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…………………………. UNIVERSITY OF YAOUNDE II SOA
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ASIGNMENT OF POLITIQUE DE CHANGE

TPE ON: the functioning of the exchange rate regime, efficacy of devaluation
PRESENTATION ON: the European monetary system

Done by: NJI MENKA LIONELLE

Matricle : 13E556A

Academic year 2019/2020

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 (TPE) THE EFFICACY OF DEVALUATION

Devaluation is depreciation under a fixed regime of exchange rate. Depreciation is a decrease

in the value of a currency relative to another, resulting from a decrease in demand for the
currency or an increase in the supply of the currency on the forex market.
Efficacy is the ability to produce a desired result or objective.
The objective of devaluation of a country is to reestablish the equilibrium of external commerce.
The decrease in the exchange rate will lead to an increase in the volume of price.
In the short run, devaluation will worsen the commercial deficit, prices of importation increase
while the purchasing power of exportation decrease. This is the price effect.
Devaluation contributes to reduce the commercial balance deficit, imported products become
more expensive while exported product become cheaper.
In a general manner a devaluation increases cost for the importer, the variation in exchange rate
equally affect exportation. The variation in the export and import prices are therefore the
consequence of external balance. It is easier to export at lower prices and to support a laser cost
if the cost of importation decreases. Devaluation of a national currency is a source of
competition for the country, this has a cost which is enrichment of imported goods and services.
A continuous devaluation of a national currency will lead to an amelioration of the commercial
balance when the decrease in the price of importation permit an increase of this exports and a
negative price effect is released on imports. This is possible in long run in condition that the
exporting enterprise be able to rapidly respond to the increase in supply knowing that imports
are immediately affected by depreciation or the quantity of the currency. That is a decrease in
the value of money will cause an external deficit at short term. But the increase in export caused
by the devaluation will thereby compensate the economic incidence of an increase in the value
of imported goods and services. Therefore, a devaluation of a currency can lead to the
amelioration of the external balance. But this is not certain. The exchange of a currency serves
mostly a render exchange possible.

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 (TPE) The functioning of the exchange regime

An exchange rate regime is the way a monetary authority of a country or a currency union
manages the currency in relation to other currencies and foreign exchange market. There exist
fixed exchange rate regimes, where the currency is tied to another currency such as the US
dollar or the euro and other basket of currencies. Equally floating exchange rate regime where
the economy dictates the movements in the exchange rate. There are equally intermediate
exchange rate regimes that combines elements of the other regimes.
Fixed exchange regime
A pegged exchange regime is one in which the monetary authority pegs its currency’s exchange
rate to another currency, and may allow the rate to fluctuate within a narrow range. To maintain
the exchange rate within the range, the monetary authority usually intervenes in the foreign
exchange market. A movement in the peg rate is called revaluation or devaluation.
Currency board is an exchange rate regime where a country’s exchange rate maintains a
fixed regime with a foreign currency based on an explicit legislative commitment. This type of
fixed regime has a special legal and procedural rule designed to make the peg durable.
Dollarization (currency substitution) is when a country unilaterally adopts the currency of
another country.
Currency union is an exchange regime where two or more countries use the same
currency. There is a transnational structure such as a single central bank or monetary authority
that is accountable to the member states.
Floating exchange rate regime
A flexible exchange rate regime is one in which a country’s exchange rate fluctuate in a wider
range and the monetary authority makes no attempt to fix it against any base currency. A
movement in the exchange rate is called appreciation or depreciation.
Free float (clean float) implies the value of the currency is allowed to fluctuate in response
to foreign exchange market mechanism without government intervention.
Managed float (dirty float) implies government intervenes in the exchange market in
different forms and degrees, in an attempt to make the exchange rate change in a direction
conducive to the economic development of the country during extreme appreciation or
depreciation.
Intermediate rate regime
It is between fixed and flexible regime
Band is when there is a tiny variation around the fixed exchange rate against another
currency, within +/-2%
Crawling peg is when a currency steadily depreciates or appreciate at an almost constant
rate against another currency, with the exchange rate following a simple trend.
Crawling band is when some variation about the rate is allowed, and adjusted as above.

