Chapter 2: The balance of payments and the foreign exchange market 1- Exchange rates and international transactions Currency Overview Asia 11:36 a.m. EDT 03/25/09 Last (bid) Prior Day Late Tuesday in New York. Australian Dollar (in dollars) 0.7002 0.6953 Hong Kong Dollar 7.7497 7.7500 Indian Rupee 50.500 50.429 Indonesian Rupiah 11520 11468 Japanese Yen 97.54 97.78 Malaysian Ringgit 3.6260 3.6258 Singapore Dollar 1.5080 1.5135 South Korean Won 1362.20 1386.58 Taiwanese Dollar 33.820 33.852 Thai Baht 35.400 35.411 Europe & Others 11:36 a.m. EDT 03/25/09 Last (bid) Prior Day Late Tuesday in New York. Euro (in dollars) 1.3550 1.3451 Czech Republic Koruna 20.1140 20.1450 Denmark Krone 5.4961 5.5371 Norwegian Krone 6.5135 6.4020 Polish Zloty 3.3485 3.3704 Russian Ruble 33.6201 33.5010 Swedish Krona 8.0789 8.1500 Swiss Franc 1.1231 1.1317 U.K. Pound (in dollars) 1.4610 1.4663 Egyptian Pound 5.6220 5.6300 Israeli Shekel 4.0920 4.0617 South African Rand 9.4210 9.4967 Key Currency Cross Rates: 11:47 a.m. EDT 03/25/09 Dollar Euro Pound SF ranc Peso Yen CdnDlr Canada 1.2242 1.6582 1.7870 1.0901 0.08597 0.01255 --- Japan 97.570 132.16 142.42 86.883 6.8516 --- 79.701 Mexico 14.240 19.289 20.787 12.681 --- 0.14595 11.632 Switzerland 1.1230 1.5211 1.6392 --- 0.07886 0.01151 0.91733 U.K. 0.68507 0.92793 --- 0.61004 0.04811 0.00702 0.55961 Euro 0.73828 --- 1.0777 0.65742 0.05184 0.00757 0.60307 U.S. --- 1.3545 1.4597 0.89047 0.07022 0.01025 0.81686 (Source: Thomson Reuters) http://online.wsj.com/public/page/news-currency-currencies-trading.html -1-
The real euro/dollar exchange rate, denoted q, is the euro price of the American basket relative to that of the euro area: q = (E x P $ )/P (2-1) The nominal effective exchange rate: n NEER i = ωj.e ji j=1,j i (2-2a) where, NEER i = (nominal) effective exchange rate of currency i, E ji = nominal exchange rate of currency i with respect to currency j, ωj = weight given to currency j in the construction of the index; by definition the sum of weights equals one. The real effective exchange rate: n REER i = ωj.q ji j=1,j i (2-2b) where, NEER i = (nominal) effective exchange rate of currency i, q ji = real exchange rate of currency i with respect to currency j, ωj = weight given to currency j in the construction of the index; by definition the sum of weights equals one. Graph 1: (Source: BIS, Quarterly review, March 2009) -2-
Currency Futures, Tuesday, March 24, 2009 Euro (CME)- 125,000; $ per Jun 09 1.3622 1.3678 1.3431 1.3519 -.0111 1.5740 1.2344 111,881 Sep 09 1.3547 1.3677 1.3440 1.3525 -.0111 1.5672 1.2494 1,058 Dec 09 1.3598 1.3664 1.3479 1.3533 -.0111 1.5622 1.2645 29 Est vol 211,426; vol Mon 163,834; open int, 112,974, +1,655. Sources: Thomson Reuters; WSJ Market Data Group -3- http://online.wsj.com/mdc/public/page/2_3023-fut_currencyfutures.html?mod=mdc_curr_pglnk LIFETIM E Open High Low Settle Chg High ( ) Low Open Int 3. The balance of payments as the net demand for foreign currency Table 2-1: Comparing euro rates of return on dollar and euro deposits Euro interest rate Dollar interest rate Expected rate of euro depreciation against dollar Rate of return difference between euro and dollar deposits Case R R $ (E e /$ - E /$ )/E /$ R - R $ - (E e /$ - E /$ )/E /$ 1 0.04 0.06 0.00-0.02 2 0.04 0.06-0.02 0.00 3 0.04 0.06-0.04 0.02 4 0.04 0.03 0.02-0.01 The uncovered interest parity condition between dollar and euro deposits shows that the equality between the two assets expected rates of return measured in euros: R = R $ + (E e - E)/E (2.5) Table 2-2: Today s euro/dollar exchange rate and the expected euro return of dollar Euro exchange rate, direct terms deposit when E e = per dollar Expected rate of depreciation of euro against dollar Interest rate on dollar deposits Expected euro return on dollar deposits Case E R $ (0.65 - E)/E R + (0.65 - E)/E 1 0.69 0.06-0.058 0.002 2 0.67 0.06-0.030 0.030 3 0.65 0.06 0.000 0.060 4 0.63 0.06 0.032 0.092 5 0.60 0.06 0.083 0.143
Figure 2-2: The relation between the current euro/doll r exchange rate and the expected euro return on dollar deposits 0,7 0,68 Today's euro/dollar exchange rate 0,66 0,64 0,62 0,6 0,58 0,002 0,03 0,06 0,092 0,143 Expected euro return on dollar deposits The covered interest parity condition can be written R = R $ + (F E)/E (2-7) with F the one-year forward price of dollars in terms of euros. -4-
