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Lecture Multinational financial management: Lecture 8 - Dr. Umara Noreen

Lecture 8 - Government influence on exchange rates. After completing this chapter, students will be able to: To describe the exchange rate systems used by various governments; to explain how governments can use direct and indirect intervention to influence exchange rates; and to explain how government intervention in the foreign exchange market can affect economic conditions. | Government Influence On Exchange Rates 8 Lecture Chapter Objectives To describe the exchange rate systems used by various governments; To explain how governments can use direct and indirect intervention to influence exchange rates; and To explain how government intervention in the foreign exchange market can affect economic conditions. Exchange Rate Systems Exchange rate systems can be classified according to the degree to which the rates are controlled by the government: fixed freely floating managed float pegged System: Rates are held constant or allowed to fluctuate within very narrow bands only. Examples: Bretton Woods era (1944-1971), Smithsonian Agreement (1971) MNCs know the future exchange rates. Governments can revalue their currencies. Each country is also vulnerable to the economic conditions in other countries. Fixed Exchange Rate System System: Rates are determined by market forces without governmental intervention. Each country is more insulated from the economic . | Government Influence On Exchange Rates 8 Lecture Chapter Objectives To describe the exchange rate systems used by various governments; To explain how governments can use direct and indirect intervention to influence exchange rates; and To explain how government intervention in the foreign exchange market can affect economic conditions. Exchange Rate Systems Exchange rate systems can be classified according to the degree to which the rates are controlled by the government: fixed freely floating managed float pegged System: Rates are held constant or allowed to fluctuate within very narrow bands only. Examples: Bretton Woods era (1944-1971), Smithsonian Agreement (1971) MNCs know the future exchange rates. Governments can revalue their currencies. Each country is also vulnerable to the economic conditions in other countries. Fixed Exchange Rate System System: Rates are determined by market forces without governmental intervention. Each country is more insulated from the economic problems of other countries. Central bank interventions just to control exchange rates are not needed. Governments are not constrained by the need to maintain exchange rates when setting new policies. Freely Floating Exchange Rate System Less capital flow restrictions are needed, thus enhancing market efficiency. MNCs may need to devote substantial resources to managing their exposure to exchange rate fluctuations. The country that initially experienced economic problems (such as high inflation, increased unemployment) may have its problems compounded. Freely Floating Exchange Rate System System: Exchange rates are allowed to move freely on a daily basis and no official boundaries exist. However, governments may intervene to prevent the rates from moving too much in a certain direction. A government may manipulate its exchange rates such that its own country benefits at the expense of other countries. Managed Float Exchange Rate System System: The currency’s value is pegged to a foreign .