International Trade & Banking - Essay Example

International Trade & Banking International Bank Management by 29 August International Trade & Banking International Bank Management Introduction What role central banks play under various exchange rate regimes has long been a matter of professional debate. Much has been written and said about the benefits and drawbacks of various exchange rate systems. The role of central banks in emerging and developed economies has been explored in abundance. However, new research and the changing realities of life shift the role of central banks in national and international economies. The fixed vs. volatile exchange rate dichotomy is no longer relevant. Globalization and financial liberalization impose new demands on central banks. Whatever the type of exchange rate regime countries choose, under the pressure of globalization central banks strive to preserve and strengthen their independence, governed by market-based forces and pressured to enhance financial stability at the national level. The changing role of central banks in various exchange rate regimes in conditions of globalization What exchange rate regime to choose has long been a matter of governments’ concern. For many years, national and international financial systems have been dominated by a long-standing fixed vs. volatile exchange rate systems dichotomy. At the very basic level, choosing an exchange rate regime is the same as choosing a monetary policy and its direction (Stockman 2000). In this sense, central banks are expected to develop and implement the exchange rate policy that responds to the specific financial demands of home countries. In fixed exchange rate systems, the role of central banks is minimal, since money supply and demand adjust automatically and do not require changes in interest rates or other financial indicators (Stockman 2000). By contrast, in floating exchange rate systems central banks play the major role, by managing short-run disruptions that usually follow real monetary shocks (Stockman 2000). In both systems, central banks fulfill three principal functions: (1) maintain price stability with the help of the instruments appropriate under the given exchange rate regime; (2) foster the development of financial institutions and maintain financial stability; and (3) help the government to meet its financial needs at times of crises (Bebchuk & Spamann 2010; Eichengreen & Bordo 2003). Even the choice of the monetary policy and exchange rate regime depends upon and aims at maintaining financial stability and fostering financial growth at a national scale. Yet, everything changes, and central banks are not secured from the powerful influence of globalization. To begin with, globalization changes the long-standing floating vs. fixed exchange rate dichotomy. The bipolar view of exchange rate systems is no relevant for several reasons. First, many countries claim to have floating exchange rate regimes, whereas, in reality, keep affecting monetary mass behaviors through interest rate regulation and intervention policies (Fischer 2001). Second, as the borders between states are gradually disappearing, so are the boundaries between various exchange rate systems. Globalization and evolution give rise to new, alternative exchange rate regimes, led by a rapid increase in financial floats and global crises (Levy-Yeyati & Sturzenegger 2005). As a result, central banks’ roles vary significantly across countries, markets, and financial systems. Simultaneously, several important trends are noteworthy. It would be noted, that globalization by itself is a very vague term. According to Mishkin (2006), globalization is essentially about economic integration, which implies the opening up of national economies to external inflow of goods, services, capital, and business. Contrary to earlier beliefs, globalization is hardly a new phenomenon, dating back to the end of the 19th century and the age of industrialization (Mishkin 2006). “The globalization system, unlike the Cold War system, is not static, but a dynamic ongoing process: globalization involves integration of markets, nation-states and technologies to a degree never witnessed before — in a way that is enabling individuals, corporations and nation-states to reach around the world farther, faster, deeper and cheaper than ever before, and in a way that is also producing a powerful backlash from those brutalized or left behind by this new system” (Friedman, 1999, pp. 7-8). Yet, even today it is too early to say that globalization has achieved its peak. Central banks are still in their way but far from achieving real financial globalization. The latter presupposes having a single global currency and a single global financial authority (Arestis, Basu & Mallick 2005). According to Way (2000), “independent central banks produce sharply lower inflation rates where Left cabinets are prevalent but at a cost of increasing unemployment” (Way, 2000). In the absence of financial stability and global financial homogeneity, central banks acquire a new role of adjusting their decisions and exchange rates policies to the needs of the international financial community, including the issues of currency convertibility and access to financial resources. More often than not, central banks will have to apply a degree of creativity, to create and impose the exchange rate regime that meets the government’s monetary needs. Globalization is invariably associated with the decline in real output volatility and, simultaneously, increased volatility of asset prices (Rogoff 2006). In these highly unstable financial environments, the best central banks can do is to learn – and continuous learning is slowly turning into the main factor of financial success. Regardless of the exchange rate regime in which central banks operate, their striving to greater independence has already become an essential ingredient of financial globalization. Central do not merely “insure that frameworks and institutions are robust to the risk of an eventual slowing down or reversal of some of the favorable factors” (Laxton & Pesenti 2003, p.1112). Rather, in the atmosphere of globalization which exerts numerous coercive and mimetic pressures on states, central banks are willing to separate themselves from the executive branch and exercise greater freedom of decision and policy-making (Polillo & Guillen 2004). That does not mean that the state as the main monetary policymakers loses its power; rather, globalization causes profound shifts in how various state forces are organized. In this complex environment, executive branches are losing power and trust in financial decisions, giving central banks freedom and flexibility in determining and managing exchange rate regimes. Conclusion Why the role of central banks in the global financial system changes is not difficult to see: globalization is the trend that affects all aspects of national and international financial performance. In this situation, central banks are becoming extremely susceptible to changes in the international financial conjuncture and, simultaneously, have to adjust to new conditions of taking financial decisions at a global scale. According to Grilli, Masciandaro, and Tabellini (1991), “the main virtue of having an independent central bank is that it can provide credibility” (Grilli et al, 1991). Much has been written and said about the benefits and drawbacks of various exchange rate systems. For many years, national and international financial systems have been dominated by a long-standing fixed vs. volatile exchange rate systems dichotomy. In the absence of financial stability and global financial homogeneity, central banks acquire a new role of adjusting their decisions and exchange rates policies to the needs of the international financial community, including the issues of currency convertibility and access to financial resources. Whatever the type of exchange rate regime countries choose, under the pressure of globalization central banks strive to preserve and strengthen their independence, governed by market-based forces and pressured to enhance financial stability at the national level. These changes have far-reaching implications for the future of the global financial system and imply that, with the growing independence of central banks, financial institutions will have to restructure themselves, to meet new demands of the global financial reality. References Arestis, P, Basu, S & Mallick, S 2005, ‘Financial globalization: The need for a single currency and a global central bank’, Journal of Post Keynesian Economics, vol.27, no.3, pp.507-532. Bebchuk, LA & Spamann, H 2010, ‘Regulating bankers’ pay’, Georgetown Law Journal, vol.98, no.2, pp.247-287. Calvo, GA & Mishkin, FS 2003, ‘The mirage of exchange rate regimes for emerging market countries’, The Journal of Economic Perspectives, vol.17, no.4, pp.99-118. Eichengreen, B & Bordo, M 2003, ‘Crisis now and then: What lessons from the last era of financial globalization’, in P Mizen (ed), Monetary history, exchange rates and financial markets: Essays in honor of Charles Goodhart, UK: Edward Elgar, pp.52-91. 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