International_Economics_Tenth_Edition (1)

almost but not completely fixed, being kept within a band of 1 percent on either side of parity for a total spread of 2 percent. National exchangestabilization funds were used to maintain the band limits. In 1971, the exchange-support margins were widened to 2.25 percent on either side of parity to eliminate payments imbalances by setting in motion corrective trade and capital movements. Devaluations or revaluations could be used to adjust the par value of a currency when it became overvalued or undervalued.

Although adjustable pegged rates are intended to promote a viable balance-of-payments adjustment mechanism, they have been plagued with operational problems. In the Bretton Woods system, adjustments in prices and incomes often conflicted with domestic-stabilization objectives. Also, currency devaluation was considered undesirable because it seemed to indicate a failure of domestic policies and a loss of international prestige. Conversely, revaluations were unacceptable to exporters, whose livelihoods were vulnerable to such policies. Repegging exchange rates only as a last resort often meant that when adjustments did occur, they were sizable. Moreover, adjustable pegged rates posed difficulties in estimating the equilibrium rate to which a currency should be repegged. Finally, once the market exchange rate reached the margin of the permissible band around parity, it in effect became a rigid fixed rate that presented speculators with a one-way bet. Given persistent weakening pressure, for example, at the band's outer limit, speculators had the incentive to move out of a weakening currency that was expected to depreciate further in value as the result of official devaluation.

These problems reached a climax in the early 1970s. Faced with continuing and growing balance- of-payments deficits, the United States suspended the dollar's convertibility into gold in August 1971. This suspension terminated the U.S. commitment to exchange gold for dollars at $35 per ounce-a commitment that had existed for 37 years. This policy abolished the tie between gold and the international value of the dollar, thus floating the dollar and permitting its exchange rate to be set by market forces. The floating of the dollar terminated U.S. support of the Bretton Woods system of fixed exchange rates and led to the demise of that system.

IFloating Exchange Rates

Instead of adopting fixed exchange rates, some nations allow their currencies to float in the foreignexchange market. By floating (or flexible) exchange rates, we mean currency prices that are established daily in the foreign-exchange market, without restrictions imposed by government policy on the extent to which the prices can move. With floating rates, there is an equilibrium exchange rate that equates the demand for and supply of the home currency. Changes in the exchange rate will ideally correct a payments imbalance by bringing about shifts in imports and exports of goods, services, and short-term capital movements. The exchange rate depends on relative productivity levels, interest rates, inflation rates, and other factors discussed in Chapter 12.

Unlike fixed exchange rates, floating exchange rates are not characterized by par values and official exchange rates; they are determined by market supply and demand conditions rather than central bankers. Although floating rates do not have an exchange-stabilization fund to maintain existing rates, it does not necessarily follow that floating rates must fluctuate erratically. They will do so if the underlying market forces become unstable. Because there is no exchange-stabilization fund under floating rates, any holdings of international reserves serve as working balances rather than to maintain a given exchange rate for any currency.

Achieving Market Equilibrium

How do floating exchange rates promote payments equilibrium for a nation? Consider Figure 15.2 on page 450, which illustrates the foreign-exchange market in Swiss francs in the United States. The intersection of supply schedule So and demand schedule Do determines the equilibrium exchange rate of $0.50 per franc.

Referring to Figure 15.2(a), suppose a rise in real income causes U.S. residents to demand more Swiss cheese and watches, and therefore more francs; letthe demand for francs rise from Do to D\. Initially the market is in disequilibrium, because the quantity of francs demanded (60 francs) exceeds the quantity supplied (40 francs) at the exchange rate of $0.50 per franc. The excess demand for

francs leads to an increase in the exchange rate from $0.50 to $0.55 per franc; the dollar thus falls in value, or depreciates, against the franc, while the franc rises in value, or appreciates, against the dollar. The higher value of the franc prompts Swiss residents to increase the quantity of francs supplied on the foreign-exchange market to purchase more U.S. goods, which are now cheaper in terms of the franc; at the same time, it dampens U.S. demand for more expensive Swiss goods. Market equilibrium is restored at the exchange rate of $0.55 per franc, at which the quantities of francs supplied and demanded are equal.

