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101 Concepts for the Level I Exam

Concept 36: Exchange Rate Regimes

Exchange rate regimes for countries that do not have their own currency:

  • Formal dollarization: A country uses the currency of another currency, typically the US dollar.
  • Monetary Union: Several countries use a common currency.

Exchange rate regimes for countries that have their own currency:

  • Currency board system: An explicit commitment to exchange domestic currency for a specified foreign currency at a fixed exchange rate.
  • Fixed parity: A country pegs its currency within margins of 1% vs. another currency.
  • Target zone: Like fixed parity but with wider bands (+/- 2%); gives monetary authority more flexibility.
  • Crawling peg: Exchange rate is adjusted periodically, typically to adjust for higher inflation versus the currency used in the peg.
  • Managed float: Monetary authority attempts to influence the exchange rate in response to specific indicators – balance of payments, inflation rates, or employment – without any specific target exchange rate.
  • Independently float: Exchange rate is entirely market-driven.

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