ECON1020 Lecture Notes - Lecture 11: International Monetary Fund, Bretton Woods System, Capital Control
Lecture 11 - International Finance System
Thursday, 17 May 2018
2:00 PM
<<ECON1020 Lecture 11.pdf>>
Exchange rate systems
• An exchange rate system is an agreement between countries on how exchange rates should
be determined
• Floating currency is a currency whose exchange rate is determined by demand for and supply
of the currency in foreign exchange markets
• Managed float exchange rate system is the same as a floating currency, but with occasional
central bank or government intervention
• Fixed exchange rate system is where two countries keep their exchange rates fixed
The current exchange rate system
• Three important aspects
o Australia, Britain and the US allow their currencies to float against other currencies with
some intervention from central bank or government
o Most countries in Western Europe are in the euro zone and use the same currency
o Some developing countries aim to keep their exchange rate fixed with major currencies
like the USD
• The floating dollar
o The Australian dollar was floated in December 1983
o Since then it has fluctuated widely against other major currencies
o The Trade Weighted Index (TWI) measures the value of the AUD against a 'basket' of the
currencies in Australia's main trading partners
• What determines exchange rates in the long run?
o Purchasing power parity: This is the theory that in the long run, exchange rates move to
equalise the purchasing power of different countries
• Things against purchasing power parity
▪ Not all products can be traded internationally
▪ Products and consumer preferences are different across countries
▪ Countries impose barriers to trade
o Barriers to trade include tariffs and quotas
• There are four determinants for exchange rates in the long run
o Relative price levels
o Relative rates of productivity growth
o Preferences for domestic and foreign goods
o Tariffs and quotas
• The euro
o Economists disagree over whether a common currency helps economic growth
o A common currency makes trade easier and cheaper, thereby encouraging competition
o However countries can no longer operate an independent monetary policy, but can have
their own fiscal policies
o Also, a country in recession will not experience a currency depreciation, which would
revive exports
• Pegging against the USD
o Pegging: the decision by a country to keep the exchange rate fixed between its currency
and another currency
o Pegging makes business planning easier, fixes foreign debt levels and payments and
reduces fluctuations in import prices
o However it can create problems
• Can lead to persistent surpluses or shortages of currency
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