Suppose instead that real income in the United States falls, which causes U.S. residents to demand less Swiss cheese and watches, and therefore fewer francs. In Figure 15.2(b), let the demand for francs fall from Do to D2 • The market is initially in dise-

quilibrium because the quantity of francs supplied (40 francs) exceeds the quantity demanded (20 francs) at the exchange rate of $0.50 per franc. The excess supply of francs causes the exchange rate to fall from $0.50 to $0.45 per franc; the dollar thus appreciates against the franc, while the franc depreciates against the dollar. Market equilibrium is restored at the exchange rate of $0.45 per franc, at which the quantities of francs supplied and demanded are equal.

This example illustrates one argument in favor of floating rates: When the exchange rate is permitted to adjust freely in response to market forces, market equilibrium will be established at a point where the quantities of foreign exchange supplied and demanded are equal. If the exchange rate promotes market equilibrium, monetary authorities will not need international reserves for the purpose of intervening in the market to main-

rain exchange rates at their par value. Presumably, these resources can be used more productively elsewhere in the economy.

Trade Restrictions, Jobs, and

Floating Exchange Rates

During economic downturns, labor unions often lobby for import restrictions in order to save jobs for domestic workers. Do import restrictions lead to rising total employment in the economy?

As long as the United States maintains a floating exchange rate, the implementation of import restrictions to help one industry will gradually shift jobs from other industries in the economy to the protected industry, with no significant impact on aggregate employment. Short-run employment gains in the protected industry will be offset by long-run employment losses in other industries.

Suppose the United States increases tariffs on autos imported from Japan. This policy would reduce auto imports, causing a decrease in the U.S. demand for yen to pay for imported vehicles. With floating exchange rates, the yen would depreciate against the dollar (the dollar would appreciate against the yen) until balance in international transactions was attained. The change in the exchange rate would encourage Americans to purchase more goods from Japan and the Japanese to purchase fewer goods from the United States. Sales and jobs would therefore be lost in other U.S. industries. Trade restrictions thus result in a zero-sum game within the United States. Job increases in Detroit are offset by job decreases in Los Angeles and Portland, with exchange-rate changes imposing costs on unprotected workers in the U.S. economy.

Arguments for and Against Floating Rates

One advantage claimed for floating rates is their simplicity. Floating rates allegedly respond quickly to changing supply and demand conditions, clearing the market of shortages or surpluses of a given currency. Instead of having formal rules of conduct among central bankers governing exchange-rate movements, floating rates are market determined. They operate under simplified institutional arrangements that are relatively easy to enact.

Because floating rates fluctuate throughout the day, they permit continuous adjustment in the balance of payments. The adverse effects of prolonged disequilibriums that tend to occur under fixed exchange rates are minimized under floating rates. It is also argued that floating rates partially insulate the home economy from external forces. This means that governments will not have to restore payments equilibrium through painful inflationary or deflationary adjustment policies. Switching to floating rates frees a nation from having to adopt policies that perpetuate domestic disequilibrium as the price of maintaining a satisfactory balance-of-payments position. Nations thus have greater freedom to pursue policiesthat promote domestic balance than they do under fixed exchange rates.

Although there are strong arguments in favor of tloating exchange rates, this system is often considered to be of limited usefulness for bankers and businesspeople. Critics of floating rates maintain that an unregulated market may lead to wide fluctuations in currency values, discouraging foreign trade and investment. Although traders and investors may be able to hedge exchange-rate risk by dealing in the forward market, the cost of hedging may become prohibitively high.

Floating rates in theory are supposed to allow governments to set independent monetary and fiscal policies. But this flexibility may cause a problem of another sort: inflationary bias. Under a system of floating rates, monetary authorities may lack the financial discipline required by a fixed exchangerate system. Suppose a nation faces relatively high rates of inflation compared with the rest of the world. This domestic inflation will have no negative impact on the nation's trade balance under floating rates because its currency will automatically depreciate in the exchange market. However, a protracted depreciation of the currency would result in persistently increasing import prices and a rising price level, making inflation self-perpetuating and the depreciation continuous. Because there is greater freedom for domestic financial management under floating rates, there may be less resistance to overspending and to its subsequent pressure on wages and prices. Table 15.5 summarizes the advantages and disadvantages of floating exchange rates.

I Managed Floating Rates

The adoption of managed floating exchange rates by the United States and other industrial nations in 1973 followed the breakdown of the international monetary system based on fixed rates. Before the 1970s, only a handful of economists gave serious consideration to a general system of floating rates. Because of defects in the decision-

making process caused by procedural difficulties and political biases, however, adjustments of par values under the Bretton Woods system were often delayed and discontinuous. It was recognized that exchange rates should be adjusted more promptly and in small but continuous amounts in response to evolving market forces. In 1973, a managed floating system was adopted, under which informal guidelines were established

by the IMF for coordination of national exchange-rate policies.

