Methods of Controlling Exchange Rate: Unilateral and Bilateral Methods

Exchange rate control refers to the measures taken by a country to regulate or stabilize the value of its currency relative to foreign currencies. These controls aim to manage balance of payments, stabilize the currency, and protect the economy from excessive volatility.

1. Unilateral Methods

Unilateral methods are those exchange rate control measures adopted by a country independently, without consultation or agreement with other countries. These are direct interventions and regulations imposed domestically.

Key Unilateral Methods:

Regulation of Bank Rate:
Changing the domestic interest rate influences capital flows. A higher bank rate attracts foreign capital, increasing demand for the domestic currency and causing its appreciation. Lowering the rate has the opposite effect.
Regulation of Foreign Trade:
Encouraging exports and discouraging imports can increase demand for the domestic currency, leading to its appreciation. Trade policies such as tariffs and quotas are tools used here.
Rationing of Foreign Exchange:
Governments may limit the amount of foreign currency available for imports or capital outflows, controlling the supply-demand balance and stabilizing the exchange rate.
Exchange Pegging:
Fixing the exchange rate at a certain level above or below the market rate. "Pegging up" fixes the rate higher than market value; "pegging down" fixes it lower. This is often used during crises or wars to prevent volatility.
Multiple Exchange Rates:
Different exchange rates are set for different types of transactions or goods to maximize foreign exchange earnings by making exports cheaper or imports more expensive. This system is generally discouraged by international bodies like the IMF.
Exchange Equalization Fund:
A government fund used to buy or sell foreign currency to stabilize the exchange rate by managing supply and demand in the foreign exchange market.
Blocked Accounts:
Foreigners’ deposits and assets are blocked, preventing conversion or transfer abroad. This restricts capital outflows and helps conserve foreign exchange reserves.

2. Bilateral (or Multilateral) Methods

Bilateral methods involve agreements or arrangements between two or more countries to regulate exchange flows and trade balances, often to avoid currency crises or trade imbalances.

Key Bilateral Methods:

Private Compensation Agreement:
Countries agree that firms must balance their exports and imports with each other, resembling barter trade, to avoid trade imbalances and reduce foreign exchange needs.
Clearing Agreement:
Payments for imports and exports between two countries are made through a clearing account in domestic currency, reducing the need for foreign currency transactions. Only the net balance is settled in foreign exchange.
Standstill Agreement:
Debtor countries are given time to adjust their external payments by temporarily freezing or delaying capital outflows or debt repayments.
Payments Agreement:
Arrangements where creditor countries agree to import more from debtor countries and restrict their own exports to help the debtor country improve its trade balance and repay debts.

Summary Table

Method Type	Description	Purpose/Effect
Unilateral	Independent domestic controls (e.g., bank rate, pegging)	Control currency value, restrict capital flows
Bilateral	Agreements between countries (e.g., clearing, compensation)	Balance trade, reduce foreign exchange needs

Conclusion

Unilateral methods give a country direct control over its currency but may cause tensions with trading partners. Bilateral methods rely on cooperation and help manage exchange rates and trade balances more smoothly between countries.

Top 20 MCQs on Methods of Controlling Exchange Rate (Unilateral and Bilateral)

