exchange domestic currency for a specified foreign currency at a fixed exchange rate, combined with restrictions on the issuing authority to ensure the fulfillment of its legal obligation. This implies that domestic currency will be issued only against foreign exchange and that it remains fully backed by foreign assets, eliminating traditional central bank functions, such as monetary control and lender-of-last-resort, and leaving little scope for discretionary monetary policy. Some flexibility may still be afforded, depending on how strict the banking rules of the currency board arrangement are.

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Other Conventional Fixed Peg Arrangements The country (formally or de facto) pegs its currency at a fixed rate to another currency or a basket of currencies, where the basket is formed from the currencies of major trading or financial partners and weights reflect the geographical distribution of trade, services, or capital flows. The currency composites can also be standardized, as in the case of the SDR. There is no commitment to keep the parity irrevocably. The exchange rate may fluctuate within narrow margins of less than ±1 percent around a central rate – or the maximum and minimum value of the exchange rate may remain within a narrow margin of 2 percent – for at least three months. The monetary authority stands ready to maintain the fixed parity through direct intervention (i.e. via sale/purchase of foreign exchange in the market) or indirect intervention (e.g. via aggressive use of interest rate policy, imposition of foreign exchange regulations, exercise of moral suasion that constrains foreign exchange activity, or through intervention by other public institutions). Flexibility of monetary policy, though limited, is greater than in the case of exchange arrangements with no separate legal tender and currency boards because traditional central banking functions are still possible, and the monetary authority can adjust the level of the exchange rate, although relatively infrequently. Pegged Exchange Rates within Horizontal Bands The value of the currency is maintained within certain margins of fluctuation of at least ±1 percent around a fixed central rate or the margin between the maximum and minimum value of the exchange rate exceeds 2 percent. It also includes arrangements of countries in the exchange rate mechanism (ERM) of the European Monetary System (EMS) that was replaced with the ERM II on January 1, 1999. There is a limited degree of monetary policy discretion, depending on the band width. Crawling Pegs The currency is adjusted periodically in small amounts at a fixed rate or in response to changes in selective quantitative indicators, such as past inflation differentials vis-à-vis major trading partners, differentials between the inflation target and expected inflation in major trading partners, and so forth. The rate of crawl can be set to generate inflationadjusted changes in the exchange rate (backward looking), or set at a pre-announced fixed rate and/or below the projected inflation differentials (forward looking). Maintaining a crawling peg imposes constraints on monetary policy in a manner similar to a fixed peg system. Exchange Rates within Crawling Bands The currency is maintained within certain fluctuation margins of at least ±1 percent around a central rate – or the margin between the maximum and minimum value of the exchange rate exceeds 2 percent – and the central rate or margins are adjusted periodically at a fixed rate or in response to changes in selective quantitative indicators. The degree of exchange rate flexibility is a function of the band width. Bands are either symmetric around a crawling central parity or widen gradually with an asymmetric choice of the crawl of upper and lower bands (in the latter case, there may be no pre-announced central rate). The commitment to maintain the exchange rate within the band imposes constraints on monetary policy, with the degree of policy independence being a function of the band width. Managed Floating with No Predetermined Path for the Exchange Rate The monetary authority attempts to influence the exchange rate without having a specific exchange rate path or target. Indicators for managing the rate are broadly judgmental


