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Chapter 2: The balance of payments and the foreign exchange market

1- Exchange rates and international transactions

Currency Overview

• Asia 5:42 a.m. EDT 03/30/10

Last (bid) Prior Day †

Australian Dollar (in dollars) 0.9194 0.9172

Hong Kong Dollar 7.7640 7.7633

Indian Rupee 45.100 44.823

Indonesian Rupiah 9085 9091

Japanese Yen 92.50 92.46

Malaysian Ringgit 3.2670 3.2680

Singapore Dollar 1.3979 1.3996

South Korean Won 1130.00 1135.46

Taiwanese Dollar 31.790 31.786

Thai Baht 32.310 32.352

† Late Monday in New York.

• Europe & Others 5:47 a.m. EDT 03/30/10

Last (bid) Prior Day †

Euro (in dollars) 1.3462 1.3481

Czech Republic Koruna 18.8690 18.8500

Denmark Krone 5.5268 5.5218

Norwegian Krone 5.9766 5.9559

Polish Zloty 2.8776 2.8785

Russian Ruble 29.4400 19.4990

Swedish Krona 7.2610 7.2516

Swiss Franc 1.0631 1.0624

U.K. Pound (in dollars) 1.5060 1.4984

Egyptian Pound 5.5018 5.5030

Israeli Shekel 3.6975 3.7064

South African Rand 7.3961 7.4129

† Late Monday in New York.

• Europe & Others 5:55 a.m. EDT 03/30/10

Last (bid) Prior Day †

Argentine Peso 3.8655 3.8730

Brazilian Real 1.7944 1.7973

Canadian Dollar 1.0181 1.0208

Mexican Peso 12.4285 12.4425

† Late Monday in New York.

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Key Currency Cross Rates: 6:00 a.m. EDT 03/30/10

Dollar Euro Pound SFranc Peso Yen CdnDlr

Canada 1.0182 1.3718 1.5354 0.95840 0.08202 0.01101 ---

Japan 92.480 124.60 139.46 87.048 7.4498 --- 90.827

Mexico 12.414 16.725 18.720 11.685 --- 0.13423 12.192

Switzerland 1.0624 1.4314 1.6021 --- 0.08558 0.01149 1.0434

U.K. 0.66313 0.89344 --- 0.62418 0.05342 0.00717 0.65128

Euro 0.74223 --- 1.1193 0.69863 0.05979 0.00803 0.72896

U.S. --- 1.3473 1.5080 0.94127 0.08056 0.01081 0.98213

(Source: Thomson Reuters) http://online.wsj.com/mdc/public/page/mdc_currencies.html?refresh=on The real euro/dollar exchange rate, denoted q, is the euro price of the American basket relative to that of the euro area: q = (E x P$)/P€ (2-1) The nominal effective exchange rate:

NEERi = ∑j=1,j≠i

n

ωj.Eji (2-2a)

where, NEERi = (nominal) effective exchange rate of currency i, Eji = nominal exchange rate of currency i with respect to currency j,

ωj = weight given to currency j in the construction of the index; by definition the sum of weights equals one. The real effective exchange rate:

REERi = ∑j=1,j≠i

n

ωj.qji (2-2b)

where, NEERi = (nominal) effective exchange rate of currency i, qji = real exchange rate of currency i with respect to currency j,

ωj = weight given to currency j in the construction of the index; by definition the sum of weights equals one.

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(Source: BIS, Quarterly review, March 2010)

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Graph 2:

(Source: BIS, Quarterly review, March 2010)

Graph 3:

(Source: BIS, Quarterly review, March 2010)

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Currency Futures, Tuesday, March 30, 2010 Mar 30 10:31:32 GMT • All quotes are in Greenwich Mean Time • Euro – CME Month Last Chg Open High Low Volu

me OpenInt Excha

nge Date Time

June 10 1.34770 0.00130 1.34760 1.35380 1.34540 95133 220634 CME 03/30/10 10:21:31

Sept 10 1.34880 0.00200 1.34900 1.35270 1.34710 73 1815 CME 03/30/10 09:24:25

Dec 10 1.34970 0.00340 1.34970 1.34970 1.34970 1 83 CME 03/30/10 02:50:08

Mar 11 1.34650 2 CME 03/29/10 21:00:42

http://online.wsj.com/mdc/public/page/2_3028.html?category=Other&subcategory=Currency&contract=Euro%2520-%2520cme&catandsubcat=Other%7CCurrency&contractset=Euro%2520-%2520cme 3. The balance of payments as the net demand for foreign currency

