1 International Finance Chapter 19 The International Monetary System Under Fixed Exchange rates.
Chapter 19ESV S2.1314 - The International Monetary System
Transcript of Chapter 19ESV S2.1314 - The International Monetary System
-
8/11/2019 Chapter 19ESV S2.1314 - The International Monetary System
1/61
CHAPTER 19:
The International
Monetary System
-
8/11/2019 Chapter 19ESV S2.1314 - The International Monetary System
2/61
Content
The Gold Standard, 1870
1914
Macroeconomics Policy Goals
The Interwar, 1918 - 1939
The Bretton Woods System and IMF
-
8/11/2019 Chapter 19ESV S2.1314 - The International Monetary System
3/61
Text book: KO textbook, Chapter 19
Readings: IMF Case Studies
Reference
-
8/11/2019 Chapter 19ESV S2.1314 - The International Monetary System
4/61
-
8/11/2019 Chapter 19ESV S2.1314 - The International Monetary System
5/61
Macroeconomic Policy Goals
Macroeconomic Policy Goals
in an Open Economy
1
The Gold Standard
(1870 1914)
2
The Interwar Years
(1918 1939)
3
The Bretton WoodsSystems and IMF
-
8/11/2019 Chapter 19ESV S2.1314 - The International Monetary System
6/61
Macroeconomic Policy Goals
Macro-
economic
Policy
External Balance: Optimal Level of Current
Account
Internal Balance: Full Employment
Price Level Stability
-
8/11/2019 Chapter 19ESV S2.1314 - The International Monetary System
7/61
Macroeconomic Policy Goals
Internal Balance:
Full employment of a countrys resources
Domestic price level stability
Why the government must maintain price levelstability and prevent large output fluctuations?
-
8/11/2019 Chapter 19ESV S2.1314 - The International Monetary System
8/61
Macroeconomic Policy Goals
Internal Balance:
Employment:
Underemployment
Overemployment WASTE ?
-
8/11/2019 Chapter 19ESV S2.1314 - The International Monetary System
9/61
Macroeconomic Policy Goals
Internal Balance:
Price Level:
Instability Inflation or Deflation
Less certain real value of money
Less useful guide for economic decisions
Effect on the real value of loan contracts
Controlling money supply growthStability
-
8/11/2019 Chapter 19ESV S2.1314 - The International Monetary System
10/61
Macroeconomic Policy Goals
External Balance: Balance of Current Account
Imbalance is not necessarily undesirable
Intertemporal trade
Deficit CA
Surplus CA
Borrowing from others
Investing abroad
2. Description of the contents
-
8/11/2019 Chapter 19ESV S2.1314 - The International Monetary System
11/61
Macroeconomic Policy Goals
External Balance:
Account Deficit = temporarily high consumption+ badly planned investment projects
Sudden stop of lending
Signal government to restore external balance
How?
-
8/11/2019 Chapter 19ESV S2.1314 - The International Monetary System
12/61
Macroeconomic Policy Goals
External Balance:
Account Surplus:
Accumulating assets located abroad = Lower
investment in domestic plant equipment (S = CA + I)Policy makers prefer higher levels of domestic
investment: Easier to tax on domestic returns
Reduce domestic unemployment and improve nationalincome
Foster technological spillover between domestic industries
-
8/11/2019 Chapter 19ESV S2.1314 - The International Monetary System
13/61
Macroeconomic Policy Goals
External Balance:
No balanced current account as a policy target inreality
Rules for Current account target:
Avoid extremely large external surpluses or deficit
Be cautious when figuring out the exact currentaccount to maximize the gain from inter-temporaltrade
Optimal balance can change unpredictably over timeas of the economy condition change
-
8/11/2019 Chapter 19ESV S2.1314 - The International Monetary System
14/61
02The Gold Standard,
1870 - 1914
-
8/11/2019 Chapter 19ESV S2.1314 - The International Monetary System
15/61
The Gold Standard, 1870 - 1914
Why not other metal?
The Useof Gold
Medium ofExchange
Store of value
Unit of account
-
8/11/2019 Chapter 19ESV S2.1314 - The International Monetary System
16/61
The Gold Standard, 1870 - 1914
Origins of the Gold Standard:
1819: The gold standard as a legal institutiondates from 1819 in Britain
Other nations adopted the gold standard toimitating British institutions.