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 Currency basket peg is commonly used to minimize the risk of currency fluctuation.
Most developing countries choose the floating exchange rate regime because policy
requirements for maintaining a pegged exchange rate can be very demanding in circumstances
of high international capital mobility. These regimes appear to have been helpful in handling a
variety of economic shocks, including the pressure of recent crises, thereby providing evidence
that floating rates are often the most workable regimes for many emerging market countries.
For floating rate regime to function effectively, it is important that the exchange rate move in
both directions in response to market forces, sometimes by significant amounts in short periods.
For emerging market countries that are generally quite open to international trade as well as to
global finance, movements in exchange rates have important economic consequences, and it is
often appropriate for economic policies, including monetary policies and official exchange
market intervention, to take account of and react to exchange rate developments.
Some emerging markets prefer pegged exchange rate regimes and their required supporting
policies and institution can be workable, despite substantial involvement with global financial
markets. These countries have put in place the policies and institutions needed to support a
pegged exchange rate, have established the credibility of policies and institutions. a pegged
exchange rate regime that is adopted (de jure or de facto) when conditions are favorable, but
without adequate policy commitment and institutional foundation, can become an invitation to
costly crisis when conditions turn less favorable. However, if monetary policy can maintain
reasonable discipline, then pegged exchange rate regimes (or bands or crawling pegs or
crawling bands) can be viable for extended periods; and, if adjustments are undertaken in a
timely manner, they need not be associated with costly crises. Countries may turn to pegged
exchange rate to stabilize their economies from high inflation. The main challenge in these
endeavors is to recognize that while an exchange rate peg initially may be very useful in the
stabilization effort, the exchange rate peg (or crawling peg or band) may not be sustainable in
the longer term.

(TPE) The effects of devaluation

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Devaluation is depreciation under a fixed regime of exchange rate.
Depreciation is a decrease in the value of a currency relative to another, resulting from a
decrease in demand for the currency or an increase in the supply of the currency on the forex
market.
The main effects of devaluation are : export are cheaper to foreign custormers,imports are
more expensive . in short term, devaluation tends to cause inflation, higher growth and
increased demand exports.
Cheaper export
The devaluation of exchange rate will make exports more competitive and appear cheaper to
foreigners.
Import more expensive
A devaluation will lead to products such as petrol, food and raw materials to become more
expensive. This will reduce the demand for imports
Increased aggregate demand
A devaluation could cause higher economic growth. Part of aggregate demand(export-import)
lead to higher export and lower import thereby increasing aggregate demand.
Inflation
Devaluation will lead to inflation since imports are more expensive causing cost push
inflation, aggregate demand increase leads to demand pull inflation and since export become
cheaper, manufacturers may have less incentive to cut costs and become more efficient
leading to increased cost.
Improvement in the current account
Since export are more competitive and imports more expensive, there will be higher export
and lower imports which will reduce the current account deficit.
Real Wages fall
In a period of stagnant wage growth devaluation can cause a fall in real wages since
devaluation cause inflation but the rate of inflation is higher than wage increase, then real
wage will fall.
The effects of devaluation depends on;
Elasticity of demand for exports and imports. If demand is price inelastic, a fall in price of
export will lead to a small rise in quantity. Therefore, the value of exports may actually fall.
The demand for export of the devaluing country and the demand for foreign products should
be elastic. If the demand is inelastic, it is not likely to remove the BOP deficit rather the BOP
will worsen.

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State of the global economy: if the global economy is in recession, a devaluation may be
insufficient to boost export demand. If growth is strong, there will be a greater increase in
demand. However, in a boom a devaluation is likely to exacerbate inflation.
Inflation: it will depend on factors such as; the spare capacity in an economy import prices are
not the only determinant of inflation, other factors such as wage increase may be important.
It depends on why the currency is being devalued: if it is due to a loss of competitiveness,
then a devaluation can help to restore competitiveness and economic growth. If the
devaluation is to meet a certain exchange rate target, the devaluation may be inappropriate for
the economy.
Thus, devaluation helps in improving the balance of payment deficit through promoting
exports and restriction of imports

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 A presentation on the European monetary system(EMS)

