Exchange Rate System

Topics: Foreign exchange market, Bretton Woods system, International economics Pages: 13 (4398 words) Published: December 14, 2010
The objective of this paper is to investigate the exchange rate volatility and its effects on international Trade in Bangladesh during May 2003-Dec 2008. The concept of the study is taken from one off the working papers of Bangladesh Bureau of Statistics (BBS), Bangladesh Bank, Centre for Policy Dialogue (CPD) and leading English and Bengali Dailies in Bangladesh.

The depth and intensity of exchange rate volatility and its impact on the volume of international trade was recognized during 1970s when the world economy shifted from fixed exchange rate to free floating exchange rate. The hypothesis may be that if the exchange rate volatility is higher then it will generate uncertainty of the future profit from export trade. To mitigate the uncertainty, investors can go for currency hedge and minimize the uncertainty related to international trade in short time. Exchange rate volatility may also affect trade indirectly by influencing firm’s investment decision in the long run.

In Bangladesh free floating exchange rate was adopted since May 31st. 2003. At the initial stage of the exchange rate, the fluctuation was very nominal. However, exports evolved largely in line with total world imports. Bangladesh’s share in world imports was more or less stable after adopting the floating exchange rate. In 2003, the total amount of export of Bangladesh was US$ 6548.44 million and in 2008 gradually it has increased to the amount of US$ 16333.04 million and the growth is almost 2.83 percent. On the other hand exchange rate was (US$1= Tk 50.31) in 1990 and in 2008 it was (US$ 1=Tk 68.50), which was increased by 1.36 percent in 18 years.


Exchange rate systems normally fall into one of the following categories: i. Fixed Exchange Rate
ii. Floating Exchange Rate
iii. Managed Float Exchange Rate
iv. Pegged Exchange Rate

i. Fixed Exchange Rate: In a fixed exchange rate system, exchange rates are either held constant or allowed to fluctuate only within very narrow boundaries. If an exchange rate begins to fluctuate too much, governments arbitrate to maintain it within the level of tolerance. In consideration of the gravity of situations, a government may devalue its currency while in other cases it will revalue its currency against other currencies.

Advantages: Multinational Company’s are able to engage in international trade without worrying about the future exchange rates. They reduce the risk of doing business in that country too. Disadvantages: The government is in a position to manipulate the value of the currency. Also, a fixed exchange rate system may make each country more vulnerable to economic conditions in other countries.

ii. Floating Exchange Rate:

Also known as a clean float. In a freely floating exchange rate system, exchange rate values are determined by market forces without intervention by the governments.

Advantages: A major advantage of this system is the insulation of a country from the inflation or unemployment problems in other countries. An additional advantage of this system is that a central bank is not required to constantly maintain ER within specified boundaries. Disadvantages: A country’s economic problems can sometimes be compounded by freely floating ER. Under such a system, MNCs would need to devote substantial resources to measuring and managing exposure to ER fluctuations.

iii. Managed float exchange rate system: Also known as a dirty float. It is similar to a freely floating system in that exchange rates are allowed to fluctuate on a daily basis and there are no official boundaries. It is similar to a fixed rate system in that governments can and sometimes do intervene to prevent their currencies from a sharp fall.

Advantage: It prevents a crash in the value of the currency, should it happen. Disadvantage: Some criticize such a policy as it seeks to protect the home currency at the expense of others....

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Letters, 37, 173 -177.
Bailey, M. J., Tavlas, G. S., and Ulan, M. (1987), “The Impact of Exchange Rate Volatility on Export
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