INTERNATIONAL MONEY MARKET Foreign Exchange Market Foreign exchange rate Balance of payments International money market
Foreign Exchange Market
Foreign exchange market (or FX or FOREX market) exists wherever one currency is traded for another
FX market includes trading between
large international banks (main participants) central banks, currency speculators, multinational corporations, governments and other institutions
Exchange Rate and Quotation
Exchange rate (or foreign-exchange rate or FX rate)
between two currencies specifies how much one currency is worth in terms of the other For example an exchange rate of 22,5 Czech Crown (CZK) to the United States dollar (USD, $) means that CZK 22,5 is worth the same as USD 1.
Exchange rate quotation
is given by stating the number of units of a price currency that can be bought in terms of 1 unit currency Direct quotation: which is ratio of 1 foreign exchange to appropriate amount of national currency, e.g. 1 USD = 22,5 CZK Indirect quotation: as reverse ratio, e.g. 1 CZK = 0,044
Fluctuation in Exchange Rates
Market based exchange rate will change whenever the values of either of the two component currencies change
Devaluation is a reduction in the value of a currency with respect to other monetary units currency will become less valuable whenever demand is less than available supply (this does not mean people no longer want money, it just means they prefer holding their wealth in some other form, possibly another currency)
Revaluation means a rise of currency to the relation with a foreign currency currency will tend to become more valuable whenever demand for it is greater than the available supply
Example: exchange rate of USD and CZK: October 2000 ... 1 USD = 41,8 CZK October 2006 … 1 USD = 22,4 CZK
Factors Affection Exchange Rate
Foreign trade e.g. if export of Czech products to France increases, a demand for Czech Crowns increases as well, since Crown is needed to pay for Czech goods
Capital investments in the form of investment purchases abroad
Changes in real interest rates money invested in countries with high interest rates are called “hot money”
Inflationary depreciation high inflation tends to deprecation and demand for foreign currencies increases
Purchasing Power Parity
Purchasing power parity exchange rate
equalizes the purchasing power of different currencies in their home countries for a given basket of goods
these special exchange rates are often used to compare the standards of living of two or more countries
Pja … price of j-th good in country A Pjb … price of j-th good in country B Qj … amount of j-th good in a market basket
A p j * Qj B p j * Qj
Systems of exchange rates
Fixed exchange rate is a type of exchange rate regime wherein a currency's value is matched to the value of another single currency or to a basket of other currencies, or to another measure of value, such as gold. Exists from first half of 1930s [the People's Republic of China's fixed exchange rate with the US dollar until 2005 led to China's rapid accumulation of foreign reserves, placing an appreciating pressure on the Chinese yuan.] Free floating exchange rate is a type of exchange rate regime wherein a currency's value is allowed to fluctuate according to the foreign exchange market. The rate results from demand and supply interaction without institutionary interventions. Managed floating exchange rate the rate is formed by market interaction and also by interventions on foreign exchange markets. Those interventions are done through purchases and sales of foreign exchanges.
CNB intervention 2013
The aim of using the exchange rate as an additional monetary policy instrument – and therefore of using foreign exchange interventions to weaken the koruna – is the same as in the case of interest rates. In line with the CNB’s statutory mandate, the objective is to maintain price stability in the Czech economy, which is expressed by the CNB’s inflation target of 2%. In other words, the aim is to prevent deflation, to ensure that the 2% inflation target is achieved in a sustainable manner and to accelerate the return to a situation where the CNB will again be able to use its standard tool, i.e. interest rates. The CNB Bank Board decided to use the exchange rate as a monetary policy instrument, and therefore to commence foreign exchange interventions, on 7 November 2013.
Concert about deflation Automatic & unlimited interventions Increase import prices Support of Czech export
recovery in production
ensure that the 2% inflation target is achieved in a sustainable manner
Selling koruna and buying foreign currencies Boost domestic economic activity, reduce households’ purchasing power > households’ demand may be redirected towards domestic goods and services profitability of corporations and their willingness to invest
contributes to a rise in employment and wages, which increases the purchasing power of households
CNB intervention 2013
CNB will not allow the koruna to appreciate to levels it would no longer be possible to interpret as “close to CZK 27/EUR”. The CNB prevents such appreciation by means of automatic and potentially unlimited interventions, i.e. by selling koruna and buying foreign currency. If the exchange rate departs from CZK 27/EUR on the weaker side, the CNB allows the koruna exchange rate to move according to supply and demand on the foreign exchange market. A weakening of the exchange rate of the koruna leads to an increase in import prices and thus also in the domestic price level. To a lesser extent, it also boosts domestic economic activity. The rise in import prices can be expected to reduce households’ purchasing power, but households’ demand may be redirected towards domestic goods and services to a greater extent and additionally supported by lower real interest rates as a result of higher inflation expectations. At the same time, the weaker exchange rate supports Czech exports and the profitability of corporations and their willingness to invest. The recovery in production then contributes to a rise in employment and wages, which increases the purchasing power of households.
