Countries. Arbitrager will have opportunity through international trade may be obscured by quotations in different currencies at volatile rates. An additional cost of a national currency is from home bias on the demand side: people and firms tend to spend relatively more on nationally produced goods and services, after controlling for other demand determinants. International evidence suggests that national spending displays some home bias. It is very hard to quantify the benefits of giving up the currency that arise from lower price discrimination on the supply side and lower home bias on the demand side.
3. Larger international trade from lower exchange rate risk and elimination of the
exchange risk premium
It seems clear that exchange rates are volatile, and that its behavior is usually
unexplained by fundamentals. This volatility typically is transferred to the real exchange
rate. If financial markets are incomplete and unable to provide hedge against this volatility, the associated uncertainty will imply higher interest rates (due to the risk premium), which in turn can affect the level of investment and growth, as well as portfolio decisions. In the case of Chile, this premium on annual maturities ranges currently from 0.57% to 3.7% per year. Estimation of the associated output and welfare costs is not easy because they are model-specific and exchange-rate premiums are volatile.
4. Other benefits
Chile has flexible prices and factor mobility, thus allowing for adjustment in response
to shocks which they will minimize loss exchange rate flexibility and monetary stabilization. Next, External shocks and economic cycles are symmetric between both countries so the
common monetary policy can provide simultaneous stabilization. Next, Chile is open economies with significant bilateral trade (which maximizes the benefits of eliminating risk, enhance integration and reduce transaction costs). Lastly, Chile have a diversified portfolio and productive structure: this prevents that countries differ significantly in their characteristics and in the kind of shocks they face.
Brazil
History of Exchange rate system
Brazilian monetary authorities hold the philosophy that inflations are neutral as long as they don't skew the supply and demand for goods and services. Consequently, they have always used money creation to cure budget deficits internally. While to maintain its externally competitiveness, a devaluation exchange system with its currencies "crawling pegged" to the U.S. dollar was adopted from 1967 to 1990. This philosophy, together with Brazil's foreign debt burden, and fluctuations in the prices of its agricultural exports and oil imports, has put Brazil in a long history of inflation. The authorities usually adopted a currency changeover when the inflation rate made the circulating currency useless. The currencies that had been adopted since 1967 include: Cruzeiro (1967-1986), Cruzado (1986-1989), and Novo Cruzado (1989-1990).
Since 1990, a floating exchange rate regime (with minor government intervention) has been adopted. However, this regime was subject to an adjustable band from 1995-1999 in a program to control the money creation. However, during this period of time, inflation was still a problem.
In the year 1999, Brazil was involved in a currency crisis, as a result from the 1997 Asian crisis and the 1998 Russian crisis. The currency was then set into an independently floating regime since then.
The National Monetary Council (CMN) is responsible for formulating overall foreign exchange policy. In accordance with the guidelines established by the Coucil, exchange controls, regulations affecting foreign capital, and the management of international reserves are under the jurisdiction of the Central Bank.
Brazil has a real appreciated 16.9 percent against the dollar during the second half of 2004 from BRL3.11/US$ to BRL2.66/US$. Brazil’s sovereign risk spread stood at 383 basis points over U.S. Treasuries at end-2004 versus 646 basis points at the end of June. Year-on-year inflation stood at 7.6 percent in December, above the central bank’s 5.5 percent target for 2004 but within the target band. Brazil had a $6.3 billion, or 2.0 percent of GDP, current account surplus in the second half of 2004 compared to $5.4 billion, or 1.9 percent of GDP, in the first half. The United States had a trade deficit with Brazil of $4.9 billion in the second half of 2004 compared to a $3.4 billion deficit in the second half of 2003. Foreign direct investment increased to $14.1 billion in the second half of 2004 compared with $4.0 billion in the first half. The central bank increased net international reserves to $27.5 billion by end-December 2004 compared to $24.9 billion at end-June, as the central bank purchased international reserves at the end of the year. Real GDP (saar) increased 4.4 percent and 1.7 percent in the third and fourth quarters respectively. For the full-year 2004, GDP posted a 5.2 percent increase—the highest growth rate in ten years
History of Brazil exchange rate system will be included in following table:
Benefit of giving up fixed exchange rate system to be managed float exchange rate system
- A country has monetary independence
In a recession, when unemployment is temporarily high and real growth temporarily low, the central bank can respond by increasing money growth, lowering interest rates, depreciating the currency, and raising asset prices, all of which work to mitigate the downturn. Under a pegged currency, however, the central bank loses that sort of freedom. It must let recessions run their course. But the last few decades have seen widespread disillusionment, both among academics and practitioners, with the proposition that governments are in practice able to use discretionary monetary policy in an intelligent and useful way. This is particularly true in the case of developing countries. As a consequence, the trend in the 1990s was away from government discretion in monetary policy and toward the constraints of nominal anchors.
