![]() ![]() Historically, though, the strategy has led to high average returns. Since exchange rates can move quickly and sharply, the carry trade entails a significant amount of risk. Thus, the investor speculates that the exchange rate will not move adversely enough to undo the positive returns from the spread in interest rates. At the end of the investment horizon, the investor converts the proceeds back to the original funding currency to close the transaction. In a carry trade, an investor borrows money in a low interest rate currency and uses the borrowed funds to purchase assets denominated in the currency of a country with high interest rates. According to this view, persistent differences in interest rates arise because of the riskiness of “carry trades.” dollar through the lens of research that has recently emerged in international finance. We evaluate the effects of a renminbi peg to a basket of currencies instead of the U.S. Recent insights from international finance Here we focus on one channel, the variance of the exchange rate between the two currencies, through which China’s choice of exchange rate regime affects U.S. Since China is the largest trade partner of the United States and the renminbi is a frequent topic in policy discussions, it is important to consider the effects of changes in the PBOC’s policies. Over the same period, China loosened its capital controls to make the renminbi more attractive for inclusion in the IMF’s Special Drawing Rights, an effort that succeeded in late November 2015. dollars to satisfy the excess demand and thus prevent the appreciation of its currency. ![]() To avoid this unwanted appreciation, the PBOC needed to sell renminbi for U.S. For example, if the PBOC had not intervened during times of excess global demand, market forces would have pushed the renminbi to a higher valuation than China’s exchange rate policy mandated. dollar, the PBOC had to intervene in foreign exchange markets. dollar daily onshore/offshore exchange rates The volatility of its value subsequently increased as the PBOC abandoned its stabilization relative to the dollar. ![]() One can see that exchange rates were stable during the so-called hard peg from 2003 to 2005 the renminbi gradually appreciated from 2005 to 2008 the currencies were repegged between 20. dollar exchange rate since 2003, with vertical lines indicating changes in China’s policy. dollar to one in which the flexibility is limited relative to a group or “basket” of currencies.įigure 1 shows the RMB-U.S. In 2016, the IMF changed China’s classification from an arrangement in which the flexibility of the renminbi is limited vis-à-vis the U.S. In 2015, the China Foreign Exchange Trade System (CFETS), a division of the PBOC, published an exchange rate index of 13 currencies in an effort to shift markets away from interpreting renminbi exchange rate movements as being driven only by its connection to the U.S. In 2010, the policy changed to a “crawl-like arrangement” relative to the U.S. dollar and between 20, it was stabilized relative to the dollar. dollar from 2003 to 2005 from 2006 to 2008, the renminbi was allowed to gradually appreciate under a policy classified as a crawling peg to the U.S. The IMF reports that the policy of the People’s Bank of China (PBOC), the country’s central bank, was classified as a conventional peg to the U.S. China’s foreign exchange policiesĪccording to the International Monetary Fund’s annual reports on exchange arrangements (IMF 2016 and various years), China has changed its foreign exchange policy repeatedly over the past decades. dollar peg to a peg relative to a basket of currencies increases China’s interest rates while decreasing U.S. In this Economic Letter, we use this framework to analyze a decoupling of the renminbi (RMB) from the U.S. Furthermore, if the country removing the peg has market power, its decision can affect the risk associated with holding either of the currencies involved. If a country removes this so-called peg to a safer currency, recent research suggests it will increase the risk and reduce the attractiveness of its currency to investors. Many countries stabilize their exchange rate relative to some target currency. dollar to a basket of currencies suggests that China’s interest rates increase while U.S. Analyzing the effects of a scenario that changes a peg of the renminbi from the U.S. When a country with market influence removes its peg from a safer country, the risk associated with holding either currency can be affected. Removing a peg to a safer currency can make the home currency more risky and less attractive to investors. Exchange rate stabilization or currency “pegs” are among the most prevalent interventions in international financial markets. ![]()
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