The motivation for the formulation of guidelines for floating arose from two concerns. The first was that nations might intervene in the exchange markets to avoid exchange-rate alterations that would weaken their competitive position. When the United States suspended its gold-convertibility pledge and allowed its overvalued dollar to float in the exchange markets, it hoped that a free-market adjustment would result in a depreciation of the dollar against other, undervalued currencies. Rather than permitting a clean float (a market solution) to occur, foreign central banks refused to permit the dollar depreciation by intervening in the exchange market. The United States considered this a dirty float, because the free-market forces of supply and demand were not allowed to achieve their equilibrating role. A second motivation for guidelines was the concern that floats over time might lead to disorderly markets with erratic fluctuations in exchange rates. Such destabilizing activity could create an uncertain business climate and reduce the level of world trade.

Under managed floating, a nation can alter the degree to which it intervenes on the foreignexchange market. Heavier intervention moves the nation nearer the fixed exchange-rate case, whereas less intervention moves the nation nearer the floating exchange-rate case. Concerning day-to-day and week-to-week exchange-rate movements, a main objective of the floating guidelines has been to prevent the emergence of erratic fluctuations. Member nations should intervene on the foreign-exchange market as necessaryto prevent sharp and disruptive exchange-rate fluctuations from day to day and week to week. Such a policy is known as leaning against the wind-intervening to reduce short-term fluctuations in exchange rates without attempting to adhere to any particular rate over the long run. Members should also not act aggressively with respect to their currency exchange rates; that is, they should not enhance the value when it is appreciating or depress the value when it is depreciating.

Under the managed float, some nations choose target exchange rates and intervene to support them. Target exchange rates are intended to reflect long-term economic forces that underlie exchange-

rate movements. One way for managed floaters to estimate a target exchange rate is to follow statistical indicators that respond to the same economic forces as the exchange-rate trend. Then, when the values of indicators change, the exchange-rate target can be adjusted accordingly. Among these indicators are rates of inflation in different nations, levels of official foreign reserves, and persistent imbalances in international payments accounts. In practice, defining a target exchange rate can be difficult in a market based on volatile economic conditions.

Managed Floating Rates in

the Short Run and Long Run

Managed floating exchange rates attempt to combine market-determined exchange rates with foreign-exchange market intervention in order to take advantage of the best features of floating exchange rates and fixed exchange rates. Under a managed float, market intervention is used to stabilize exchange rates in the short run; in the long run, a managed float allows market forces to determine exchange rates.

Figure 15.3 on page 454 illustrates the theory of a managed float in a 2-country framework, Switzerland and the United States. The supply and demand schedules for francs are denoted by So and Do; the equilibrium exchange rate, at which the quantity of francs supplied equals the quantity demanded, is $0.50 per franc.

Suppose there occurs a permanent increase in U.S. real income, as a result of which u.s. residents demand additional francs to purchase more Swiss chocolate. Let the demand for francs rise from Do to D1, as shown in Figure 15.3(a). Because this increase in demand is the result of long-run market forces, a managed float permits supply and demand conditions to determine the exchange rate. With the increase in the demand for francs, the quantity of francs demanded (180 francs) exceeds the quantity supplied (100 francs) at the exchange rate of $0.50 per franc. The excess demand results in a rise in the exchange rate to $0.60 per franc, at which the quantity of francs supplied and the quantity demanded are equal. In this manner, long-run movements in

exchange rates are determined by the supply and demand for various currencies.

Figure 15.3(b) illustrates the case of a shortterm increase in the demand for francs. Suppose U.S. investors demand additional francs to finance purchases of Swiss securities, which pay relatively high interest rates; again, let the demand for francs rise from Do to D1. In a few weeks, suppose Swiss interest rates fall, causing the U.S. demand for francs to revert to its original level, Do. Under floating rates, the dollar price of the franc would rise from $0.50 per franc to $0.60 per franc and then fall back to $0.50 per franc. This type of exchange-rate irascibility is widely considered to be a disadvantage of floating rates because it leads to uncertainty regarding the profitability of international trade and financial transactions; as a result, the pattern of trade and finance may be disrupted.