- The central bank lacks the reflexes to pursue a skillful and timely discretionary monetary policy
Under a floating exchange rate deterioration in the international market for a country’s exports should lead to an automatic fall in the value of its currency. The resulting stimulus to production will mitigate the downturn even without any deliberate action by the government. Some have argued, for example, that Australia came through the 1997-98 Asian crisis in relatively good shape because its currency was free to depreciate automatically in response to the deterioration of its export markets. Canada and New Zealand, like Australia, are said to be commodity-exporting countries with floating currencies that automatically depreciate when the world market for their export commodities is weak. Again, this mechanism is normally lost under a rigid nominal anchor.
- The pegging problem still more difficult.
If a country has rigidly linked its monetary policy to some nominal anchor, exogenous fluctuations in that anchor will create gratuitous fluctuations in the country’s monetary conditions that may not be positively correlated with the needs of that particular economy.
Argentina
Argentina is one of the countries which it cannot neglect the inflation and currency crisis when discussing its historical exchange rate regime. Since mid 1960s, Argentina has adopted 6 programs aimed at stabilizing domestic prices. Fixed exchange rate was used as an anchor in these programs, in the belief that with fixed exchange rates domestic inflation would recover quickly to world level. These programs somewhat tamed the inflation at the beginning. However, the pressures of external debts, decreases in the export price, and speculative attacks always led to failures of these programs. When a program failed, the government always abolished the fixed exchange rate regime, or devalued the Argentine currency, or set a two-tier exchange market which allowed the exchange rate for financial payments to float.
Changing the domestic currency was also a measure in these programs. For example, from June 1985 to January 1992, also as a part of the price control program, Argentina had once replaced the circulating Peso with a currency named Austral.
The most recent currency crisis Argentina has met was triggered by its default on a US$132 billion loan payment. Before that, Argentina had been fixing its Peso to the U.S. Dollar under a currency board. However, the huge spending and decrease in commodity price led to great deficit in its currency account. In January 2002, in a necessary attempt to secure further aids from the IMF, Argentina un-pegged Peso from the U.S. dollar.
A currency board is a fixed exchange rate regime where there are enough foreign currency reserves to convert all domestic money into foreign currency. In Argentina’s currency board, which was 1 peso to 1 dollar, the Argentinean Central Bank could only issue as many pesos as it had dollar reserves which it abandoned its convertibility law which currency remained relatively steady in the second half of 2004, depreciating 0.5 percent from 2.96 pesos per dollar to 2.97 pesos per dollar. Argentina’s trade surplus was $6.2 billion in the second half of 2004, with exports rising 20 percent and imports rising 53 percent compared to the same period the previous year.
History of Argentina exchange rate system will be included in following table:
Benefit of giving up fixed exchange rate system to be managed float exchange rate system
- A purely floating exchange rate regime is lower risk
it reduces the probability of economic contractions associated with adverse
external developments and facilitates internal adjustment. The purely floating exchange rate is require simple operation with a smoother management with the exchange rate risk and it more fluid adjustment to the exchange rate system. It is auto stabilized in disequilibrium in balance of payment and this is no required to reserve the foreign exchange rate.
-
Better macro and structural policies
For overall a move to a float makes more sense than dollarization for Argentina. The risk of overshooting and high inflation may be limited with an floating exchange rate system (inflation targeting) while the balance sheet effects of the real depreciation can be addressed through a larger write-down of sovereign debt and a selective write-down of some private debt. Some monetary autonomy, however restricted, will be maintained under a float and the nominal exchange rate adjustment will allow a change in real exchange rates when internal and external shocks require it.