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(e.g. balance of payments position, international reserves, parallel market developments), and adjustments may not be automatic. Intervention may be direct or indirect. Independently Floating The exchange rate is market-determined, with any official foreign exchange market intervention aimed at moderating the rate of change and preventing undue fluctuations in the exchange rate, rather than at establishing a level for it. Monetary Policy Framework The exchange rate regimes are presented alongside monetary policy frameworks in order to present the role of the exchange rate in broad economic policy and help identify potential sources of inconsistency in the monetary–exchange rate policy mix. Exchange Rate Anchor The monetary authority stands ready to buy/sell foreign exchange at given quoted rates to maintain the exchange rate at its pre-announced level or range; the exchange rate serves as the nominal anchor or intermediate target of monetary policy. This type of regime covers exchange rate regimes with no separate legal tender; currency board arrangements; fixed pegs with and without bands; and crawling pegs with and without bands. Monetary Aggregate Anchor The monetary authority uses its instruments to achieve a target growth rate for a monetary aggregate, such as reserve money, M1, or M2, and the targeted aggregate becomes the nominal anchor or intermediate target of monetary policy. Inflation Targeting Framework This involves the public announcement of medium-term numerical targets for inflation with an institutional commitment by the monetary authority to achieve these targets. Additional key features include increased communication with the public and the markets about the plans and objectives of monetary policymakers and increased accountability of the central bank for attaining its inflation objectives. Monetary policy decisions are guided by the deviation of forecasts of future inflation from the announced target, with the inflation forecast acting (implicitly or explicitly) as the intermediate target of monetary policy. Fund-Supported or Other Monetary Program This involves implementation of monetary and exchange rate policies within the confines of a framework that establishes floors for international reserves and ceilings for net domestic assets of the central bank. Indicative targets for reserve money may be appended to this system. Other The country has no explicitly stated nominal anchor but rather monitors various indicators in conducting monetary policy, or there is no relevant information available for the country. Based on ‘Exchange Arrangements and Foreign Exchange Markets: Developments and Issues’ (SM/02/233, July 22, 2002).

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Table 1. 1 De Facto Exchange Rate Arrangements and Anchors of Monetary Policy as of April 31, 20081 Exchange Monetary Policy Framework rate arrangement Exchange rate anchor (Number of countries) U.S. dollar (66)

Euro (27) Composite (15)

Other (7)

Exchange arrangement with no separate legal tender (10)

Ecuador El Salvador Marshall Islands Micronesia, Fed. States

Montenegro San Marino

Kiribati

Currency board arrangement (13)

Antigua and St. Lucia2 St. Vincent and Barbuda2 the Grenadines2 Djibouti 2 Dominica Grenada2 Hong Kong SAR St. Kitts and Nevis2

Bosnia and Herzegovina Bulgaria Estonia3 Lithuania3

Brunei Darussalam

Other conventional fixed peg arrangement (68)

Angola Argentina Aruba Bahamas, Bahrain Bangladesh Barbados Belarus Belize Eritrea Guyana Honduras Jordan Kazakhstan Lebanon Malawi Maldives Mongolia Netherlands Antilles Oman Qatar Rwanda Saudi Arabia

Benin4 Burkina Faso4 Cameroon5 Cape Verde Central African Rep.5 Chad5 Comoros Congo, Rep.5 Côte d'Ivoire4 Croatia Denmark3 Equatorial Guinea 5 Gabon 5 GuineaBissau4 Latvia3 Macedonia, FYR Mali4 Niger4 Senegal4 Togo4

Palau Panama Timor-Leste

Seychelles Sierra Leone Solomon Islands Sri Lanka Suriname Tajikistan Trinidad and Tobago Turkmenistan United Arab Emirates Venezuela, Rep. Bolivariana de Vietnam Yemen, Rep. Zimbabwe

Fiji Kuwait Libya Morocco Russian Federation Samoa Tunisia

Bhutan Lesotho Namibia Nepal Swaziland

Monetary aggregate target

Inflation targeting framework

(22)

(44)

Other1

(11)

Argentina Malawi Rwanda Sierra Leone

Slovak Rep.3 Syria. Tonga

Pegged exchange rate within horizontal bands (3) Crawling peg Bolivia China (8)

Botswana Iran, I.R. of.

Ethiopia Iraq Nicaragua Uzbekistan

Continued on the next page.


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Exchange rate arrangement (Number of countries)

Monetary Policy Framework Exchange rate anchor

U.S. dollar (66)

Crawling band (2)

Costa Rica

Cambodia Managed Kyrgyz Rep. floating with Lao P.D.R. no preLiberia determined path Mauritania Mauritius for the Myanmar exchange Ukraine rate (44)

Independently floating (40)

Monetary Inflation targeting aggregate framework target Euro (27) Composite (15) Other (7)

(22)

(44)

(11)

Afghanistan, I.R. of Burundi Gambia, The Georgia Guinea Haiti Jamaica Kenya Madagascar Moldova Mozambique Nigeria Papua New Guinea São Tomé and Príncipe Sudan Tanzania Uganda

Armenia6 Colombia Ghana Guatemala Indonesia Peru Romania Serbia6 Thailand Uruguay

Dominican Rep. Egypt India Malaysia Pakistan Paraguay

Zambia

Albania Australia Austria7 Belgium7 Brazil Canada Chile Cyprus7 Czech Rep. Finland7 France7 Germany7 Greece7 Hungary Iceland Ireland7 Israel Italy7 Korea, Rep.

