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The currency and financial crises of the nineties, as well as the last crisis in Turkey have shown that the international financial system is highly susceptible to interference. The reasons for this are complex nature and have been intensively discussed in many papers. I would like to focus my brief opinion entirely on the macroeconomic dimension of the problem. This raises above all the question whether a reform of the international monetary system is needed in order to ensure greater stability in the domestic and global financial markets in the future. Might conceivably be used to exchange rate target zones, measures to regulate international capital flows and a redefinition of the tasks of the International Monetary Fund. For answers to these questions, it is especially important that the crises of recent years are due more to errors in the national economic policies or defects in the international monetary system.
I’m procedure here that I first discuss the problems of a monetary policy with fixed or determinable exchange rates. In a second step, I will describe the macroeconomic difficulties that arise in purely market-driven (“flexible”) can result in foreign exchange rates on this basis can then be checked whether the now dominant concept of “managed floating” can help ensure that critical developments also under the institutional status quo of the international monetary system can be avoided.
2. Currency Crises with fixed or determinable exchange rates
All as a “currency crises” designated events of the last ten years have characterized in that central banks were forced under the pressure of speculative attacks, abandon fixed or pre-announced targets for the exchange rate of the domestic currency. Thus, a definition of the monetary crisis has naturalized, which excludes it from the outset that such an event occurs under other currency regime. However, we will present in the following that may lead to critical development even in free-flexible courses and the “managed floating”.
Despite differences in national circumstances most currency crises of recent years can be attributed to a relatively similar pattern.
- The central bank is pursuing a monetary policy strategy based mainly on a fixed exchange rate (or a specified exchange rate path) to a reserve currency (or a basket of major currencies) supports.
- At the same time, monetary policy, however, is not ready, the interest rate policy completely subordinated to the exchange rate policy. She tries rather by a partial sterilization of foreign exchange market interventions to pursue a domestically-oriented interest rate policy.
As a result, this results in a monetary compromise solution in which the interest rate is too low to secure a domestic economic equilibrium. The result is inflationary processes with a tendency to over-investment and increases in real estate and stocks. At the same time interest rates are too high to ensure external balance. The result is temporarily high capital inflows, a strong tendency of residents to borrow in foreign currency and thus also a high fragility of the national financial system.
The problem with such a constellation of interest rates and monetary policy is the high incentive seemingly safer speculative profits for foreign investors and domestic borrowers. Attempts by individual countries to stop the inflow of capital controls have proven generally considered less effective. This experience has already had to make the Bundesbank in the years 1970-73, when it was in a similar situation (low dollar interest rates, fixed-dollar exchange rate, trial of an autonomous interest rate policy) inundated by massive capital inflows, although they had introduced far-reaching restrictions on capital movements. Brazil, Malaysia and Thailand have not been able to stop the crisis through controls on capital inflows. Chile is known as the most important evidence of the success of such regulations. However, it should be borne in mind that this country pursued a very flexible exchange rate management, in which it is only been partially possible to predict the change in the exchange rate.
In retrospect, it can be established for these crises, it would have been possible by an alternative policy mix of monetary policy to keep the issue of inflows as well as the foreign currency debt limits. This could for a greater range of variation in the change control requires to reduce the predictability of the speculators. Secondly, it would have been necessary to rely more on macroeconomic stabilization on interest than on the exchange rate.
Concretely, for example, would Thailand in 1994 or 1995 a limited appreciation of the Bath can allow then to drive by the increased level of devaluation. Such a downward slide would have opened the possibility of making a rate hike, without triggering speculative inflows. In one aimed at the prevention of inflows macroeconomic policies, the risk of speculative outflows would have been much lower, even though it had not been ruled out in principle. For the stability of national financial markets it would have been advantageous that had existed no incentives in the alternative policy mix to include foreign currency loans.
3. Crises in “Flexible Exchange Rates”
In response to the bad experience with fixed or pre-announced exchange rates, many central banks have opted for a policy of “managed floating”. This strategy may not with “flexible exchange rates” – be confused – in the sense of purely market-determined exchange rates. A number of studies have shown that even countries that are led by the International Monetary Fund in the category “independent floating”, specifically through interventions take on what is happening in the forex market influence.
Thus, there are relatively few countries that operate consistently over a long period a policy of “flexible courses”. This as “fear of floating” Marked phenomenon is due to the fact that it can also lead to critical developments in purely market-determined prices. This is because market-determined exchange rates tend to behave quite differently over longer periods than would appear from the underlying macroeconomic data appears. A good example of this is the sharp depreciation of the euro in 2000, which was a complete contrast to the fact that the euro zone in a considerably better macroeconomic condition was at this time than in the entire nineties. This single finding is confirmed by a wealth of econometric studies.