Mexico
The currency of Mexico was the Mexican Peso (Mex$). The intervention currency was U.S. Dollar. There were no taxes or subsidies on purchases or sales of foreign exchange, and banks were freely engaged in exchange transactions between the peso and any other currency. From 1954, the Official Rate of Mexican Peso was set at Mex$12.50 per U.S. Dollar. Mexico maintained a fixed peso-dollar exchange rate even after the collapse of the Bretton Woods system in 1971 and the world oil price shock in 1973. However, the distortions caused by import substitution policies, the public expenditure-led growth financed mainly by borrowing from the BOM, the accumulation of foreign debt, high inflation, the overvaluation of the peso, and a large capital flight led finally to the devaluation of the peso in 1976. This basically ended the regime of fixed exchange rates. The Peso switched to the managed floating exchange rates in 1976, which gave more flexibility for discretionary economic policy (Li). The exchange rates were determined largely on the basis of demand and supply conditions in the exchange markets. However, the authorities intervened when necessary to maintain orderly conditions in the exchange market.
In August 1982, the Effective Rate was abolished. There were two exchange markets (the controlled market and the free market), with 2 Preferential Rate and Free Market Rate. The exchange rate in the controlled market was adjusted daily, based on the differential between the rates of inflation expected in Mexico and its main trading partners and other indicators. In the same month, the Free Market Rate was changed to Ordinary Rate. At the end of 1982, the Ordinary Rate converted to Free Market Rate again and a Special Rate was introduced. However, the Special Rate was abolished in March 1983. In the following years, the exchange rate of Mexican Peso depreciated continuously. At the end of 1991, the Controlled Rate and Super Free Market Rate were unified into Official Rate while the Controlled Exchange Market was eliminated. Started from the end of 1994, a floating rate policy was maintained by the government, with BOM intervening in the foreign exchange market under exceptional circumstances to minimize volatility and ensure an orderly market.
History of Argentina exchange rate system will be included in following table:
Benefit of giving up fixed exchange rate system to be managed float exchange rate system
- Floating exchange rate remains vulnerable to sudden fluctuations in
the global markets and to external shocks.
For strong currency depreciation in the face of adverse circumstances feeds rapidly into the inflation rate, in view of the large proportion of the national output on external trade, and in view of low credibility expectations fueled by a sequence of exchange rate collapses over the last quarter century. In 1994, there is increased of 637percent in the price level, as inflation shot up from 7 percent to 52 percent in a single year, despite the austerity program implemented in 1995. Eliminating the risk posed by holding peso assets would remove the monetary credibility gap and short-circuit the cycle of systematic monetary erosion.
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A policy shift to reduce currency transactions costs
The government tries to adopt a common unit of account which it will create an attractive option for foreign investor to invest in the country and consistent with the expansion of trade globally and the need for lowering the cost of capital will be stimulated by this policy.
Government intervention in Chile
During Chile's macroeconomic stabilization of 1973 the government adopted a set of orthodox policy measures consisting mainly of tight fiscal and monetary policies. The next stage was exchange rate-based stabilization. The authorities first established a tablita, i.e., a preannounced schedule of nominal depreciation.
In June 1979, in attempt to reduce inflation by using exchange rate, the dollar exchange rate was fixed at $39, after that the government collapsed the fixed exchange rate system and set crawling peg to control the inflation until 1990. There are several interventions which can be explained as follows: firstly, it was a crawling band whose center or reference value was periodically adjusted to reflect the difference between domestic and foreign inflation in the preceding month. Secondly, the bands width was gradually increased with time because of intraband interventions by the Central Bank in the foreign exchange market. As the reluctance to abandon the exchange rate band in spite of all these conflicts and pressures forced the Central Bank to try different options between 1990 and 1997. Central Bank was again tightening monetary policy and intervening in exchange rate market, capital controls to inflows were relaxed and the Central Bank intervened by issuing 3-year bonds payable in pesos but denominated in dollar. Lastly, The band itself suffered a number of amendments during the decade that aimed to accommodate a more appreciated peso which it is increasing the bands width, which it went from 10% in 1990 to 25% in 1997, it is also discounting a productivity factor. In addition, there is a changing (increasing) the foreign inflation. Moreover, on September 1999, the Central Bank has let the exchange rate float freely since then.
