Exchange rate regime

By Lev Herasymenko

Content

• Definition• Floating and fixed exchange rate systems• Common opinion• Ukrainian exchange rate• Conclusion and recommendations

DefinitionAn exchange-rate

regime is the way an authority manages its currency in relation to other currencies and the foreign exchange market. It is closely related to monetary policy and the two are generally dependent on many of the same factors.

The basic types: •A floating exchange rate; •A pegged float; •A fixed exchange rate.

Floating and fixed exchange rate systems

A floating exchange rate or fluctuating exchange rate is a type of exchange-rate regime in which a currency's value is allowed to fluctuate in response to market mechanisms of the foreign-exchange market.

Pegged floats are:•Crawling bands – when the rate is allowed to fluctuate in a band around a central value, which is adjusted periodically. •Pegged with horizontal bands – when the rate is allowed to fluctuate in a fixed band (bigger than 1%) around a central rate.

A fixed exchange rate (pegged exchange rate), is a type of exchange rate regime where a currency's value is fixed against the value of another single currency, to a basket of other currencies, or to another measure of value, such as gold.

This belief that fixed rates lead to stability is only partly true, since speculative attacks tend to target currencies with fixed exchange rate regimes, and in fact, the stability of the economic system is maintained mainly through capital control.

Capital controls are residency-based measures such as transaction taxes, other limits, or outright prohibitions that a nation's government can use to regulate flows from capital markets into and out of the country's capital account.

A fixed exchange rate regime should be viewed as a tool in capital control.

Common opinion

• Floating exchange rates are preferable to fixed exchange rates.

• As floating exchange rates automatically adjust, they enable a country to dampen the impact of shocks and foreign business cycles, and to preempt the possibility of having a balance of payments crisis.

Hybrid exchange rate systems have evolved in order to combine the characteristics features of fixed and flexible exchange rate systems. They allow fluctuation of the exchange rates without completely exposing the currency to the flexibility of a free float.

Ukrainian exchange rate

If we look through Ukrainian economical history, we can mark two methods of exchange rate control: fixed exchange rate and pegged exchange rate.

The last periods when National Bank of Ukraine used fixed exchange rate was September-October 2014. Previous time was during 2010-2013 years.

• NBU started to use pegged exchange rate after Euromaidan.

• After that, they came back to fixed exchange rate for stop fall of hryvnia in September 2014.

And what we can see? When NBU use fixed exchange rate we can’t buy dollars or euros in commercial banks. Prices continue to rise.

And foreign exchange reserves of NBU decrease. When NBU lets exchange rate flows it jump extremely high.

Conclusion and recommendations So, what is the cure for Ukrainian monetary

system? There are some obvious steps.

Some of them are easy to do, some are more complicated.

• Stop panic. Ordinary people should understand that floating exchange rate is normal situation.

• Eliminate the dollar from the standpoint of business exchange.

• NBU should use only pegged floating exchange rate. • It is necessary to abolish the illegal exchange offices.