In a system with flexible exchange rates, critical developments express mainly in massive real appreciation and depreciation. This describes developments, much stronger at the exchange rate appreciates (depreciates), as it corresponds to the difference between prices and wages vis. A particularly dramatic example of such a crisis is the development of Japan in the years 1990 to 1995 inclusive.
Although the country was hit in the late eighties by the collapse of a large speculative bubble, which greatly weakened domestic demand, it came from 1990 to 1995 to a massive appreciation of the yen against the dollar (and partly also against the European currencies). In this way (“pricing-to-market”), the Japanese companies were forced to reduce their profit margins in the export business drastically or incurring a decline in their export business. As a result, corporate balance sheets and indirectly the banks’ balance sheets deteriorated. It is therefore not surprising that many countries are no longer willing to suspend their economies completely passive erratic fluctuations in the foreign market.
4. The concept of the “managed floating”
The preferred today by many countries strategy of “managed floating” is distinguished in that it avoids the problems of both the flexible and the solid (or pre-announced) courses.
- The “managed floating” differs from the flexible courses in that exchange rate movements will no longer no longer predominantly left alone and often the foreign exchange market. This makes it possible in particular to avoid the problems associated with strong real appreciation problems.
- Compared to fixed (or predictable) exchange rates is the “managed floating” the advantage that it does not allow for predictability of price development any more is a prerequisite for seemingly risk-free capital gains. It also allows a much more flexible policy mix than is the case in particular for fixed exchange rates.
For an understanding of the “managed floating” it is necessary to briefly describe the main principles of such a strategy. Interventions in the foreign exchange market, it is crucial to distinguish between a situation of strength and weakness of the domestic currency:
- Is the domestic currency downward pressure is only limited possible for the central bank to support this through interventions in the foreign exchange market. Since they sold it buys currency reserves and its currency is confronted with the hard currency reserves budget constraint of a limited inventory.
- For upward pressure on the domestic currency, the central bank buys the foreign currency and is the domestic currency in the market. In this situation, there is no budget constraint. In principle, the central bank can now intervene without limit.
An important characteristic of a policy of “managed floating” is the fact that the central banks despite their – in some cases massive – interventions in the foreign exchange market really wish to pursue an independent interest rate policy. While this is considered by many theorists as impossible is the practice of many central banks that this certainly is given a leeway.
To understand these relationships, one has to take into account, first, that the intervention of a central bank with a strong currency always an extension of the domestic banking liquidity (“cash basis”) are connected. Separately, they would therefore lead to the domestic money market rate falls sharply, which would mean a too expansionary monetary policy. However, the central bank can neutralize the excess liquidity through its monetary policy instruments (“sterilization”) by:
- loans to the domestic banking system reduced accordingly, or
- the banks current interest-bearing securities or
- an interest-bearing demand deposit offering (“deposit facility”).
If a central bank has a sufficient volume of such instruments has, so they can pursue an independent interest rate policy despite its foreign exchange market interventions. The only restriction that they must take into accounts yet, the cost of the interventions. These arise in part as the difference between:
- the interest rate on the domestic currency: this has to be paid on the deposit facility or for the short-term securities issued. It also determines the opportunity cost of a lower stock of loans to the banking system; and
- the interest rate on the purchased currency: this determines the income arising from the purchase of foreign exchange, since such funds are invested by a central bank always earn interest on the money market of the country with the weak currency.
A second component of sterilization cost is the exchange rate movements between the domestic and the foreign currency:
- Evaluates the domestic currency, the central bank incurred valuation losses because the value of the currency reserves decreases in domestic currency.
- For a depreciation of the domestic currency valuation gains arising on the other hand.
The entire sterilization costs are the sum of these two components. Sterilized interventions are therefore always free if the domestic interest rate is higher (lower) than the foreign interest rate and the domestic currency devalued precisely the extent of the interest rate differential with respect to the foreign currency (upgraded) is. If a central bank wants to keep their sterilization costs low, so it should ensure that the controlled of their exchange rate path is not too much different from the prevailing interest rate differentials.
On the whole, so you can hold on to the policy of “managed floating”, that this
- is particularly efficient if a central bank intervenes in a situation of upward pressure,
- stability is politically acceptable, if a central bank has a sufficiently high sterilization potential,
- is associated with very low cost, if the central bank in case of a positive interest rate differential vis the exchange rate controls so that the devaluation of the difference corresponds.
5. Advantages of “managed floating”
Overall, proves the “managed floating” as a pragmatic approach of the vagaries of a purely market-determined exchange rate, as well as avoiding the rigidity of a fixed rate or a pre-announced exchange rate path. Examples of successful “managed floating” are:
- the interventions of the Bank of Japan in phase from June 1999 to June 2000: the Bank of Japan bought this time to around $ 100 billion and prevented an appreciation of the yen below the threshold of 100 yen / dollar; you can imagine what would have meant such an appreciation for the Japanese economy is easy;
- the interventions of Korea and Thailand in the period from 1998 to the present: in these countries was also very large sums (Korea around 70 billion dollars) intervened in the foreign exchange market to the revaluation process, which ceased after the crisis, in controlled channels to let go;
- the operations of the European Central Bank in October and November 2000: An amount of approximately $ 8.5 billion, the ECB has succeeded in bringing about a turnaround in the euro-dollar exchange rate.