Exchange rate system over the past six months period in Chile
American Dollars to 1 CLP (,)
Chilean peso is quite fluctuated during past 6 months, However, comparing in January
with June, Chilean peso has depreciated from 508 Chilean peso to around 538 Chilean peso
per dollar. This is because of the government intervention in the monetary system as well as
they launched new fiscal policy to reduce the inflation impact of the Chile for tightly
controlled system and in order to keep Chile depreciating, the central bank raised the interest
rate as high as 45% and spent billions of dollars worth of its international reserves without
much success. Therefore, the currency depreciation would bring some positive effects such as
increased exports and decreased imports and negative impacts such as potential increase in
import and domestic prices, decrease in real income and wealth, and outflows of capital and
the important point is that there is lower spending on investment form foreign country due to
global economic recession through this six months. Moreover, the government of Chile has to
control on the expected inflation which it will be increase after the currency has depreciated
because the demand of Chile currency will increase after the currency has depreciate, then
foreign consumers will need Chile currency more and more so the currency will be appreciate
Therefore, the inflation will be followed. Then, the government has to make sure that they
can controlled all the factors that has effected by the currency depreciation.
Government intervention in Mexico
As the political authorities tend to focus on short term horizons, and usually discount the future very heavily. This is particularly the case in the emerging economies, where Central Banks lack the degree of independence that many industrial countries’ Central Banks have. Moreover, in the few emerging nations where the Central Bank is independent, exchange rate policy is determined by the politically appointed minister of finance.
A particularly attractive feature of super-fixed regimes is that, in principle, by reducing speculation and devaluation risk, domestic interest rates will be lower and more stable than under alternative regimes which a lower exchange risk is translated into a lower country risk premium.
Next, fiscal solvency. In the stronger version of super-fixed models this is taken care-of
almost automatically, as the authorities understand that they have no alternative but to run a sustainable fiscal policy. This is because the authorities are aware that the traditional recourse of reducing the real value of the public debt through a surprised devaluation is not any longer available. This imposed fiscal responsibility is, in fact, considered to be one of the most positive aspects of the super-fixed regime.
However, the fiscal requirement has to go beyond solvency, and has to include
specific operational aspects. In particular, the country in question has to develop an institutional setup that allows it to run counter-cyclical fiscal policies.
Exchange rate system over the past six months period in Mexico
Mexican peso is quite fluctuate during past 6 months, and appreciate during past 4
month from January to April 2010 and depreciate from May to Jun 2010. However, comparing
in January with June, Mexican peso has depreciated from 12.8543 Mexican peso to around
12.275 Mexican peso per dollar in April 22. This will effect the economic in Mexico country
which when the currency faces appreciation that there will be an increase in expected
inflation rate because the consumers with in Mexico perceive the price of foreign country
low. Therefore, they will buy foreign products and need more foreign currency then the
Mexican currency will be depreciate at last.
References
Chile
- World Currency Yearbook (WCY)
- IMF Annual Report on Exchange Arrangement and Exchange Restriction (IMF)
-
Javier, Leon and Oliva Carlos. 1999. Determinants of the Exchange Rate Regime: A Time Series Analysis for Chile. International-Economic-Journal; 13(2), Summer 1999, pages 89-102. (Javier)
- The Effective Rate of Chilean Peso, which were extracted from World Currency Yearbook (WCY).
- Fixed Official Rate in 1979 (Javier, p.92-93).
- McCallum 1996, Wei 1996, Helliwell 1998
Brazil
- World Currency Yearbook. (WCY)
- IMF Annual Report on Exchange Arrangement and Exchange Restriction. (IMF)
- Gruben, W.C. and Welch, J.H. (2001): "Banking and Currency Crisis Recovery: Brazil's Turnaround of 1999", Economic & Financial Review, 4th Quarter, 2001.
-
The paper is available online at http://www.dallasfed.org/htm/pubs/pdfs/efr/efr0104b.pdf
Argentina
- World Currency Yearbook (WCY)
- IMF Annual Report on Exchange Arrangement and Exchange Restriction (IMF)
- Choueiri, Nada and Kaminsky, Graciela (1999): "Has the Nature of Crises Changed?
-
Quarter Century of Currency Crises in Argentina ", IMF Working Paper, WP99/152, 41 pages.
Mexico
- World Currency Yearbook (WCY)
- IMF Annual Report on Exchange Arrangement and Exchange Restriction (IMF)
- Li, Carmen A., Apostolis Philippopoulos and Elias Tzavalis. 2000. Inflation and Exchange Rate Regimes in Mexico. Review of Development Economics, 4(1), 87-100. (Li)