Azerbaijan

Algeria Singapore Vanuatu

Luxembourg7 Malta7 Mexico Netherlands7 New Zealand Norway Philippines Poland Portugal7 Slovenia7 South Africa Spain7 Sweden Turkey United Kingdom

1/ Includes countries that have no explicitly stated nominal anchor, but rather monitor various indicators in conducting monetary policy. 2/ The member participates in the Eastern Caribbean Currency Union. 3/ The member participates in the ERM II. 4/ The member participates in the West African Economic and Monetary Union. 5/ The member participates in the Central African Economic and Monetary Community. 6/ The central bank has taken preliminary step toward inflation targeting and is preparing for the transition to full-fledged inflation targeting. 7/ The member participates in the European Economic and Monetary Union. 8/ As of end-December 1989. 31 April 2008 (published on the IMF website)

Banks, firms or individuals making financial decisions have to make judgments about exchange rate risks and the profit (or loss) they can obtain from 8

Other1


Congo, Dem. Rep. Japan Somalia8 Switzerland United States


exchange rate changes. And in order to do that, they have to understand countries’ exchange rate regimes and possible changes to them. For example, until 1997 South Korea’s regime was effectively a pegged exchange rate, tying its currency to the US dollar; investors in South Korean bank deposits should have taken that into account in assessing their returns and should also have taken account of the possibility that the pegged exchange rate regime would change (as it did when South Korea was forced to abandon that peg by the 1997 Asian crisis).

Review Question Having abandoned its pegged exchange rate regime as a result of the 1997 crisis, what exchange rate regime did South Korea have subsequently? It is shown as Korea in the Table of Box 1.1. At this point in the unit, it is useful for you to study some of the main twentieth century developments in the international financial system. They are the roots from which the present international financial system has grown.

Reading Please read now the first sections of Chapter 3, pages 79-94 (up to the section on ‘Emerging Markets and Regime Choices’), of your textbook by Eiteman, Stonehill and Moffett, Multinational Business Finance.

David Eiteman, Arthur Stonehill and Michael Moffett (2013) Multinational Business Finance, Chapter 3, ‘The International Monetary System’.

While reading those pages, please make sure your notes cover the following: the features of the exchange rate regime associated with the International Monetary Fund from 1945 to 1973 the nature of Eurocurrencies.

1.2 Fixed and Floating Exchange Rates In this unit we focus on the world’s exchange rate regimes and their evolution. As you saw from Box 1.1, the IMF classifies them into eight categories. In order to analyse exchange rate regimes, economists simplify the alternatives to two: • fixed exchange rate regimes • floating exchange rate regimes and they compare their advantages and disadvantages.

1.2.1 Can governments set their country’s exchange rate? When ordinary people consider their country’s economic situation, they often think the government (or central bank) should change the exchange rate. Export-oriented manufacturers and their employees might argue that the government should devalue the currency, reducing its price in terms of foreign currencies. Others might favour higher exchange rates to keep down import costs. However, in the world’s large developed economies, the


