The choice of the exchange rate regime is essentially for a country. According to the
impossible trinity principle a country desires a fixed exchange rate, an autonomous
monetary policy and full capital mobility simultaneously. Unfortunately only two
features at the same time can be realized. A fixed exchange rate has two major
benefits compared to a floating exchange rate. If stable it makes the trade of goods
and assets between countries easier and less costly. Additionally a fixed exchange
rate may improve monetary policy discipline as expansionary monetary policy is
less available to maintain a fixed exchange rate. This may lead to a lower inflation
rate in the long run. But the major disadvantage is that a fixed exchange rate regime
removes the possibility to use monetary policy in a flexible way to deal with
recessions (Abel, Bernanke and Croushore, 2011). Therefore many countries
choose an exchange rate regime between both extreme cases (fixed or flexible
exchange rate regime). In the second chapter I will give some important theoretical
background concerning exchange rate regimes. In particular I will explain different
types of exchange rate regimes and show the difference between ‘de jure’ and ‘de
facto’ exchange rate regimes. In the last part of the second chapter I will illustrate
the complex exchange rate regime of the European Union. In the third chapter I will
show the toolbox of a central bank to influence its exchange rate. In the last part of
the third chapter I will show briefly the different instruments using the example of
Switzerland in the recent past. In my conclusion I will try to answer the question
‘how can different exchange rate regimes being identified’.
Table of Contents
I Introduction
II Theoretical background
II.1 Types of exchange rate regimes
II.2 De jure vs. de facto exchange rate regimes
II.3 Status quo European Union
III Central Bank’s toolbox to manage its exchange rate
III.1 Instruments
III.2 Analysis for the Swiss National Bank
IV Conclusion
V Bibliography
Research Objectives and Key Topics
This paper examines how various exchange rate regimes function in practice and explores methodologies for accurately identifying them. It addresses the discrepancy between official government classifications and the actual market behavior of currencies, while analyzing the instruments available to central banks to maintain their desired exchange rate policies.
- The distinction between de jure and de facto exchange rate regimes
- Mechanisms and tools used by central banks for exchange rate management
- Case study analysis of the Swiss National Bank’s intervention strategies
- Overview of the complex exchange rate framework within the European Union
- Methodological approaches to identifying true currency policy in volatile markets
Excerpt from the Book
Types of exchange rate regimes
I will explain the differentiation of exchange rate regimes from the most flexible regime to the most fixed one although there does not exist one clear order in the literature.
Freely floating: The simplest form of an exchange rate regime is ‘freely floating’. The monetary authority declines to have any responsibility concerning its exchange rate and does not intervene in foreign exchange markets. The exchange rate is completely determined in foreign exchange markets. The main advantage of this regime is that the central bank is able to use its monetary policy to full capacity as the central bank does not look at its exchange rate. The main disadvantage is that the exchange rate may fluctuate a lot. High volatility of the exchange rate in a short period of time may disturb exporters and importers who generally prefer a solid base for their calculations.
Managed floating (dirty floating): If central banks are concerned about excess volatility of the exchange rate, also called ‘fear of floating’, and if the central bank does not want to commit to a specific exchange rate target the central bank may use a managed floating exchange rate regime. In this exchange rate regime the central bank intervenes in foreign exchange markets from time to time. If the central bank thinks its exchange rate being too strong then the central bank sells the domestic currency and buys foreign exchange reserves. On the contrary, if the central bank thinks its exchange rate being too weak then the central bank buys the domestic currency and sells foreign exchange reserves. This kind of management is limited by the size of the central bank’s reserves. Practically speaking, in a managed floating exchange rate regime the central bank has a view about its exchange rate and acts accordingly.
Summary of Chapters
I Introduction: This chapter introduces the "impossible trinity" principle and outlines the thesis objective of analyzing the identification of real-world exchange rate regimes.
II Theoretical background: This section details various exchange rate classifications and examines the difference between official declarations (de jure) and actual practices (de facto), including the European Union's complex system.
III Central Bank’s toolbox to manage its exchange rate: This chapter provides a technical analysis of how central banks influence exchange rates through interest rates, verbal interventions, and direct market operations, exemplified by the Swiss National Bank.
IV Conclusion: The conclusion synthesizes the findings, suggesting that identifying a regime requires a combination of statistical analysis of volatility, reserve levels, and qualitative market monitoring.
V Bibliography: A list of academic sources and official documents referenced throughout the paper.
Key Terms
Exchange rate regime, Impossible trinity, De jure, De facto, Central bank, Monetary policy, Floating exchange rate, Managed floating, Swiss National Bank, European Union, Foreign exchange reserves, Sterilized intervention, Price stability, Fear of floating, Currency peg.
Frequently Asked Questions
What is the core subject of this seminar thesis?
The paper focuses on the operational mechanisms of alternative exchange rate regimes and the methodological challenges in identifying which regime a country actually employs.
What are the primary thematic areas covered?
The core themes include theoretical definitions of exchange rate systems, the toolbox of central banks, the distinction between de jure and de facto regimes, and the specific application of these concepts in the EU and Switzerland.
What is the main research question?
The thesis explores how different exchange rate regimes operate and seeks to answer how observers can accurately identify the true nature of a country's exchange rate policy.
Which scientific methods are utilized?
The author employs a qualitative analysis of economic theory, comparative examination of institutional frameworks, and case studies involving historical exchange rate data and central bank balance sheets.
What topics are discussed in the main body?
The main body covers the spectrum of exchange rate regimes from freely floating to currency boards, the mechanisms of central bank interventions, and a detailed look at the Swiss National Bank's transition during the financial crisis.
How would you characterize this work using keywords?
The work is best characterized by terms like international economics, monetary policy, currency pegs, intervention strategies, and de facto classification models.
Why is the "de jure" versus "de facto" distinction important?
Because official government claims regarding exchange rate policies often do not match the actual market actions taken by central banks, making empirical analysis necessary to understand the true policy.
How does the Swiss National Bank example illustrate the thesis?
The Swiss case provides a practical example of how a country shifted from a freely floating regime to a managed and eventually a pegged regime in response to capital inflows during the financial crisis.
What is a "sterilized intervention"?
It is an intervention where a central bank performs an equal transaction in foreign and domestic assets in opposite directions to cancel out the effect on the domestic money supply.
- Quote paper
- Malte Vieth (Author), 2013, How do alternative exchange rate regimes operate and how can they be identified?, Munich, GRIN Verlag, https://www.grin.com/document/271201