Under managed floating rates, the response to this temporary disturbance is exchange-rate intervention by the Federal Reserve to keep the exchange rate at its long-term equilibrium level of

$0.50 per franc. During the time period in which demand is at D j , the central bank will sell francs to meet the excess demand. As soon as the disturbance is over, and demand reverts back to Do, exchange-market intervention will no longer be needed. In short, central bank intervention is used to offset temporary fluctuations in exchange rates that contribute to uncertainty in carrying out transactions in international trade and finance.

Since the advent of managed floating rates in 1973, the frequency and size of U.S. foreignexchange interventions have varied. Intervention was substantial from 1977 to 1979, when the dollar's exchange value was considered to be unacceptably low. U.S. stabilization operations were minimal during the Reagan Administration's first term, consistent with its goal of limiting government interference in markets; they were directed at offsetting short-run market disruptions. Intervention was again substantial in 1985, when the dollar's exchange value was deemed unacceptably high, hurting the competitiveness of U.S. producers. The most extensive u.s. intervention operations took

place after the Louvre Accord of 1987, when the major industrial nations reached informal understandings about the limits of tolerance for exchange-rate fluctuations.

Exchange-Rate Stabilization

and Monetary Policy

We have seen how central banks can buy and sell foreign currencies to stabilize their values under a system of managed floating exchange rates. Another stabilization technique involves a nation's monetary policy. As we shall see, stabilizing a currency's exchange value requires the central bank to adopt (1) an expansionary monetary policy to offset currency appreciation, and

(2) a contractionary monetary policy to offset currency depreciation.

Figure 15.4 illustrates the foreign-exchange market for the United States. Assume the supply schedule of British pounds is denoted by So and the demand schedule of pounds is denoted by Do. The equilibrium exchange rate, at which the quantity

Exchange-Rate Stabilization and Monetary Policy

of pounds supplied and the quantity demanded are equalized, is $2 per pound.

Suppose that as a result of production shutdowns in Britain, caused by labor strikes, U.S. residents purchase fewer British products and therefore demand fewer pounds. Let the demand for pounds decrease from Do to D 1 in Figure 15.4(a). In the absence of central-bank intervention, the dollar price of the pound falls from $2 to $1.80; the dollar thus appreciates against the pound.

To offset the appreciation of the dollar, the Federal Reserve can increase the supply of money in the United States, which will decrease domestic interest rates in the short run. The reduced interest rates will cause the foreign demand for U.S. securities to decline. Fewer pounds will thus be supplied to the foreign-exchange market to buy dollars with which to purchase U.S. securities. As the supply of pounds shifts leftward to S1' the dollar's exchange value reverts to $2 per pound. In this manner, the expansionary monetary policy has offset the dollar's appreciation.

456 Exchange-Rate Systems and Currency Crises

Referring now to Figure 15.4(b), suppose a temporary surge in British interest rates causes U.S. investors to demand additional pounds with which to purchase additional British securities. Let the demand for pounds rise from Do to Dj • In the absence of central-bank intervention, the dollar's exchange value would rise from $2 to $2.20 per pound; the dollar has depreciated against the pound.

To offset this dollar depreciation, the Federal Reserve can decrease the supply of money in the United States, which will increase domestic interest rates and attract British investment. More pounds will thus be supplied to the foreign-exchange market to purchase dollars with which to buy U.S. securities. As the supply of pounds increases from 50 to 5" the dollar's exchange value reverts to $2 per pound. The contractionary monetary policy thus helps offset the dollar depreciation.

These examples illustrate how domestic monetary policies can be used to stabilize currency values. Such policies are not without costs, however, as seen in the following example.

Suppose the U.S. government increases federal spending without a corresponding increase in taxes. To finance the resulting budget deficit, assume the government borrows funds from the money market, which raises domestic interest rates. High U.S. interest rates enhance the attractiveness of dollardenominated securities, leading to increased foreign purchases of these assets, an increased demand for dollars, and an appreciation in the dollar's exchange value. The appreciating dollar makes U.S. goods more expensive overseas and foreign goods less expensive in the United States, thus causing the U.S. trade account to fall into deficit.

Now suppose the Federal Reserve intervenes and adopts an expansionary monetary policy. The resulting increase in the supply of money dampens the rise in U.S. interest rates and the dollar's appreciation. By restraining the increase in the dollar's exchange value, the expansionary monetary policy enhances the competitiveness of U.S. businesses and keeps the U.S. trade account in balance.