Balance of Payments
Balance of payments (or BOP)
measures the payments that flow between any individual country and all other countries
it is used to summarize all international economic transactions for that country during a specific time period, usually a year.
BOP is determined by the country's exports and imports of goods, services, and financial capital, as well as financial transfers.
it reflects all payments and liabilities to foreigners (debits) and all payments and obligations received from foreigners (credits). BOP has three parts:
current account balance (C/A), capital account balance (K/A), official transaction account (change in foreign exchange reserves) (OT/A)
Current Account Balance
The balance of trade is a statement of export and import of a country over some period, usually a year
Therefore, it’s balance of export and import, the difference is called net export.
v mld. Kč
Ex – Im > 0 …… balance is in surplus
Ex – Im < 0 …… balance is in deficit
Ex – Im = 0 …… balance is in equilibrium
Capital Account Balance
Net change in foreign ownership of domestic assets
If foreign ownership of domestic assets has increased more quickly than domestic ownership of foreign assets in given year capital account surplus
If domestic ownership of foreign assets has increased more quickly than foreign ownership of domestic assets in given year capital account deficit
Official Transaction Account:
1993 v mld. Kč
Gold reserves, IMF Special Drawing Rights, foreign exchange reserves
International Monetary System
International monetary system
is represented by system of standards and institutions that form monetary relations development in its international scale system existing after WWII up to beginning of 1970s is called Bretton Woods system after the conference held in Bretton Woods.
Bretton Woods Conference
was held from 1 July to 22 July 1944 agreements were signed to set up the International Bank for Reconstruction and Development, the General Agreement on Tariffs and Trade (GATT), and the International Monetary Fund (IMF) conference also proposed the creation of an International Trade Organization (ITO) to establish rules and regulations for international trade.
International Monetary Fund
International Monetary Fund
is an international organization that oversees the global financial system by observing exchange rates and balance of payments, as well as offering financial and technical assistance when requested. Its headquarters are located in Washington, D.C.
In order to make responsible decisions about financial aid fund needs relevant economic data on the country to help (mainly about foreign trade and assets reserves).
In 1953 Czechoslovakia refused to provide those information and was asked to leave IMF. In 1990 Czechoslovakia has been accepted back into IMF.
International Bank for Reconstruction and Development
International Bank for Reconstruction and Development (or World Bank)
is an international organization whose original mission was to finance the reconstruction of nations devastated by WWII.
The IBRD provides loans to governments, and public enterprises, always with a government (or "sovereign") guarantee of repayment.
The funds for this lending come primarily from the issuing of World Bank bonds on the global capital markets - typically $12-15 billion per year.
These bonds are rated AAA (the highest possible) because they are backed by member states' share capital, as well as by borrowers' sovereign guarantees. Because of the IBRD's credit rating, it is able to borrow at relatively low interest rates.
Precedessor of Euro: ECU (European currency unit) till 1998
Use of EURO outside EU
With formal agreements: Monaco, San Marino, Vatican City, Saint Pierre and Miquelon, Mayotte, Akrotiri and Dhekelia
Those countries outside the EU have adopted the euro as their currency. For formal adoption, including the right to mint their own coins, a monetary agreement must be concluded. Monaco, San Marino and Vatican City previously used versions of yielded member state currencies (Italian lira and Monegasque Franc pegged to the French Franc). Agreements were also concluded for two overseas territories of France. They are outside the EU but have been allowed to use the euro as their currency. However, they are not allowed to mint any coins.
Use of EURO outside EU
Without formal agreements: Andorra, Kosovo, Montenegro, Saint Barthélemy, Saint Martin
Andorra: Does not have an official currency and hence no specific euro coins. It previously used the French franc and Spanish peseta as de facto legal tender currency. There has never been a monetary arrangement with either Spain or France; however, the EU and Andorra are currently in negotiations regarding the official status of the euro in Andorra.
Montenegro and Kosovo: have also used the euro since its launch, as they previously used the German mark rather than the Serbian dinar. This was due to political concerns that Serbia would use the currency to destabilise these provinces (Montenegro was then in a union with Serbia) so they received western help in adopting and using the mark (though there was no restriction on the use of the dinar or any other currency).
budget deficit of less than 3 % of their GDP
debt ratio of less than 60 %of GDP
interest rates close to the EU average.
Introduced in 1999
Physical coins and banknotes in 2002
Eventual use of Euro is mandatory for all new EU members
Managed and administrated by European Central Bank (ECB) and European System of Central Banks (ESCB)
ECB has sole authority to set monetary policy
a total of 23 countries and territories that do not belong to the EU have currencies that are directly pegged to the euro In Europe: Bosnia and Hercegovina, Bulgaria Denmark Macedonia Outside Europe: Morocco, Cape Verde, African currency unions, …