- In Eastern Europe, Slovenia has for years pursued a very successful policy of “managed floating”, in which a high degree of macroeconomic stability has been accompanied by a very dynamic real economic development with the dominance of “managed floating” has become the shock susceptibility of the international financial architecture from a macroeconomic significantly reduced visibility. This has important implications for the reform proposals discussed in recent years:
Since the exchange rate paths can be anticipated by market participants no longer readily, it is very much harder to achieve seemingly risk-free profits on short-term investments. At reduced inflows and outflows risk decreases abruptly. The need for controls on capital inflows and outflows is therefore significantly lower than for fixed or predictable exchange rates.
The discussion of target zones is unnecessary insofar as the “managed floating” with a focus on managing exchange rates by central banks (and governments) to help avoid a massive real appreciation and depreciation and related disorders macro economy. Unlike the target zone proposals, however – and for good reason – decided not to publish the targeted rate paths. As the examples of Thailand, Korea and Japan show that control the “managed floating” can be done much more consistent than it was propagated with the concept of “soft buffers” of the representatives of the target zones.
6. weaknesses of a global financial architecture that is based on the “managed floating”
Unlike the monetary system of the Bretton Woods system, the present, based on the concept of “managed floating” international monetary system proves to be a “spontaneous order” which has evolved ultimately solely from the self-interest of the countries involved. This does not in principle be detrimental, but it is obvious that such an order has considerable shortcomings.
The main shortcoming of the “managed floating” is that the exchange rate policy lies solely in the hands of national governments. The danger is therefore not to be dismissed out of hand, that under the guise of “managed floating” a strategic trade policy is operated. The fact that the foreign exchange reserves of the “emerging market economies” of 1990 has increased to 1999 from 153 billion to $ 663 billion, shows that in this decade massive intervention by central banks operate in these countries, without which it marked a would have appreciation of their currencies. So if the “managed floating” is now widely recognized as an organizing principle for the world monetary relations, it is essential that the International Monetary Fund and the WTO, check carefully that the exchange rate policy of a country is effectively managed only by macroeconomic considerations, or whether it is this is an attempt at a “beggar-my-neighbor” policy.
From the perspective of foreign trade is – compared to a system of fixed rates or forward price of canceled Paths – A second disadvantage of the “managed floating” can be seen in the reduced predictability of exchange rates. However, it is between short-term and long-term predictability to distinguish. For short-term speculative inflows defense, it is important that the exchange rate in the short term have some variability. However, against this, the foreign traders can easily lock. In the longer term, however, a policy of “managed floating” allows a relative stable development of the real exchange rate – especially compared to a system of floating rates. This is particularly important for investors in the industrial area of importance A third weakness of the “managed floating” is the asymmetric controllability of exchange rates. As already mentioned, it is much easier for a central bank to prevent an appreciation as devaluation. It can therefore not be excluded in the “managed floating”, that a central bank – e.g. comes under a considerable speculative attack – because of a contagion effect. This can make an unwanted devaluation required, which leads to domestic disturbances:
To avert inflationary pressure, the central bank must now embark a policy mix with considerably higher real interest rates. This not only increases interest of public expenditure, it also leads to a disproportionate restriction pressure on the domestic economic sectors (construction, services) that can not benefit from the devaluation. The facilities newly created by the International Monetary Fund in recent years (Supplemental Reserve Facility (SRF); Contingent Credit Line (CCL)) offer very flexible and large short-term financial assistance to countries that have fallen through no fault under downward pressure. To ask is, however, whether it is really appropriate for the CCL to demand an interest premium of 300 to 500 basis points, as for candidate countries are subject to very strict criteria.
In 2001, presents the international financial market architecture in a much less error-prone condition than a few years earlier. That does not mean that crises escalations can be completely ruled out in Turkey as the last. The example of Turkey also shows that crises are to be expected, especially if the macroeconomic stabilization solely or largely based on the instrument in a ‘exchange rate anchor “.
The main disadvantage of this emerged in recent years, “spontaneous order” is that will operate a targeted “monetary dumping” under the guise of “managed floating”. Careful monitoring of exchange rate policies of the IMF and the WTO seems urgently.
With the dominance of “managed floating” capital controls are most in extreme crisis cases required, but never as a constituent element of the international monetary system, as envisaged by, for example, the supporters of a “Tobin tax”. The concept of target zones has become obsolete, because with “managed floating” is already a very specific exchange rate policy is pursued.
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