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exchange rate is not controlled by the government or central bank (‘the authorities’). How is the exchange rate determined? In all cases where a currency may be traded, the foreign exchange price of a country’s exchange rate – the nominal exchange rate – is determined by the foreign exchange markets. The foreign exchange markets are driven by ‘buy’ and ‘sell’ orders emanating from banks, firms and individuals pursuing trade and, particularly, by investment decisions. In an economy with a fixed rate (such as the ‘other conventional fixed peg category’ in Box 1.1) the authorities buy and sell foreign and domestic currency in order to prevent the exchange rate moving far from its target value or peg. Thus, they add policy-driven demand and supply to the ‘buy’ and ‘sell’ orders emanating from banks, firms and individuals pursuing trade and, particularly, investment decisions. In such countries, the authorities can intervene directly to change the peg to a new fixed rate and buy and sell currency to support it. In discussing the merits of fixed rates we shall assume that the authorities’ intervention always succeeds in determining the exchange rate, but in fact it has to interact with private buy and sell orders, and speculative flows might outweigh the authorities’ effect. In an economy with an independent (pure) floating rate, the authorities do not add their own buy or sell orders to influence the exchange rate. Instead the exchange rate moves wholly in response to ‘buy’ and ‘sell’ orders emanating from banks, firms and individuals pursuing trade and investment decisions. The government cannot change the exchange rate directly unless it abandons the regime of independent floating. Therefore the citizens of the 35 countries listed in Box 1.1 as independently floating cannot expect their authorities to alter the exchange rate directly. That includes the major economies of the US, Japan, the UK and the Eurozone (since the Eurozone as a body is not a member state of the IMF, it is not included in the 35).

1.2.2 Interaction of exchange rate and monetary policy Whether we are considering fixed or floating exchange rates, governments and central banks can adopt policies that have indirect effects on exchange rates. For example, higher interest rates relative to other countries’ can be expected to cause upward pressure on the exchange rate by attracting capital inflows. The fact that governments and central banks can influence the exchange rate indirectly through monetary policy on the interest rate illustrates one of the most important characteristics of exchange rate policy: •

exchange rates and monetary policy are interdependent.

Study Note In your reading of Section 1.1, you might have already noticed a clue indicating that the exchange rate and monetary policy are interdependent. The table in Box 1.1 lists countries according to their exchange rate regime. But it also subdivides them on another dimension, their monetary policy regime. In case you did not notice that, please look at the table again.

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1.2.3 The impossible trinity Because the exchange rate and interest rates are interdependent, countries that attempt to have fixed exchange rates have to make some difficult choices. You have already read about a famous set of choices in the section of the textbook titled (misleadingly) ‘Attributes of the “Ideal” Currency’ (Eiteman, Stonehill and Moffett, pp 89-90). Let us look again at the idea of ‘the impossible trinity’ explained there, for it is at the centre of a debate over the way that the international financial system is evolving. ‘The impossible trinity’ starts from the idea that countries would like to have three things: 1 a stable exchange rate (analysed by assuming that means a fixed peg) 2 full integration into the global financial market (analysed by assuming that means absence of controls on capital inflows and outflows) 3 monetary independence (analysed by assuming this means the ability to set interest rates at a level that is best for the country’s domestic economy and is generally different from other countries’ interest rates). In order to analyse ‘the impossible trinity’ and the alternatives available to a country we usually define each of the three goals more precisely as three policy regimes: 1’ a fixed peg exchange rate regime 2’ perfect capital mobility (absence of controls and costs on inflows and outflows of capital) 3’ monetary policy target defined in terms of domestic economic indicators alone (such as interest rates adjusted to attain inflation targets). Why is the trinity impossible? Why can a country not have all three? We can explain with the help of a characteristic example. Imagine a country that fixes its exchange rate against the US dollar. In order to maintain its fixed level it must have its interest rate at a level, relative to others, that ensures that net capital flows are sustainable. If, then, US interest rates were to be reduced by the Federal Reserve but no other key variables changed, this country would have to lower its own interest rate and therefore, instead of having an independent monetary policy, would have to follow US monetary policy. If it did not follow the US interest rates down, there would be an increased net capital inflow (remember that one element of the trinity is free capital flows) and the inflow would put upward pressure on the exchange rate. In order to absorb that pressure and maintain the fixed exchange rate, the country’s central bank would have to buy US dollars and, in the process, increase the stock of the domestic currency, putting downward pressure on domestic real interest rates and fuelling inflation. Thus, the impossible trinity means that the government can have any two of the three things listed, but not all three. In our example, the country could abandon its full integration into the global financial market by imposing capital controls. In that case, it could have both monetary independence (its own interest rate policy) and a stable exchange rate. Or it could abandon its fixed exchange rate, allowing it to float so that an independent interest rate


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policy which, with full integration into the global market, would change capital inflows and thereby cause an unhindered change in exchange rate.

Review Question What is the third pair of policies the country could choose?

