International Financial Management Essay Example | Topics and Well Written Essays - 3000 words - 1

International Financial Management - Essay Example The basic types of exchange rate regimes are the fixed exchange rate and the floating exchange rate. In the latter case the market decides the movements of the exchange rate. Exchange rate volatility is a common denominator of a country's exposure to international risk through foreign transactions, whether international trade or investment (Madura, 2009). The higher the degree of exposure the higher the degree of risk associated with such exposure. Thus the exchange rate can be considered as an important indicator in monetary policy and it mainly depends on the monetary policy framework of a particular country. Exchange rate can be identified as a target for particular government's policy and that it can actively manage with the other components of a monetary policy such as inflation, balance of payments and so on. For instance the changes in exchange rate in a short term can impact on the real economy and the balance of payments and in the long term those effects can be adjusted with the exchange rate movements. Therefore developing countries that depend on commodity exports to a greater extent are more likely to face a greater degree of risk due to the fact that commodity prices in international markets are subject to huge fluctuations. As a result their currencies against those of advanced industrialized economies are weaker. Even the well developed countries especially UK has been faced with this reality but their ability to manipulate exchange rates in international markets is considerably higher when compared to those developing countries (Wheele, 1995). 2. Literature ReviewCurrently available literature on the subject of exchange rate regime and related price stabilization policy in a modern economy has both a theoretical approach and a broader empirical approach. Price stabilization policy refers to a government macroeconomic strategy designed and executed by the central bank to ensure stable economic growth based primarily on stable prices and lower unemployment levels. This is a contingency macroeconomic model that presupposes a smoothing out effect on erratic fluctuations in aggregate supply. Alogoskoufis (1992) shows that the broader policy level approach includes monitoring and adjusting cyclical growth process and interest rates so that aggregate demand can be managed to achieve broader macroeconomic policy goals.This