2 management - School of International Business and ...

167 The Puzzle of Globalization
The following exchange regimes are most common:
– Managed floating: Monetary authorities intervene into the currency markets e.g. to pre
vent over- or undershooting of the exchange rates, adjusting surplus or deficit of the
balance of payments, securing currency reserves. The intervention does not follow a spe-
cific exchange rate path or target.
– Crawling pegs: The monetary authority intervenes periodically at a fixed rate to adjust
t h e e x c h a n g e r a t e t o in d ic a t o r s s u c h a s p a s t in fl a t io n d iff e r e n t ia ls t o m a jo r t r a d in g p a r t n e r s .
– Pegged exchange rates with horizontal bands: The monetary authority intervenes if the
exchange rate reaches the ceiling or the floor of a fixed bandwidth. The Exchange Rate
Mechanism II within the European Union [Summaries of EU Legislation] is regulating the
relation between the Euro and the non-Euro area currency. »A central rate is determined
between the euro and each participating non-euro area currency, with a standard fluctu-
ation band of 15% above and below that rate… Intervention at the margins is, in principle,
automatic and unlimited…The ECB and the participating non-euro area NCBs may agree
to carry out coordinated intramarginal intervention.«
– Currency Board Arrangement: The exchange rate regime is based on a legal commitment
to exchange domestic currency into a specified other currency at a fixed rate. The restric-
tion to issue domestic currency only against foreign exchange guarantees that the domes-
tic money supply is fully backed by foreign assets.
– Formal Dollarization: The currency of another country has formally replaced the domes-
tic currency. In contrast, the currency union is established by introducing a new currencies
for all member states (e.g. the Euro notes and coins were introduced as the legal tender
on 1st January 2002).
When it comes to the question of interdependencies between the exchange rate and the balance
of payments the microeconomic model of perfect competition presents a simple answer: The
mechanism on the foreign exchange market equals supply and demand, thus leading to balance
the overall monetary inflows and outflows of a country. Under these assumptions the balance of
payments in a two-country model can neither show deficit nor surplus. Empirical observations
show that balance of payments are statistically balanced but usually unbalanced in their main
parts. Many countries experience periodic or even steady deficits in their current account or cap-
ital account. Few countries show continuous surplus in their current account. The U.S.A. is the
only country that can afford deficits in its foreign exchange account over many years because of
the function of the US Dollar as international currency. Anyhow, especially the latest financial cri-
sis has strengthened the consensus among economists and political decision makers that large
current account imbalances do matter.
Macroeconomic approaches analyzing the determinants of current account imbalances start with