1879: The U.S. pegged to gold the note
London: Center of the IMS built on the goldstandard
-
8/11/2019 Chapter 19ESV S2.1314 - The International Monetary System
17/61
The Gold Standard, 1870 - 1914
External Balance:
Central banks responsibilities:
To preserve the official parity between its currency
and gold To maintain an adequate stock of gold reserves
Not to make rapid change to gold reserves by:
Gain gold from abroad
Lose gold to foreigners
To keep balance of payments equilibrium
-
8/11/2019 Chapter 19ESV S2.1314 - The International Monetary System
18/61
The Gold Standard, 1870 - 1914
External Balance:
The Price Specie Flow Mechanism:
Suppose in British:
Current Account + Capital Account surplus > NonreserveFinancial account deficit
Flows of international reserves of gold into Britain
Foreign money supplies reduce, Britain money supply
increaseForeign prices British prices
-
8/11/2019 Chapter 19ESV S2.1314 - The International Monetary System
19/61
The Gold Standard, 1870 - 1914
External Balance:
The Price Specie Flow Mechanism:
Pound appreciates:
Reduce foreign demand for British goods and services
Increase British demand for foreign goods and services
Reduce Britains current account surplus and foreigncurrent account deficit
BoP equilibrium = Reserve movement stop
-
8/11/2019 Chapter 19ESV S2.1314 - The International Monetary System
20/61
The Gold Standard, 1870 - 1914
External Balance:
Rules of the Game Myth:
Central banks that were losing gold:
Sell domestic assets
Interest rates
Attract inflows of capital from abroad
Central banks that were gaining gold:
Purchase domestic assets Interest rates
Increase financial outflows and driving gold abroad
-
8/11/2019 Chapter 19ESV S2.1314 - The International Monetary System
21/61
The Gold Standard, 1870 - 1914
External Balance:
Rules of the Game Reality:
Deficit countries
Had more incentives to obey the rules than surpluscountries
Had burden to bringing all countries BoP into equilibrium
Governments ignored the rules of the game and the
effects of their actions
-
8/11/2019 Chapter 19ESV S2.1314 - The International Monetary System
22/61
The Gold Standard, 1870 - 1914
Internal Balance:
Change in relative prices of gold and othercommodities
The Gold Standard had not much effect onensuring full employment
Concentration on External Balance rather than
on Internal BalanceResulted in worldwide economic instability of
the interwar years, 1918 - 1939
-
8/11/2019 Chapter 19ESV S2.1314 - The International Monetary System
23/61
The Interwar Years,
1918 - 193903
-
8/11/2019 Chapter 19ESV S2.1314 - The International Monetary System
24/61
The Interwar Years, 1918 - 1939
Background:
Gold standard was suspended during WWI
Government finance their military expenditure
by printing money
Labor forces and productive capacity had beenreduced sharply
Higher price level, sharp rise in money supplies
-
8/11/2019 Chapter 19ESV S2.1314 - The International Monetary System
25/61
The Interwar Years, 1918 - 1939
Small countries
Large countries
Hold as reserves thecurrencies of several large
countries
Own international reservesconsisting entirely of gold
Partial gold exchange standard
Partial gold exchange standard
-
8/11/2019 Chapter 19ESV S2.1314 - The International Monetary System
26/61
The Interwar Years, 1918 - 1939
The Return to Gold:
1925: Britain returned to the gold standard bypegging pound to gold at the prewar price
Follow contractionary monetary policies thatcontributed to severe unemployment
1931: Foreign holders of sterling lost confidence
in Britains promise and converted their sterlingto gold
Britain left gold
-
8/11/2019 Chapter 19ESV S2.1314 - The International Monetary System
27/61
The Interwar Years, 1918 - 1939
International Economic Disintegration:
Great Depression mostly affected on countriespegging to gold standard
International trade and payments wererestricted as of Gold Standard
Uncertain government policies lead to:
Sharp reserve movements for countries with peggedexchange rate
Sharp ex rate movement for those with floating rates
-
8/11/2019 Chapter 19ESV S2.1314 - The International Monetary System
28/61
The Interwar Years, 1918 - 1939
International Economic Disintegration:
Repudiations of International debts
Prohibitions on private financial account
transactions
Countries must resolve the choice betweenexternal and internal balance
