International Trade & Banking / International Bank Management by [Author’s Name] 29 August 2011 International Trade & Banking / International Bank Management Introduction What role central banks play under various exchange rate regimes has long been a matter of professional debate…
The fixed vs. volatile exchange rate dichotomy is no longer relevant. Globalization and financial liberalization impose new demands on central banks. Whatever the type of exchange rate regime countries choose, under the pressure of globalization central banks strive to preserve and strengthen their independence, governed by market-based forces and pressured to enhance financial stability at the national level. The changing role of central banks in various exchange rate regimes in conditions of globalization What exchange rate regime to choose has long been a matter of governments’ concern. For many years, national and international financial systems have been dominated by a long-standing fixed vs. volatile exchange rate systems dichotomy. At the very basic level, choosing an exchange rate regime is the same as choosing a monetary policy and its direction (Stockman 2000). In this sense, central banks are expected to develop and implement the exchange rate policy that responds to the specific financial demands of home countries. In fixed exchange rate systems, the role of central banks is minimal, since money supply and demand adjust automatically and do not require changes in interest rates or other financial indicators (Stockman 2000). By contrast, in floating exchange rate systems central banks play the major role, by managing short-run disruptions that usually follow real monetary shocks (Stockman 2000). In both systems, central banks fulfill three principal functions: (1) maintain price stability with the help of the instruments appropriate under the given exchange rate regime; (2) foster the development of financial institutions and maintain financial stability; and (3) help the government to meet its financial needs at times of crises (Bebchuk & Spamann 2010; Eichengreen & Bordo 2003). Even the choice of the monetary policy and exchange rate regime depends upon and aims at maintaining financial stability and fostering financial growth at a national scale. Yet, everything changes, and central banks are not secured from the powerful influence of globalization. To begin with, globalization changes the long-standing floating vs. fixed exchange rate dichotomy. The bipolar view of exchange rate systems is no relevant for several reasons. First, many countries claim to have floating exchange rate regimes, whereas, in reality, keep affecting monetary mass behaviors through interest rate regulation and intervention policies (Fischer 2001). Second, as the borders between states are gradually disappearing, so are the boundaries between various exchange rate systems. Globalization and evolution give rise to new, alternative exchange rate regimes, led by a rapid increase in financial floats and global crises (Levy-Yeyati & Sturzenegger 2005). As a result, central banks’ roles vary significantly across countries, markets, and financial systems. Simultaneously, several important trends are noteworthy. It would be noted, that globalization by itself is a very vague term. According to Mishkin (2006), globalization is essentially about economic integration, which implies the opening up of national economies to external inflow of goods, services, capital, and business. Contrary to earlier beliefs, globalization is hardly a new phenomenon, dating back to the end of the 19th century and the age of industrialization (Mishkin 2006). “The globalization system, unlike the Cold War system, is not static, but a dynamic ...
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1 In addition to producing earnings from exports, international trade enables firms to acquire resources that are not available in the domestic market. However, risks increase when firms operate outside of the domestic market, despite the fact that a firm may use a number of methods for effecting export transactions.
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