Topics: Foreign exchange market, United States dollar, Bretton Woods system Pages: 14 (6835 words) Published: September 20, 2014

Chapter 6

Government Influence on Exchange Rates

Lecture Outline

Exchange Rate Systems
Fixed Exchange Rate System
Freely Floating Exchange Rate System
Managed Float Exchange Rate System
Pegged Exchange Rate System
Classification of Exchange Rate Arrangements

A Single European Currency
Impact on European Monetary Policy
Impact on the Valuation of Businesses in Europe
Impact on Financial Flows
Impact on Exchange Rate Risk
Status Report on the Euro

Government Intervention
Reasons for Government Intervention
Direct Intervention
Indirect Intervention

Intervention as a Policy Tool
Influence of a Weak Currency on the Economy
Influence of a Strong Currency on the Economy

Chapter Theme

This chapter introduces the various exchange rate systems.  In addition, it stresses the manner by which governments can influence exchange rates. Since exchange rate move­ments are critical to an MNC’s performance, and the government has much influence over these exchange rates, the MNC is affected by government intervention.

Topics to Stimulate Class Discussion

1.If you were elected to choose between a fixed, freely floating, or a dirty float exchange rate system, which would you choose for your home country?  Why?

a.Assume that both the U.S. and Europe experience high unemployment.  How can the U.S. central bank attempt to adjust the dollar value to reduce this problem?  Is the European central bank likely to go along with the U.S. central bank’s strategy or retaliate?  Why?

Should China Be Forced to Alter the Value of Its Currency?

POINT: U.S. politicians frequently suggest that China needs to increase the value of the Chinese yuan against the U.S. dollar, even since China has allowed the yuan to float (within boundaries). The U.S. politicians claim that the yuan is the cause of the large U.S. trade deficit with China. This issue is periodically raised not only with currencies tied to the dollar, but also with currencies that have a floating rate. Some critics argue that the exchange rate can be used as a form of trade protectionism. That is, a country can discourage or prevent imports and encourage exports by keeping the value of its currency artificially low.

COUNTER-POINT: China might counter that its large balance of trade surplus with the U.S. has been due to the differences in prices between the two countries, and that it should not be blamed for the high U.S. prices. It might argue that the U.S. trade deficit can be partially attributed to the very high prices in the U.S., which are necessary to cover the excessive compensation for executives and other employees at U.S. firms. The high prices in the U.S. encourage firms and consumers to purchase goods from China. Even if China’s yuan is revalued upward, this does not necessarily mean that the U.S. firms and consumers will purchase U.S. products. They may shift their purchases from China to purchase products in Indonesia or other low-wage countries rather than buy more products from the U.S. Thus, the underlying dilemma is not China, but any country that has lower costs of production than the U.S.

WHO IS CORRECT? Use the Internet to learn more about this issue. Which argument do you support? Offer your own opinion on this issue.

ANSWER: The issue is important because it affects the potential degree of economic growth in the U.S. The sustained trade deficit with China may suggest that the yuan is overvalued, but if the yuan is revalued, the U.S. may import more products from other countries where there are low costs of production. Thus, the trade deficit with China may be reduced, but the overall trade deficit may remain. Regardless of any student’s opinion, the key is that all students recognize both sides of the issue. Answers to End of Chapter Questions

1.Exchange Rate Systems. Compare and contrast the fixed, freely floating, and managed float...
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