1
$\begingroup$

I think there is a mistake in the following Wikipedia-article: https://en.wikipedia.org/wiki/Fixed_exchange_rate_system

at figure 2 and 3.

I think the ECB has to BUY (not sell) the dollars as in point $e$ the dollar is depreciated with respect to the bandwidth-exchange rate. So the ECB has to appreciate the dollar to the bandwidth. Hence, the ECB should increase the demand of the dollar, hence buying dollars for domestic currency euro (=buying foreign currency). So there are two possibilities:

  1. The text is wrong or
  2. The \$/€-axis should be a €/$-axis as the dollar is appreciated since the text says the ECB sells dollars (=increased dollar supply --> depreciation of dollar, less \$/€ would be appreciation)

Am I right and the article contains a mistake?

Second question: Is it correct to represent the foreign exchange market intervention in figure 2 by drawing a parallel to the blue supply line shifted to the right to build a new equilibrium with the yellow D' line within the borders? Or is the foreign exchange market intervention not represented by a straight line?

$\endgroup$
1
  • $\begingroup$ If a consensus is reached here in the answers, do request to edit the Wikipedia article in the Wikipedia talk page of the article or edit it yourself of possible, would help others $\endgroup$ Jun 13, 2022 at 14:19

1 Answer 1

1
$\begingroup$

I believe you are right, in that it is partially wrong. Based on my understanding,

  • it is correct that $e$ refers to a dollar appreciation (also intuitive, because dollar demand increased by assumption)
  • the axes notation is also correct (the vertical line refers to the price of dollars in terms of 1 EUR, which corresponds to the standard EURUSD convention, which is unfortunately not how most pairs, especially fixed exchange rates, are traded and quoted in international markets)
  • the value 1.2 and 1.8 is also correct, with 1.2 meaning an appreciation of the USD relative to the EUR
  • it is correct that the ECB will need to sell dollar to reduce the dollar demand (back to at least point c, or anywhere below)

  • it is wrong, however, that the two horizontal (straight) lines are in EUR per USD (in fact they should be in USD per EUR, and less USD per EUR means USD got stronger, EUR weaker)

The two horizontal lines correspond to the upper and lower limit. If you assume a completely fixed FX rate (one value only), there would be one horizontal line only. This would refer to the supply curve of USD by the FED (not ECB) in case the FED would want to keep USD constant. No matter what the demand curve would be, the FED would simply adjust supply accordingly.

On the other hand, the ECB itself cannot supply USD (it can only use its USD reserves - which will affect the supply of EUR (not depicted / visible in the chart).

Bottom line:

Wikipedia is remarkably good, and has generally more reliable content than to Investopedia for example. However, not even the best textbooks are free from errata. In this specific case, the figure seems to be the "Own work" of a single person according to Wikipedia. The good thing is that you (or anyone else) can request this to be changed / reviewed - which is what makes Wikipedia quite reliable, despite its white male bias (although in this particular case, it seems the author was actually adding some diversity to Wikipedia's contributors).

Note, I may be wrong in my reasoning as well! Happy to hear other comments / answers.

$\endgroup$
3
  • $\begingroup$ Thank you for your answer. But what you write means that the "direction" of "dollar per Euro" - axis is wrong in the sense that going along the vertical axis from bottom to top must mean less dollar per Euro because increasing dollar demand means dollar appreciation (= less dollar per Euro). I don't understand why the ECB cannot affect the dollar exchange rate. If ECB sells dollar reserves (they have billions of dollar reserves), they can affect the dollar exchange rate. $\endgroup$ Jun 13, 2022 at 14:13
  • 1
    $\begingroup$ I never wrote the ECB cannot affect the dollar exchange rate (in fact, I wrote the opposite in the 4th bullet point). Agree, if you think of going from bottom to top, values need to increase, it is wrong. However, the figure does not show the values (apart from the 1.2 and 1.8). In general, there is nothing wrong with inverse axes and many programming languages like python offer various ways to do this. $\endgroup$
    – AKdemy
    Jun 14, 2022 at 0:41
  • $\begingroup$ I agree with @Ishan Kashyap Hazarika that it should be rewritten if a consensus is achieved here. This section has several questionable inputs. For example, the text states "the European Central Bank (ECB) may fix its exchange rate at €1 = $1", but goes on to define bands between 1.2 and 1.8 (which excludes the fixed rate). $\endgroup$
    – AKdemy
    Jun 14, 2022 at 0:44

Your Answer

By clicking “Post Your Answer”, you agree to our terms of service and acknowledge you have read our privacy policy.

Not the answer you're looking for? Browse other questions tagged or ask your own question.