Definition
It was an arrangement between European countries to link their currencies. The goal was to
stabilize inflation and stop large exchange rate fluctuation between these neighboring nations,
making it easy for them to trade goods with each other.
It was created on 13 March 1979 after 13 months of negotiation. It had as objective to
stabilize European currency.it was established under the Jenkins European commission.
After the demise of the Bretton Woods system in 1971, most countries of the EEC in 1972
agreed to maintain stable exchange rates by preventing exchange rate fluctuations of more
than 2.25%(the (European currency snake). in March 1979, this system was replaced by the
European monetary system and the European currency unit(ECU) was defined.
The basic elements of the arrangement were
❖ The ECU: here member currencies agreed to keep their foreign exchange rates
between +/- 2.25% and +/-6%.
❖ An exchange rate mechanism(ERM)
❖ An extension of European credit facilities
❖ The European monetary fund.
The Deutsch mark and the German Bundesbank emerged as the center of the EMS because of
its relative strength, the low inflation policies of the bank. thus all other currencies were
forced to follow the lead if they wanted to remain in the system. This lead to dissatisfaction in
most countries leading to one of the forces behind the drive to a monetary union (ultimately
euro)
Understanding the European monetary system
European countries were trading long before the introduction of 19th century monetary
standards such as the Gold standard. The adoption of this standard (fixed interest rate) added
to the industrial revolution period of great technological innovation, resulted in an
unprecedent increase in trade and economic transactions between states in the 1800s. The first
world war and the ensuring deterioration in the political and economic environment on the
European continent during the interwar period- economic stagnation, inefficient allocation of
resources which were challenged to the preparation of a conflict, ‘beggar-thy-neighbor’
policies manifested through currencies devaluation and protectionist measures led to the end
of the Gold standard and the signature of the Bretton wood arrangement in 1994.
According to Michele Chang, the Bretton woods system was based on the idea that
international economic transactions should be promoted through free trade and fixed
exchange rates. The great error of the Breton wood system was the institution of a world
monetary order which developed into a system with absolute lack of symmetry in the
adjustment requirement of the key currency country, the USA, and the rest of the world. With
the benefit of hindsight, one can say that the constructors of the Bretton Woods system
overlooked the implications for the system of the natural key currency role of the US dollar.
When it was abandoned in the 1970’s, currency began to float making the members of the

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European community to seek for new exchange rate agreement to complement their customs
union.
. Pierre Werner presented a report on the process to achieve economic and monetary union
within ten periods to the EEC on 8 October 1970. The integration strategy outlined in his
report was based on the assumption that exchange rates to the US dollars would remain stable.
The first of the three recommended steps involved the coordination of economic policies and
a reduction in fluctuation between European currencies. With the failure of the Bretton woods
system with the Nixon shock in 1971, the Smithsonian Agreement set bands of +/-2.25% for
currencies to move relative to their central rate against the US dollar. This provided a tunnel
within which European currencies could trade. However, it implied much larger bands in
which they could move against each other.

It was created after the collapse of the Bretton woods (with the Nixon shock 1971 )agreement
formed after the world war II the Bretton woods agreement established an adjustable fixed
foreign exchange rate to stabilize economies The founders of the European monetary system
had twofold objective;
From the external point of view the ESM was supposed to be a constructive contribution to
the creation of a viable international monetary system,
In the internal point of view, their intension was to insulate roughly half of the foreign trade
of the participating countries from the serious result of exchange volatility. Over 40% of
German foreign trade is transacted with countries participating in the EMS, and this trade was
to be spared the disintegrative effects of pronounced exchange rate fluctuations.
In 1993, most European community members signed the Maastricht treaty establishing the
European union(EU) they created the European monetary institute which later became the
European central bank(ECB).
At the end of 1998 most EU nations cut their interest rates to promote economic growth and
prepare for the implementation of euro which was born in 1999.
On 24 April 1972, EEC central-bank governors concluded the Basel Agreement creating a
mechanism called ‘the snake in the tunnel’ which was the first attempt of the monetary
cooperation in the 70’s aiming at limiting fluctuation between different European currencies.
Under this mechanisms , member states’ currencies could float (like a snake) within narrow
limits against the dollar (the tunnel) .It was an attempt at creating a single currency band for
the European Economic Community (EEC),essentially pegging all the EEC currencies to one
another The EEC members established a snake in the tunnel with bilateral margins between
their currencies limited to 2.25%, implying a maximum change between any two currencies
of 4.5%,and with all the currencies tending to move together against the dollar. This
agreement also led to the formal end of the sterling area. The tunnel collapsed in 1973 when
the US dollar floated freely. The snake proved unsustainable, with several currencies leaving
and some joining. By 1973, it had become a deutsche mark zone with just the Belgian and
Luxembourg franc, the Dutch guilder and the Danish krone tracking it.The Werner plan was
abandoned.

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The first oil crisis in 1973, weak compliance and frequent departure of members led to failure
of the ‘snake mechanism’. A new proposal for monetary union was proposed by Roy Jenkins
but was made with sceptics.
The European monetary system followed the “snake” as a system for monetary coordination
in the EEC.
Criticism of the European monetary system
In the European monetary system, exchange rates could only be changed if both member
countries and the European commission agreed. This attracted a lot of criticism.
With the economic crisis of 2008/2009, significant problems in the fundamental European
monetary system policy became evident.
In the beginning, the European monetary system policy intentionally prohibited bailouts to
ailing economies in the eurozone. With vocal reluctance from EU members with stronger
economies, the EMU finally established bailout measure to provide relief to struggling
peripheral member.
Conclusion
The European monetary system was created to stabilize the European economies and to fight
against high inflation. This system functioned well to a certain level but later on closed down
for all the members were not satisfied of the outcomes and wished for a European union.