4. Exchange rates regimes De Facto Classification of Exchange Rate Regimes and Monetary Policy Frameworks Data as of April 31, 2008 The classification system is based on the members' actual, de facto arrangements as identified by IMF staff, which may differ from their officially announced arrangements. The scheme ranks exchange rate arrangements on the basis of their degree of flexibility and the existence of formal or informal commitments to exchange rate paths. It distinguishes among different forms of exchange rate arrangements, in addition to arrangements with no separate legal tender, to help assess the implications of the choice of exchange rate arrangement for the degree of independence of monetary policy. The system presents members' exchange rate regimes against alternative monetary policy frameworks in order to highlight the role of the exchange rate in braod economic policy and to illustrate that different exchange rate arrangements can be consistent with similar monetary frameworks. The following explains the categoreis. Exchange rate anchor The monetary authority stands ready to buy or sell foreign exchange at given quoted rates to maintain the exchange rate at its predetermined level or within a range (the exchange rate serves as the nominal anchor or intermediate target of monetary policy). These regimes cover exchange rate regimes with no separate legal tender, currency board arrangements, fixed pegs with or without bands, and crawling pegs with or without bands. M onetary aggregate target The monetary authority uses its instruments to achieve a target growth rate for a monetary such as reserve money, M1, or M2, and the targeted aggregate becomes the nominal anchor or intermediate target of monetary policy. Inflation targeting framework This involves the public announcement of medium-term numerical targets for inflation, with an institutional commitment by the monetary authority to these targets. Additional key features include increased communication with the public and the markets about the plans and objectives of monetary policymakers and increased accountability of central bank for its inflation objectives. Monetary policy decisions are guided by the deviation forecasts of future inflation from the announced inflation target, with the inflation forecast acting (implicitly or explicitly) as the intermediate target of monetary policy. Other The country has no explicitly stated nominal anchor, b conducting monetary policy. This is also used when no available. rather monitors various indicators in nt information on the country is http://www.imf.org/external/np/mfd/er/2008/eng/0408.htm -5-
Figure 2-3: External Developments (Index, 2000 = 100, three-month moving average, unless otherwise noted) (Source: World Economic Outlook, IMF, April 2009) -6-
Figure 2-4: Foreign Exchange Exposure is Strongly Linked to Market Perceived Default Risk, Regardless of the ER Regime (Source: World Economic Outlook, IMF, April 2009) -7-
The exchange rate of the Deutschemark agai nt the US dollar and the French Franc 1953-1998 4,5 90 4 80 3,5 70 3 60 2,5 2 50 40 1,5 30 1 20 0,5 10 0 0 1953 1955 1957 1959 1961 1963 1965 1967 1969 1971 1973 1975 1977 1979 1981 1983 1985 1987 1989 1991 1993 1995 1997 USD 1 = DEM... FRF 100 = DEM... Source: Bundesbank (Exchange rates on the Frankfurt exchange) -8-
The annual rate of appreciation of the Deutschemark ag nst the US dollar and the French Franc 1954 1998 30 20 USD 1 = DEM FRF 100 = DEM 10 0-10 -20-30 1954 1956 1958 1960 1962 1964 1966 1968 1970 1972 1974 1976 1978 1980 1982 1984 1986 1988 1990 1992 1994 1996 1998 Source: Bundesbank (Exchange rates on the Frankfurt exchange) -9-
Annual rate o f appre ciation of the e uro agains t the Br tis h Pound and the US Do llar (% increas e) 25 20 15 10 5 GBP USD 0 2000 2001 2002 2003 2004 2005 2006 2007 2008-5 -10-15 Source: Bundesbank -10-
Implied PPP 1,2 1 0,8 0,6 0,4 0,2 0 FRA DEU GBR 1980 1982 1984 1986 1988 1990 1992 1994 1996 1998 2000 2002 2004 2006 2008 2010 Source: WEO, April 2009-11-
Effective exchange rate 1995-2009 OECD 140 130 120 110 100 90 80 France Germany United Kingdom United States Euro area 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009-12-