Table 2-1: Comparing euro rates of return on dollar and euro deposits

Euro interest rate

Dollar interest rate

Expected rate of euro depreciation against dollar

Rate of return difference between euro and dollar

deposits

Case R€ R$ (Ee€/$ - E€/$)/E€/$ R€ - R$ - (E

e€/$ - E€/$)/E€/$

1 0.04 0.02 0.00 0.02

2 0.04 0.02 0.02 0.00

3 0.04 0.02 0.04 -0.02

4 0.04 0.05 0.02 0.01

The uncovered interest parity condition between dollar and euro deposits shows that the equality between the two assets’ expected rates of return measured in euros: R€ = R$ + (Ee - E)/E (2.5)

Table 2-2: Today’s euro/dollar exchange rate and the expected euro return of dollar

deposit when Ee = per dollar

Euro exchange rate, direct

terms

Interest rate on dollar deposits

Expected rate of depreciation of euro

against dollar

Expected euro return on dollar deposits

Case E R$ (0.77 - E)/E R$ + (0.77 - E)/E

1 0.81 0.02 -0.049 -0.029

2 0.79 0.02 -0.025 -0.005

3 0.77 0.02 0.000 0.020

4 0.75 0.02 0.027 0.047

5 0.73 0.02 0.055 0.075

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Figure 2-2: Relation between current exchange rate and expected euro return in dollar deposits

0,68

0,7

0,72

0,74

0,76

0,78

0,8

0,82

-0,029 -0,005 0,02 0,047 0,075

Expected euro return in dollar deposits

Tod

ay's

eu

ro

/do

lla

r e

xch

an

ge r

ate

The covered interest parity condition can be written R€ = R$ + (F – E)/E (2-7) with F the one-year forward price of dollars in terms of euros.

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4. Exchange rates regimes

De Facto Classification of Exchange Rate Regimes and Monetary Policy Frameworks

Data as of April 31, 2008

The classification system is based on the 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 arrangements, 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 independence of monetary policy. The system presents members' exchange rate regimes against alternative monetary policy frameworks in order to highlight the role of the exchange rate in braod economic policy and to illustrate that different exchange rate arrangements can be consistent with similar monetary frameworks. The following explains the categoreis.

Exchange rate anchor

The monetary authority stands ready to buy or sell foreign exchange at given quoted rates to maintain the exchange rate at its predetermined level or within a range (the exchange rate serves as the nominal anchor or intermediate target of monetary policy). These regimes cover exchange rate regimes with no separate legal tender, currency board arrangements, fixed pegs with or without bands, and crawling pegs with or without bands.

Monetary aggregate target

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 its inflation objectives. Monetary policy decisions are guided by the deviation of forecasts of future inflation from the announced inflation target, with the inflation forecast acting (implicitly or explicitly) as the intermediate target of monetary policy.

Other

The country has no explicitly stated nominal anchor, but rather monitors various indicators in conducting monetary policy. This is also used when no relevant information on the country is available.

http://www.imf.org/external/np/mfd/er/2008/eng/0408.htm

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The exchange rate of the Deutschemark againt the US dollar and the French Franc – 1953 - 1998

0

0,5

1

1,5

2

2,5

3

3,5

4

4,51953

1955

1957

1959

1961

1963

1965

1967

1969

1971

1973

1975

1977

1979

1981

1983

1985

1987

1989

1991

1993

1995

1997

US

D 1

= D

EM

...

0

10

20

30

40

50

60

70

80

90

FR

F 1

00 =

DE

M..

.

Source: Bundesbank (Exchange rates on the Frankfurt exchange)

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The annual rate of appreciation of the Deutschemark against the US dollar and the French Franc – 1954 – 1998

-30

-20

-10

0

10

20

30

1954

1956

1958

1960

1962

1964

1966

1968

1970

1972

1974

1976

1978

1980

1982

1984

1986

1988

1990

1992

1994

1996

1998

USD 1 = DEM …

FRF 100 = DEM …

Source: Bundesbank (Exchange rates on the Frankfurt exchange)

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Annual rate of appreciation of the euro against the British Pound, the Japanes Yen and the US dollar (%)

-0,2

-0,15

-0,1

-0,05

0

0,05

0,1

0,15

0,2

0,25

2000 2001 2002 2003 2004 2005 2006 2007 2008 2009

USD

JPY

GBP

Source: Bundesbank

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Implied PPP

0,4

0,5

0,6

0,7

0,8

0,9

1

1,1

1980

1981

1982

1983

1984

1985

1986

1987

1988

1989

1990

1991

1992

1993

1994

1995

1996

1997

1998

1999

2000

2001

2002

2003

2004

2005

2006

2007

2008

2009

FRA

DEU

GBR

(Source : WEO, October 2009)

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Effective exchange rate, 1995 - 2010

-0,1

-0,05

0

0,05

0,1

0,15

0,2

1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009

France

Germany

United Kingdom

United States

Euro area

(Source: OECD, March 2010)