In A Regime Of Fixed Exchange Rates, How Might A Central Bank Operate Its Moneta

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Term Paper Title	In A Regime Of Fixed Exchange Rates, How Might A Central Bank Operate Its Moneta
# of Words	1539
# of Pages (250 words per page double spaced)	6.16

In a regime of fixed exchange rates,  how might a Central Bank operate its monetary policy and its policy for intervention in foreign exchange markets?  Why does it need foreign exchange reserves?

The last 20 years have seen an increased international interdependence due to the reduction in the controls on capital flows between countries have been much reduced.  Also,  since the early 1970’s,  many countries have permitted much more flexibility in their exchange rates.  These developments have raised several issues: how does the exchange rate regime affect the efficacy of domestic monetary and fiscal policies undertaken by small,  open economies?  In response to this question,  many analysts such as exchange rate and balance of payment using IS-LM model,  have contributed to the rapid development of the open economy models. An exchange rate regime is a description of the conditions under which national government allow exchange rate to be determined.  There are three types of exchange rates,  fixed,  flexible and managed exchange rate.

In a fixed exchange rate regime,  national governments agree to maintain the convertibility of their currency at a fixed exchange rate.  A currency is convertible if the government acting through the central bank,  agrees to buy or sell as much of the currency people wish to trade at the fixed exchange rate.  Most central banks act as the government’s banker,   the Banks’ bank,  lender of last resort and issuer of notes as well as supervising the banking system and operating monetary policy.  Monetary policy refers to the attempts to manipulate the interest rate and the money supply so as to bring about desired changes in the economy.  The aims of monetary policy are the same as those of economic policy generally.  They are the maintenance of full employment,  price stability,  a satisfactory rate of economic growth,  and a balance of payments equilibrium.

Under a fixed exchange rate regime,  governments are committed to intervention in the foreign exchange market to maintain a given nominal exchange rate.  It is important by the central bank to intervene in order to buy or sell the foreign exchange in the open market economy.   It is very apprehensible that foreigners would buy assets in any country they choose,  quickly,  with low transactions costs,  and in unlimited accounts due to the perfect capital mobility.  Perfect capital mobility means that the government cannot fix independent targets for both the money sup...

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