1.3 Exchange Rate Regimes – a Bipolar Future? In Section 1.1, you saw that countries’ exchange rate regimes can be classified into eight different types. In this section we want you to examine a view that has been debated by economists since the 1997 Asian crisis. The debate concerns the view that: There is a tendency for countries to move to one of two extreme regimes: either a fixed rate with a ‘hard peg’ (such as a currency board) or a fully flexible ‘independent float’.

1.3.1 The bipolar view That ‘bipolar view’ is based on the idea that in the modern world of highly developed global capital markets, countries find it difficult to maintain intermediate regimes and, over time, move to one of the two extremes. That means that regimes such as those described in Box 1.1 as ‘Other Conventional Fixed Peg Arrangements’, which predominated during the Bretton Woods system until 1973, are diminishing in importance. Figure 1.1 illustrates changes that appear to fit the bipolar view. Look at the decline in ‘intermediate’ (soft peg) regimes and the increase in ‘hard peg’ and ‘float’ regimes between 1991 and 2007. Figure 1. 1 Shifts in Exchange Rate Regimes since 1991. The move from soft pegs to floating or hard peg regimes in the 1990s was followed by more subtle shifts after 2001. Regimes as of end-April 2007 Percentage of total 100 FLOATING REGIMES 80 60 40

SOFT PEGS

20

—

2006 —

—

2004 —

—

2002 —

—

2000 —

—

1998 —

—

1996 —

—

1994 —

—

1992 —

—

1990 —

HARD PEGS 0

Data derived from IMF Staff Reports and IMF Annual Report on Exchange Arrangements and Restrictions database. Source: Finance and Development (March, 2008)

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Proponents of the bipolar view do more than describe such changes, for to enable us to understand existing and future trends we have to explain them. One explanation for the decrease in intermediate regimes is based upon ‘the impossible trinity’ notion. In reading the articles we assign for this section, we want you to think about the reasons for the decrease in intermediate regimes. Why do countries find it difficult (or undesirable) to maintain intermediate regimes? How do those difficulties relate to ‘the impossible trinity’? The first article assigned for this section is by Stanley Fischer, an eminent academic economist and economic policy maker.

Reading Now, please read Fischer’s article, ‘Exchange Rate Regimes: Is the Bipolar View Correct?’.

After you have read Fischer’s article, please try to write a few sentences on the two questions we posed before your reading:

Stanley Fischer (2001) ‘Exchange Rate Regimes: Is the Bipolar View Correct?’ reprinted in the Course Reader from the Journal of Economic Perspectives.

Why do countries find it difficult (or undesirable) to maintain intermediate regimes? How do those difficulties relate to ‘the impossible trinity’?

1.3.2 Do countries have other alternatives? The bipolar view, which is a description and analysis of the choices countries make, implies that the two extreme types of regime are the only alternatives available to a country. Are they? In this section, we would like you to consider an analysis of ‘the impossible trinity’ that considers a wider range of alternatives. In ‘Financial Globalisation, Exchange Rates and Capital Controls in Developing Countries’, Vijay Joshi discusses ‘the impossible trinity’ from the perspective of developing countries. He argues that some countries can and do choose alternative policies by using capital controls to diminish capital mobility. We would like you to read Joshi’s article and form your own view of whether the tendency toward the extremes identified by the bipolar view is inevitable.

Reading Please read Joshi’s article, ‘Financial Globalisation, Exchange Rates and Capital Controls in Developing Countries’.

Now that you have finished the two core readings on the subject of the bipolar view of exchange rate regimes, please pause and reflect on the following question: If you were a company director responsible for strategy and considering long-term investment in a country that currently has an intermediate exchange rate regime with a ‘conventional peg’, how would you evaluate the probability that the country will switch to a ‘hard peg’ or a fully ‘independent float’?


Vijay Joshi (2003) ‘Financial Globalisation, Exchange Rates and Capital Controls in Developing Countries’, Australian National University Working Papers in Trade and Development no.19, reprinted in the Course Reader.

