A Report on Reasons why Governments Prefer Financial Systems featuring Essay

A Report on Reasons why Governments Prefer Financial Systems featuring determined - Essay ExampleOn the other hand, a floating target of exchange is the one that is moving and received cash depends on exchange time.To maintain their local exchange appraise, central banks of European Union members bought and sold their own property in foreign exchange markets, and in return, they acquired their pegged currency. For example, if the value of a angiotensin-converting enzyme local unit currency is US$4, the central bank ensures that those dollars can be supplied in market by the country. High foreign reserve levels atomic number 18 required so as to maintain the rates (Eichengreen & Ricardo, 1999). High foreign reserve levels also ensure that there is good money supply hence preventing inflation/ deflation. An exchange rate refers to the rate at which one currency is exchanged for a nonher. Therefore, it is the value of a countrys currency in price of another. From 1870 to 1914, the ball-shaped exchange rate was bushel. During that time, currency was likened to grand, implying that a local currencys value was set at a fixed exchange rate that was determined in terms of gold ounces, that is, the gold standard (Eichengreen & Ricardo, 1999). This allowed free capital mobility and global stability in trade and currencies. The gold standard was given up when World War II started, but the end of the Second World War, the Breton Woods conference sought for efforts to stabilize the global economy and increasing global trade by establishing basic regulations and rules that governed international exchange. This led to the establishment of International Monetary Fund (IMF) for foreign trade promotion and monetary stability bread and butter of countries and hence of the global economy. It was agreed that the exchange rate would be fixed, in terms of the US dollars, which was then pegged to gold (US$35 per ounce) (Obstfeld & Kenneth, 1995). This means that a curre ncys value was directly converted in terms of its value to the US dollar. For example, to buy a euro, the Euros had to be converted into US dollars, and then into gold value. This peg was maintained till 1971, US dollar could not hold the pegged rate value of US$ 35per gold ounce. Since then, many governments adopted the floating rate system and attempts of returning to gold like a peg together with a global peg were completely abandoned. Why Governments Prefer Fixed/ Pegged alternate Rates Governments prefer fixed exchange rates because they ensure economic stability, especially in current developing nations, where a country can find to fix its currency in order to stabilize the atmosphere thus ensuring foreign investment. This is because a peg gives the investors their investment value, thus relieving them from fluctuation worries unlike low a float (Calvo, 2002). A pegged currency also helps in lowering inflation rates and generating demand, which further increases a currencys stability confidence. However, fixed regimes can cause serious financial crises because it is hard to maintain a peg in the long run. This was experienced in 1995 in Mexico, 1997 in Asia and Russia. Therefore, the governments could not meet the demands of a high value for their currencies to the peg resulting into overvaluing of their currencies. With panic and speculations, investors quickly removed their money out of these countries, and convert it to foreign currencies before the local currency was devalued against the peg. Eventually, foreign currencies became depleted. In Mexico, the government devalued the peso by 29.98%. Eventually, in Thailand, the government eventually allowed floating of