Deck 15: Exchange-Rate Systems and Currency Crises

Question 1

Discuss the philosophy and operation of the Bretton Woods system of adjustable pegged exchange rates.

Answer 1

The Bretton Woods system was an international monetary system created in 1944 by delegates from 44 member nations of the United Nations. It was a semi-fixed exchange-rate system, also known as adjustable pegged exchange rates. The system relied on the interconnection between currencies because currencies tied to each other were able to provide stable exchange rates for commercial and financial transactions. Under the Bretton Woods system, nations set the face value of their currencies in terms of gold. Nations could devalue or revalue their exchange rates whenever the balance of payments moved away from its long-term equilibrium. These adjustable pegged exchange rates promoted a practical adjustment mechanism for the balance of payments between 1946 and 1973.

Question 2

Why do nations use a crawling-peg exchange-rate system?

Answer 2

The crawling peg exchange rate system allows a nation to make small frequent changes in the par value of its currency to bring the balance of payments back to equilibrium. Nations with high inflation use this system to slowly respond to evolving market conditions. This helps them keep inflation in check by changing the value of their currencies as conditions in the economy fluctuate.

Question 3

What is the purpose of capital controls?

Answer 3

Capital controls are barriers imposed by the government to foreign investments in domestic assets or to domestic investments in foreign assets. The purpose of these controls is to prevent speculative attacks, situations in which a weak currency experiences heavy selling pressure, on currencies that stem from large changes in capital outflows and inflows. Capital controls support fixed exchange rates by limiting the amount of capital inflows into a country.

Question 4

What factors contribute to currency crises?

Question 5

Why do small nations adopt currency baskets against which they peg their exchange rates?

Question 6

What advantage does the SDR offer to small nations seeking to peg their exchange rates?

Question 7

Present the case for and the case against a system of floating exchange rates.

Question 8

What techniques can a central bank use to stabilize the exchange value of its currency?

Question 9

What is the purpose of a currency devaluation? What about a currency revaluation?

Question 10

What factors underlie a nation's decision to adopt floating exchange rates or fixed exchange rates?

Question 11

How do managed floating exchange rates operate? Why were they adopted by the industrialized nations in 1973?

Question 12

Why do some developing countries adopt currency boards? Why do others dollarize their monetary systems?