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1.4 Recent Examples of Hard Pegs and Intermediate Regimes You saw in Figure 1.1 above that since 1991 there has been a move away from ‘intermediate’ regimes to the two extreme alternatives. But it is important not to oversimplify, as can be seen if we examine some major individual examples. In this section we would like you to consider three examples: 1 One of the greatest innovations in modern times, the creation of the euro, is an outstanding example of creating a hard peg, for it linked eleven initial countries’ currencies at fixed exchange rates and abolished them as individual currencies. If we think that the individual members of the eurozone could not have sustained an intermediate regime because speculative capital flows would have undermined each peg or target, the fact that the euro could not be undermined by speculating against (non-existing) individual currencies supports the reasoning behind the bipolar view. Some take the view that if Italy, for example, had attempted to maintain a conventional peg outside the euro instead of joining the eurozone, speculative flows would have made the regime unsustainable. 2 On the other hand, at least one important country has found a form of hard peg unsustainable and moved to an intermediate regime. In 1991 Argentina moved from an intermediate regime to a hard peg in the form of a currency board. But in January 2002, enmeshed in a crisis with some ‘impossible trinity’ characteristics, Argentina abandoned it. After initially allowing a fully free float, the country moved to a regime that, in effect, amounted to a conventional peg. In Box 1.1, Argentina is classified as having a managed floating regime, but in May 2005 the IMF noted that ‘while Argentina had, de jure, a floating exchange rate regime, the exchange rate had, in fact, been confined within a very narrow range, and could be classified under an empirical rule as a currency peg’ (IMF, 2005). 3 Many countries continue to operate intermediate regimes and, as can be seen from Box 1.1, China, one of the world’s most important economies, is an outstanding example. During the early years of the twenty-first century, many have argued that China should significantly revalue its currency (renminbi, sometimes known as the yuan). China’s policy makers have argued that any move towards a floating exchange rate could not occur until the institutional framework of a deep, liquid and sophisticated foreign exchange market (and, we should add, related financial markets) has been created and matured. Now we would like you to read the textbook’s discussion of those three examples and consider whether they increase or decrease confidence in the bipolar view.

Reading Please read now the remainder of Chapter 3, from the section ‘Emerging Markets and Regime Choices’, pp. 94–104, of your textbook, and make sure your notes cover the question raised above over your degree of confidence in the bipolar view.

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David Eiteman, Arthur Stonehill and Michael Moffett (2013) Multinational Business Finance, the rest of Chapter 3 ‘The International Monetary System’.



1.5 A New Bretton Woods System? In Section 1.1, you studied the outlines of the Bretton Woods international financial system that existed between 1945 and 1973. Although in this unit we have focused on exchange rate regimes, it is important to note that they do not exist in isolation. To understand the Bretton Woods system, you have to understand two elements associated with the exchange rate regime: • The pattern of exchange rates and countries’ ability to sustain them is linked to the pattern of financing between countries. How were countries’ authorities able to borrow foreign exchange reserves or avoid the need to do so? The Bretton Woods system enabled individual countries to borrow temporarily from the IMF. Over the long term, it required the US to borrow by issuing dollars that other countries could accumulate as reserves because the system treated the US dollar as the main reserve currency. • Countries with pegged exchange rates might choose to maintain undervalued currencies or, in other words, exchange rates that boost their net exports. And it has been argued that was an important aspect of the growth of European economies and Japan after 1945. It has been commonly accepted that the system ended in 1973. But recently economists have argued that subsequent exchange rate regimes are, in effect, a new version of the same system. The argument that there is a new Bretton Woods system is based on the fact that developing Asian economies are following the same path as Europe and Japan under the original Bretton Woods system. They have pegged exchange rates at levels that are too low in the sense that they generate continuing large surpluses of net exports. And they accumulate US dollars by financing the United States’ deficits.

1.5.1 After 1973 (Optional) In this section we give you the option of reading two papers on the hypothesis that the world has developed a new Bretton Woods system since 1973. One, by Michael Dooley, David Folkerts-Landau and Peter Garber, sets out the argument that there is and will be a revived Bretton Woods System. The other, by Barry Eichengreen, is critical of their arguments. Separately, we also give you the option of reading Chapter 5, ‘The U.S. and European Financial Crises’, of your textbook by Eiteman, Stonehill and Moffett. This chapter outlines the main elements of the financial crisis that started in 2007 and reached its nadir after the collapse of Lehman Brother’s bank in September 2008. The financial crisis and its repercussions were international in scope and this chapter explores both its domestic origins in the United States and the transactions that linked it to international banking and credit markets. A key element of the ’impossible trinity’ idea you have studied is the free flow of capital into and out of countries. Much of such capital comprises transactions between banks and on short-term credit markets. If you have the time to study this optional reading, you will find that it gives a rich insight into those transactions and the international shocks that they can transmit. Centre for Financial and Management Studies

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Please remember that these are optional readings. You should read them if you are interested in studying the issues in depth and if you have enough time to read them within the period allotted for this unit.

