FIXED EXCHANGE RATES

1
FIXED EXCHANGE RATES and Foreign Exchange
Intervention
1
Central Bank Balance Sheet
Assets (1) Foreign Assets (2)
Domestic Assets H Base Money
Liabilities (1) Deposits held by
Private Banks (2) Currency in circulation H
Base Money
Base Money contracts
Foreign Assets Sale
Base Money Expands
Foreign Assets Purchase
2
2
Fixed Exchange Rate
S
fixed exchange rate
1,2
return
1
output shock
2
Automatic increase in M following CB
intervention in the foreign exchange market.
Result Base Money is endogenous
3
3
The Sustainability of Fixed Exchange Rate Regime
demand for money
(1)
interest parity
(2)
4
Purchasing Power Parity
4
(3)
Substitute (2) (3) into (1)
(4)
5
Fixed Exchange Rate
5
money supply is endogenous
A Simple Model (Krugman 1979)
fixed exchange rate
flexible exchange rate
6
7
Central Bank Balance Sheet
Domestic Credit Expands Indefinitely
rate of expansion
7
8
Logarithmic Approximation
f(x0)
8
6
International Reserves
Money supply
Money demand is constant
CB domestic assets grow at constant rate
9
9
The Shadow exchange rate is market-based
exchange rate when the central bank has no
international reserves
10
10
s
0
(2) Calculations
11
11
s
time
T
T
T
time
T
time
T
i
time
T