[0:03]Okay, hi there. Uh, in this session in our time together, we're going to walk through some of the key exchange rate or currency systems that countries can choose. This is a really important macro topic. If you've looked at the economics of exchange rates, one of the decisions that a country needs to make is what kind of exchange rate system to operate with. So we'll look at three floating, managed floating, a semi-fix system, a fully fixed exchange rate and we'll just touch on currency board systems which is essentially a different type of fixed exchange rate system. So these are the main currency systems. When we think about a free floating exchange rate, the currency value is set purely by the market, by the foreign exchange or currency markets, the forex traders. So it's the strength of currency supply match against currency demand that really drives both the level of and changes in the external value of the currency. And in a floating system, the currency can either appreciate go up or depreciate go down. So you need to use those terms appreciation and depreciation with a floating exchange rate system. In a free floating system, there's no intervention by the Central Bank. Bank of England for example, allows the pound to find its own level, its own market equilibrium. It doesn't intervene directly to try to manipulate or influence the exchange rate. And hence there's no target for the exchange rate. Yeah, the exchange rate is important. It's part of the economic policy, if there's no target for it. And that means that interest rates, the base rate for example in the UK, well that can be set to achieve other objectives, controlling inflation for example. Um, now clearly some students say to me, well if the if if interest rate goes up or down that's going to affect the exchange rate, which is true. But the Bank of England doesn't set interest rates with regard to the exchange rate. Therefore gives them more autonomy, more freedom to set interest rates with regard to growth, inflation, domestic economic conditions. A managed floating system is basically uh where day-to-day the currency floats, finds its own market level but occasionally the Central Bank will intervene. So the Brazilian Real and the Indian Rupee are two good examples of managed floating exchange rates. So day to day the the market sets the exchange rate, but a central bank may choose to intervene occasionally. Uh, they may want the currency to go up, in which case they go into the market to buy to support a currency, selling their FX reserves.
[2:34]Or they might sell to weaken a currency, adding to their FX reserves. They can also use of course interest rates to move the exchange rate up and down to achieve hot money flows and things. Now, once you have a managed floating exchange rate, the the value of the exchange rate, the value of the currency does become important as part of macroeconomic policy. So you might want a higher exchange rate for example to bring down inflationary pressure. Uh, but you might want to manage depreciation to improve your export sector competitiveness, maybe to improve your trade balance or to kickstart growth or to get an economy out of deflation. So managed floating increasingly popular as we'll see, the Singapore dollar is a managed floating um, currency, it's managed against a basket of currencies, it's not just one currency. Um, this is the uh exchange rate from the Singapore dollar to the US dollar and they're trying to keep it within a fairly narrow range there managed float. China has moved to manage floating away from some that 20 years ago, July 2005 I think they ended the fixed exchange rate and then they moved to kind of semi-fix system. Essentially now into a kind of stringent managed float. Here's our chart showing the Yuan to the US dollar. And the People's Bank of China is the Central Bank, they allow the Chinese Yuan or Renminbi to trade in a 2% range around the mid-point. So basically they don't allow the currency to move too much on a day-to-day basis. Now, how does China manage the exchange rate? Well, first of all they have capital controls. So that limits hot money inflows and outflows across across the border. There are also strict foreign investment quotas, FDI quotas and the People's Bank of China has enormous reserves of foreign currency if it wants to intervene in the currency markets. A fixed exchange rate, of course, we're now moving away from free floating to managed floating and now to fixed. So with a fixed exchange rate, the Central Bank, wow, fixes the currency value. The currency becomes pegged or anchored to one currency or maybe a range of currencies. Now crucially, if you have a fixed exchange rate at the Central Bank must hold enough foreign exchange reserves to intervene if and when it's needed in the currency market to maintain the official currency peg.
[5:03]The pegged rate becomes the official exchange rate. So when you're buying and selling imports and exports, trading currencies takes place officially at the day-to-day official rate, but of course there's often some unofficial trading particularly if the official exchange rate is out of line out of filter with what with economic fundamentals. When you have a fixed exchange rate, there can be realignment. So just a peg. Uh, so for example, the government might decide to devalue the exchange rate, reduce the exchange rate or revalue increase the exchange rate with the agreement of the IMF. Quick example point here, floating exchange rates, you talk about depreciation, appreciation, with a fixed exchange rate you talk about devaluation and revaluation. Use those words carefully. The Hong Kong dollar is pegged to the US dollar, the Bulgarian lever is pegged to the euro. Although of course Bulgaria is hoping and planning to join the single currency of the Euro in 2025 or 2026, I believe. Now, currency board system is is similar to a fixed exchange rate. It's basically where a domestic currency is fully backed by a foreign reserve currency or a specific foreign asset, typically held in a fixed exchange rate relationship. Now don't worry too much about currency. Basically it means that if push came to shove, you could fully convert one country's currency to another currency at a fixed exchange rate. So the central bank needs to hold enough foreign currency in reserve equal to the total amount of domestic currency in circulation. Don't worry too much about it. It's a slight, it's a slight geeky point. So just here's a quick summary if you're looking to advise this topic with me. So free floating, no currency target, no Central Bank, and you don't sell it need big currency reserves because you're not using those reserves to to manipulate the exchange rate. Managed, possible target, occasional intervention for exchange reserves can need need to be used for intervention, although of course Central Bank can also use interest rate changes to try and move the exchange rate up or down.
[7:22]With a semi-fixed system, we're getting harder as we go through it here. Yes, the currency can move day to day, but the parameters or the bands within which it can move are fixed. Intervention is needed if the currency moves outside the prescribed limits, and of course you've got our foreign exchange reserves. And with the fully fixed system, yes, the currency is fixed. It's an explicit target of policy. Uh, you need to, you need intervention to maintain it at that peg. So the central bank's job is to maintain the fixed exchange rate. Denmark has a fixed exchange rate against the euro. The Central Bank governor of Denmark has one job when he or she gets up in the morning to maintain the Danish Krona exchange rate against the euro.
[8:06]Must been an exciting job to do that. Uh just recently the IMF every year published kind of a kind of overview of which currencies fit into which systems. I think this is from the spring of 2023. So it's not bang up to date, but it nothing fundamental has changed. So Ecuador, Zimbabwe have a fixed exchange rate with the US dollar. Uh, Hong Kong and Bulgaria have currency board systems. Saudi and Qatar have a fixed exchange rate against the dollar. Denmark and Senegal will have a fixed exchange rate against the um, Euro. China, Jamaica, Croatia and Ethiopia have kind of semi-fixed exchange rates, moving towards managed, but essentially semi-fixed. Wow, Jamaica, Croatia, China, Ethiopia, that'll be a cracking World Cup group. A lot of countries, a lot have a managed floating exchange rate. It seems to be the most modal terms the most popular exchange system. And I think you can probably guess why because you want the advantages of some degree of stability but maybe the ability to move the exchange rate a little bit either way. So the likes of South Korea, Brazil, India, South Africa, Japan and Chile. And Australia, Canada, Norway, uh, UK, USA and US and have in theory and laws in practice a free floating exchange rate system. Now if you want to add that to your notes, just take a screenshot and add it to your digital notes. There we go. Well, thanks for joining in. This video looking at exchange rate systems. Hopefully found it useful. If you did, if you could press the like button that would be hugely appreciated. Stay curious, stay positive, and uh see you sometime soon.