However, the favorable effects of the expansionary monetary policy on the domestic economy are temporary. When pursued indefinitely (over the long run), a policy of increasing the domestic money supply leads to a weakening in the U.S.

trade position, because the monetary expansion required to offset the dollar's appreciation eventually promotes higher prices in the United States. The higher prices of domestic goods offset the benefits to U.S. competitiveness that initially occur under the monetary expansion. Ll.S, spending eventually shifts back to foreign products and away from domestically produced goods, causing the U.S. trade account to fall into deficit.

This example shows how monetary policy can be used to stabilize the dollar's exchange value in the short run. But when monetary expansion occurs on a sustained, long-run basis, it brings with it eventual price increases that nullify the initial gains in domestic competitiveness. The long-run effectiveness of using monetary policy to stabilize the dollar's exchange value is limited, because the increase in the money supply to offset the dollar's appreciation does not permanently correct the underlying cause of the trade deficit-the increase in domestic spending.

Attempting to stabilize both the domestic economy and the dollar's exchange value can be difficult for the Federal Reserve. In early 1995, for example, the dollar was taking a nosedive against the yen, and the u.s. economy showed signs of slowing. To boost the dollar's exchange value would have required the Federal Reserve to adopt a restrictive monetary policy, which would have led to higher interest rates and net investment inflows. However, further increases in domestic interest rates would heighten the danger that the U.S. economy would be pushed into a recession by the next year. The Federal Reserve thus had to choose between supporting domestic economic expansion or the dollar's exchange value. In this case, the Federal Reserve adopted a policy of lower interest rates, thus appearing to respond to U.S. domestic needs.

Is Exchange-Rate

Stabilization Effective?

Many governments have intervened on foreignexchange markets to try to dampen volatility and to slow or reverse currency movements. 1 Their

'This section is drawn !rom Michael Hutchinson, "Is Official Foreign

Exchange Intervention Effective?" Economic Letter, Federal Reserve Bank of San Francisco, July 18,2003,

concern is that excessive short-term volatility and longer-term swings in exchange rates that "overshoot" values justified by fundamental conditions may hurt their economies, particularly sectors heavily involved in international trade. And, the foreign-exchange market can be volatile. For example, one euro cost about $1.15 in January 1999, then dropped to $0.85 by the end of 2000, only to climb to over $1.18 in June 2003. Over this same period, one U.S. dollar bought as much as 133 yen and as little as 102 yen, a 30 percent fluctuation. Many other currencies have also experienced similarly large price swings in recent years.

Many central banks intervene in foreignexchange markets. The largest player is japan. Between 1991 and 2000, for example, the Bank of japan bought u.s. dollars on 168 occasions for a cumulative amount of $304 billionand sold u.s. dollars on 33 occasions for a cumulative amount of $38 billion. A typical case: On April 3, 2000, the Bank of japan purchased $13.2 billion in the foreignexchange market in an attempt to stop the more than 4 percent depreciation of the dollar against the yen that had occurred during the previous week. japan's intervention magnitudes dwarf all other countries' official intervention in the foreignexchange market. For example, it exceeded u.s. intervention in the 1991-2000 period by a factor of more than 30. However, compared to overall market transactions in the foreign-exchange market, the magnitude of japan's interventions has been quite small.

Not surprisingly, intervention supported by central-bank interest-rate changes tends to have an even larger impact on exchange rates than intervention alone. Moreover, cases where intervention was coordinated between two central banks , such as the Federal Reserve and the Bank of japan, had a larger impact on exchange rates than unilateral foreign-exchange operations. However, episodes of coordinated intervention are rather rare.

Academic researchers have often questioned the usefulness of official foreign-exchange intervention. However, proponents of foreign-exchange intervention note that it may be useful when the exchange rate is under speculative attack-that is, when a change in the exchange rate is not justified by fundamentals. It may also be helpful in coordi-

nating private-sector expectations. Recent research provides some support for the short-run effectiveness of intervention. However, this should not be interpreted as a rationale for intervention as a longer-term management tool.'

I The Crawling Peg

Instead of adopting fixed or floating rates, why not try a compromise approach, the crawling peg. This syste~n has been used by nations including Bolivia, Brazil, Costa Rica, Nicaragua, Solomon Islands, and Peru. The crawling-peg system means that a nation makes small, frequent changes in the par value of its currency to correct balance-of-payments disequilibriums. Deficit and surplus nations both keep adjusting until the desired exchange-rate level is attained. The term crawling peg implies that parvalue changes are implemented in a large number of small steps, making the process of exchange-rate adjustment continuous for all practical purposes. The peg thus crawls from one par value to another.