Optional Readings Michael Dooley, David Folkerts-Landau and Peter Garber (2003) ‘An Essay on the Revived Bretton Woods System’, NBER Working Paper no. 9971. This paper is available at: http://www.nber.org/papers/w9971 Barry Eichengreen (2004) ‘Global Imbalances and the Lessons of Bretton Woods’, NBER Working Paper No. 10497. This paper is available at: http://www.nber.org/papers/w10497

If you have studied those optional readings, please make a note of your reasons for accepting or rejecting the arguments of Dooley, Folkerts-Landau and Garber.

Optional Reading David Eiteman, Arthur Stonehill and Michael Moffett (2013) Multinational Business Finance, Chapter 5, ‘The U.S. and European Financial Crises’.

1.6 Summary In this unit you have studied the character and evolution of exchange rate regimes. Why is that useful for understanding finance in the global market? In particular, why is it useful for banks, firms and individuals with international financial assets and liabilities? There are two principal reasons: • It is important for decision makers to understand the international financial system, and exchange rate regimes are at its heart. • Decision makers have to make judgments on the future levels and volatility of exchange rates. They have two components: the probability of changes in exchange rates within the existing regime, and the probability of a change in the exchange rate regime. Now that you have finished the unit, you should understand and be able to write on the issues cited as learning outcomes on the unit introduction page: • the nature of an exchange rate regime • the exchange rate regime of the Bretton Woods system until 1973 • the difference between ‘hard peg’, fully ‘independently floating’, and intermediate regimes • the meaning of the ‘bipolar view’, the reasoning supporting it and some arguments against it • the outline modern history of the euro, of China’s exchange rate regime, and of Argentina’s exchange rate regime. And you should be able to give an answer to the question we posed at the beginning of the unit:

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• What is likely to be the future evolution of the world’s exchange rate regimes?

Review Question Please pause here and write a few paragraphs in answer to that question. There is no single right answer. Your answer will depend on the assumptions you make implicitly or explicitly.

References and Websites Dooley Michael, David Folkerts-Landau and Peter Garber (2003) ‘An Essay on the Revived Bretton Woods System’, NBER Working Paper No. 9971, September, Cambridge MA: National Bureau of Economic Research. Eichengreen Barry (2004) ‘Global Imbalances and the Lessons of Bretton Woods’, NBER Working Paper No. 10497, May, Cambridge MA: National Bureau of Economic Research. Eiteman David K, Arthur I Stonehill and Michael H Moffett (2013) Multinational Business Finance, Thirteenth edition, Harlow, UK: Pearson Education Limited. Fischer Stanley (2001) ‘Exchange Rate Regimes: Is the Bipolar View Correct?’, Journal of Economic Perspectives 15, 3–24. International Monetary Fund (2002) ‘Exchange Arrangements and Foreign Exchange Markets: Developments and Issues’ (SM/02/233, July 22, 2002) Washington DC: IMF. Website: http://www.imf.org/external/np/mfd/er/2004/eng/1204.htm International Monetary Fund (2004) IMF Staff Reports: Recent Economic Developments, and International Financial Statistics, Washington DC: IMF. International Monetary Fund (2005) Argentina: Staff Report for the 2005 Article IV Consultation, 31 May, Washington DC: IMF: http://www.imf.org/external/pubs/ft/scr/2005/cr05236.pdf Joshi, Vijay (2003) ‘Financial Globalisation, Exchange Rates and Capital Controls in Developing Countries’, Working Papers in Trade and Development No.19, Economics, RSPAS, Australian National University: http://eprints.anu.edu.au/archive/00002243/01/wp-econ-2003-19.pdf


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