Mercury Athletic Essay example

1085 Words Feb 27th, 2011 5 Pages
Examine the connection and the differences between the official exchange rate market controlled by the CADIVI and the permuta. Discuss the states of equilibrium in each of these markets. Central banks intervene in foreign exchange markets in order to achieve a variety of overall economic objectives, such as controlling inflation, maintaining competitiveness or maintaining financial stability. The precise objectives of policy and how they are reflected in foreign exchange market intervention depend on a number of factors, including the stage of a country‟s development, the degree of financial market development and integration, and a country‟s overall vulnerability to shocks. The precise definition of which operations in forex markets …show more content…
Effectively, this would decrease the supply of Bolivares, and create an inward shift in supply (fig. 2). This would be how

equilibrium is reached in the fixed rate market. It would also justify the falling foreign exchange reserves in Venezuela.

Fig. 1 Fixed vs Free Floating Currency Market

Fig. 2 Equilibrium in a Fixed Currency Market

Another reason for the decrease in reserves is the fact that Venezuelan exports would be artificially high, and imports cheaper. There would therefore be a widening balance of trade deficit. The exchange rate market used by the permuta involved buying local Venezuelan bonds in Bolivares and selling Venezuelan bonds in the international markets in US Dollars. Unlike the fixed rate used by the CADIVI, the exchange rate for the permuta fluctuates because it is subject to market supply and demand. In effect, the permuta operates like a floating exchange rate system. The relation between the two prices defines the exchange rate. The demand for the bolivar to purchase the bonds (hence the US dollar) is determined by the extent of the shortfall due to the rationing of the dollars imposed by the CADIVI. Where this demand match the supply of Bolivares available to purchase the bonds determines the equilibrium.

Naturally, if there are minimal bonds available for sale, there will be excess