Which of the following is a unilateral method of controlling exchange rates?
a) Clearing agreement
b) Regulation of bank rate
c) Private compensation agreement
d) Payments agreement
Answer: b) Regulation of bank rate
What does pegging the exchange rate mean?
a) Allowing the currency to float freely
b) Fixing the exchange rate at a certain level by government intervention
c) Letting the market decide the exchange rate
d) Using multiple exchange rates simultaneously
Answer: b) Fixing the exchange rate at a certain level by government intervention
Which method involves setting different exchange rates for different types of transactions?
a) Exchange equalization fund
b) Multiple exchange rates
c) Clearing agreement
d) Standstill agreement
Answer: b) Multiple exchange rates
Blocked accounts as a method of exchange control refer to:
a) Accounts where foreign currency is freely convertible
b) Foreigners’ deposits that cannot be converted or transferred abroad
c) Accounts used for international trade settlements
d) Accounts for government foreign reserves
Answer: b) Foreigners’ deposits that cannot be converted or transferred abroad
The exchange equalization fund is used to:
a) Provide loans to exporters
b) Stabilize the exchange rate through buying and selling foreign currency
c) Finance government budget deficits
d) Manage domestic inflation
Answer: b) Stabilize the exchange rate through buying and selling foreign currency
Which of the following is a bilateral method of exchange control?
a) Rationing of foreign exchange
b) Private compensation agreement
c) Exchange pegging
d) Regulation of bank rate
Answer: b) Private compensation agreement
In a clearing agreement, payments between countries are:
a) Made in foreign currency only
b) Made through a clearing account in domestic currency
c) Settled immediately in gold
d) Not required
Answer: b) Made through a clearing account in domestic currency
Standstill agreements are designed to:
a) Increase exports
b) Temporarily freeze or delay capital outflows or debt repayments
c) Fix exchange rates permanently
d) Remove tariffs
Answer: b) Temporarily freeze or delay capital outflows or debt repayments
Which method requires firms to balance their exports and imports with a particular country?
a) Payments agreement
b) Private compensation agreement
c) Exchange equalization fund
d) Multiple exchange rates
Answer: b) Private compensation agreement
Payments agreements typically involve:
a) Creditor countries agreeing to import more from debtor countries
b) Debtor countries refusing to repay debts
c) Fixing exchange rates unilaterally
d) Blocking foreign currency accounts
Answer: a) Creditor countries agreeing to import more from debtor countries
Rationing of foreign exchange is primarily aimed at:
a) Increasing capital inflows
b) Limiting the amount of foreign currency available for imports
c) Encouraging free trade
d) Promoting currency convertibility
Answer: b) Limiting the amount of foreign currency available for imports
Which unilateral method involves changing domestic interest rates to influence exchange rates?
a) Exchange pegging
b) Regulation of bank rate
c) Clearing agreement
d) Standstill agreement
Answer: b) Regulation of bank rate
Multiple exchange rates can lead to:
a) Simplified foreign exchange transactions
b) Distortions and inefficiencies in trade
c) Increased foreign investment
d) Stable exchange rates
Answer: b) Distortions and inefficiencies in trade
Which bilateral method reduces the need for foreign currency transactions by settling only net balances?
a) Private compensation agreement
b) Clearing agreement
c) Standstill agreement
d) Payments agreement
Answer: b) Clearing agreement
Which of the following is NOT a unilateral method of exchange control?
a) Exchange equalization fund
b) Private compensation agreement
c) Rationing of foreign exchange
d) Blocked accounts
Answer: b) Private compensation agreement
The main purpose of exchange rate controls is to:
a) Promote currency speculation
b) Stabilize the currency and manage balance of payments
c) Encourage free capital flows
d) Increase inflation
Answer: b) Stabilize the currency and manage balance of payments
In a standstill agreement, which party benefits by gaining time to adjust payments?
a) Creditor country
b) Debtor country
c) Foreign investors
d) Exporters only
Answer: b) Debtor country
Which method involves government intervention in the foreign exchange market to influence currency value?
a) Clearing agreement
b) Exchange equalization fund
c) Private compensation agreement
d) Payments agreement
Answer: b) Exchange equalization fund
Which bilateral method is similar to barter trade?
a) Standstill agreement
b) Private compensation agreement
c) Clearing agreement
d) Exchange pegging
Answer: b) Private compensation agreement
Which unilateral method can restrict capital outflows by preventing conversion of foreign currency deposits?
a) Blocked accounts
b) Regulation of bank rate
c) Payments agreement
d) Standstill agreement
Answer: a) Blocked accounts

These MCQs cover the core concepts, types, and examples of unilateral and bilateral methods of controlling exchange rates in international economics.

Reference:

Methods of Controlling Exchange Rate: Unilateral and Bilateral Methods | International Economics Notes