The crawling-peg mechanism has been used primarily by nations having high inflation rates. Some developing nations, mostly South American, have recognized that a pegging system can operate i~ ~n inflationary environment only if there is pro- vision for frequent changes in the par values. Associating national inflation rates with international competitiveness, these nations have generally us~d price indicators as a basis for adjusting crawling pegged rates. In these nations, the primary concern is the criterion that governs exchange-rate movements, rather than the currency or basket of currencies against which the peg is defined.

The crawling peg differs from the system of adjustable pegged rates. Under the adjustable peg, currencies are tied to a par value that changes infrequently (perhaps once every several years) but suddenly, usually in large jumps. The idea behind the crawling peg is that a nation can make small, frequent changes in par values, perhaps several times a year, so that they creep along slowly in response to evolving market conditions.

'Michael Hutchinson, "Intervention and Exchange Rate Stabilization Policy in Developing Countries," International Finance 6,

2003, Pl'. 41-59.

458 Exchange-Rate Systems and Currency Crises

Supporters of the crawling peg argue that the system combines the flexibility of floating rates with the stability usually associated with fixed rates. They contend that a system providing continuous, steady adjustments is more responsive to changing competitive conditions and avoids a main problem of adjustable pegged rates-that changes in par values are frequently wide of the mark. Moreover, small, frequent changes in par values made at random intervals frustrate speculators with their irregularity.

In recent years, the crawling-peg formula has been used by developing nations facing rapid and persistent inflation. However, the IMF has generally contended that such a system would not be in the best interests of nations such as the United States or Germany, which bear the responsibility for international currency levels. The IMF has felt that it would be hard to apply such a system to the industrialized nations, whose currencies serve as a source of international liquidity. Although even the most ardent proponents of the crawling peg admit that the time for its widespread adoption has not yet come, the debate over its potential merits is bound to continue.

I Currency Crises

A shortcoming of the international monetary system is that major currency crises have been a common occurrence in recent years. A currency crisis, also called a speculative attack, is a situation in which a weak currency experiences heavy selling pressure. There are several possible indications of selling pressure. One is sizable losses in the foreign reservesheld by a country's central bank. Another is depreciating exchange rates in the forward market, where buyers and sellers promise to exchange currency at some future date rather than immediately. Finally, in extreme cases where inflation is running rampant,

selling pressure consists of widespread flight out of domestic currency into foreign currency or into goods that people think will retain value, such as gold or real estate.

Experience shows that currency crises can decrease the growth of a country's gross domestic product by

6 percent, or more. That is like losing one or two years of economic growth in most countries. Table 15.6 provides examples of currency crises.

A currency crisis ends when selling pressure stops. One way to end pressure is to devalue; that is, establish a new exchange rate at a sufficiently depreciated level. For example, Mexico's central bank might stop exchanging pesos for dollars at the previous rate of 10 pesos per dollar and set a new level of 20 pesos per dollar. Another way to end selling pressure is to adopt a floating exchange rate. Floating permits the exchange rate to "find its own level," which is almost always depreciated compared to the previous pegged rate. Devaluation and allowing depreciation make foreign currency and foreign goods more costly in terms of domestic currency, which tends to decrease demand for foreign currency, ending the imbalance that triggered selling pressure. However, in some cases, especially when confidence in the currency is low, the crisis continues, and further rounds of devaluation or depreciation occur.

Currency crises that end in devaluations or accelerated depreciations are sometimes called currency crashes. Not all crises end in crashes. A way of trying to end the selling pressure of a crisis without suffering a crash is to impose restrictions on the ability of people to buy and sell foreign currency. These controls, however, create profit opportunities for people who discover how to evade them, so over time controls lose effectiveness unless enforced by an intrusive bureaucracy. Another way to end selling pressure is to obtain a loan to bolster the foreign reserves of the monetary authority. Countries that wish to bolster their foreign reserves often ask the IMF for loans. Although the loan can help temporarily, it may just delay rather than end selling pressure. The final way to end selling pressure is to restore confidence in the existing exchange rate, such as by announcing appropriate and credible changes in monetary policy.

Sources of Currency Crises

Why do currency crises occur?' A popular explanation is that big currency speculators instigate the

'Kurt Schuler, VVhJi Currency Crises }-f,lppen, Joint Economic

Committee, U.S. Congress, January 2002.