ECON 4420MIRI NAM

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Types of Fixed Exchange Rate Systems

1. The Reserve Currency Standard 2. The Gold Standard 3. The Gold-Exchange Standard

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Rules 1. Reserve Currency 1) Fix currency to another currency 2) Central bank must hold a stock of foreign exchange reserves to facilitate FOREX interventions 2. Gold Standard 1) Fix currency to a weight of gold 2) Central bank freely exchanges gold for a currency with public

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3. Gold-Exchange Standard 1) Reserve country fixes its currency to a weight of gold 2) All other countries fix their currencies to reserve 3) Reserve central bank freely exchanges gold for currency with other central banks 4) Non-reserve countries hold a stock of the reserve currency to facilitate intervention in the FOREX

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What’s a Reserve Currency Standard?

1. The typical method for fixing a currency today 2. Most countries that fix its exchange rate will fix to a currency that either is prominently used in international transactions or is the currency of a major trading partner

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How does a Reserve Currency System work?

1. The workings or a reserve system are illustrated by the system based on the U.S. dollar 2. Central banks held a large portion of their international reserves in the form of U.S. Treasury bills and short-term dollar deposit

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Example 1

Suppose Britain decided to fix its currency to the dollar at the exchange rate E$/£=1.50

To maintain this fixed exchange rate, the Bank of England would stand ready to exchange pounds for dollar (or dollars for pounds) upon demand at the specified exchange rate

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Example 2

Suppose FFr 5 per dollar while DM 4 per dollar The exchange rate between FFr and DM remains constant

at DM 0.80 per franc=(DM 4 per dollar)/(FFr 5 per dollar)

1) At rate of DM 0.85 per franc, DM would appreciate until DM 0.80 per franc reached

2) At rate of DM 0.75 per franc, DM would depreciate until DM 0.80 per franc reached

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What Happens in a Reserve Currency System?

1. The country whose currency is held as reserves occupies a special position because it never has to intervene 2. Our account of monetary policy under a reserve currency system points to a basic asymmetry 3. The inherent asymmetry of a reserve system places immense economic power in the hands of the reserve country

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The World’s Reserve Currency

1. There are now more Euro (new currency created only 7 years ago) circulation worldwide than U.S. dollars 2. It is not necessarily troubling, as the dollar remains the world’s most important reserve currency, but the rise of the Euro internationally is another sign that the U.S. dollar is not what it used to be 3. American can maintain a large trade deficit only if foreign banks continue to hold large numbers of dollars as their reserve currency

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The Latest News

United Nations, Nobel Prize-winning economist Joseph Stiglitz has called for a new global system to replace the US dollar as the world’s reserve currency

- A proposal for a new Special Drawing Rights (SDRs)-based reserve system

- Such a system could contribute to global stability, economic strength, and global equity and could be feasible, non-inflationary and easily implemented

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