Postwar IMS: Bretton Woods Agreement
-
8/11/2019 Chapter 19ESV S2.1314 - The International Monetary System
29/61
The Bretton Woods
System and the IMF04
-
8/11/2019 Chapter 19ESV S2.1314 - The International Monetary System
30/61
The BWS and the IMF
In 1944:
44 countries in Bretton Woods, New Hampshiredraft and signed the Agreement of IMF
Aims of the Agreement:Foster full employment and price stability
Allow member nations to attain external balancewithout imposing restrictions on international trade
-
8/11/2019 Chapter 19ESV S2.1314 - The International Monetary System
31/61
The BWS and the IMF
Fixed exchange ratesagainst the U.S. dollar
InternationalReserve of Gold
and Dollar Assets
MemberCountries
Pegged dollar price ofgold - $35/ 1oz of gold
InternationalReserve of Gold
The United States
The
BWS
Gold exchange standard, with dollar as its
principle reserve currency
-
8/11/2019 Chapter 19ESV S2.1314 - The International Monetary System
32/61
The BWS and the IMF
Goals and Structure of the IMF:
Avoid interwar experience through disciplineand flexibility
Discipline:Exchange rates to be fixed to the dollar
Dollar to be tied to gold
Why fixed exchange rates? To avoid: Speculative instability Harmful effect to international trade
-
8/11/2019 Chapter 19ESV S2.1314 - The International Monetary System
33/61
The BWS and the IMF
Goals and Structure of the IMF:
Flexibility:
Allow countries to attain external balance without
sacrificing internal objectives or fixed exchange ratesBy how?
Form a pool of financial resources
Exchange rates could be adjusted in cases of an economy in
fundamental disequilibrium - a country with a large andpersistent current account deficit
-
8/11/2019 Chapter 19ESV S2.1314 - The International Monetary System
34/61
The BWS and the IMF
Speculative Capital Flow and Crises:
Fundamental disequilibrium Currencydevaluation
Balance of payments crisisBecoming frequent and severe throughout 1960s -
1970s.
Massive crises brought down the Bretton Woodsstructure of fixed exchange rates
-
8/11/2019 Chapter 19ESV S2.1314 - The International Monetary System
35/61
The BWS and the IMF
Policy Options Under the Bretton WoodsSystem:
Framework:
Assumption: R = R*
P and P* are fixed
Objective:
Show how a countrys position with respect to its internaland external goals depends on the level of its fixedexchange rate and its fiscal policy
-
8/11/2019 Chapter 19ESV S2.1314 - The International Monetary System
36/61
The BWS and the IMF
Policy Options Under the Bretton WoodsSystem:
Condition:
= + + +
,
= + +
= +
,
-
8/11/2019 Chapter 19ESV S2.1314 - The International Monetary System
37/61
The BWS and the IMF
Policy Options Under the Bretton WoodsSystem:
Monetary Policy: Not a tool under fixed
exchange rate Central banks:
Alter the Foreign Reserves by buying or selling assets
Leave money supply unchangedDo not affect the state of employment and output
2. Description of the contents
-
8/11/2019 Chapter 19ESV S2.1314 - The International Monetary System
38/61
The BWS and the IMF
=
ForeignAssets
DomesticAssets
Deposits byprivatebanks
Currency incirculation
Central Bank Balance Sheet
Assets Liabilities
-
8/11/2019 Chapter 19ESV S2.1314 - The International Monetary System
39/61
The BWS and the IMF
Policy Options Under the Bretton WoodsSystem:
Maintaining the Internal Balance:
:
Fiscal expansion ( )
Devaluation of the currency ( ):
-
8/11/2019 Chapter 19ESV S2.1314 - The International Monetary System
40/61
The BWS and the IMF
Policy Options Under the Bretton WoodsSystem:
Maintaining the Internal Balance:
IISchedule: Downward sloping
To the right of II: More expansionary, overemployment
To the left of II: Too restrictive, underemployment
-
8/11/2019 Chapter 19ESV S2.1314 - The International Monetary System
41/61
The BWS and the IMF
Policy Options Under the Bretton WoodsSystem:
Maintaining the Internal Balance:
-
8/11/2019 Chapter 19ESV S2.1314 - The International Monetary System
42/61
The BWS and the IMF
Policy Options Under the Bretton WoodsSystem:
Maintaining External Balance:
:
Fiscal contraction ( )
Devaluation of the currency ( )
Assume the government has a target value, X, for thecurrent account surplus:
, =
-
8/11/2019 Chapter 19ESV S2.1314 - The International Monetary System
43/61
The BWS and the IMF
Policy Options Under the Bretton WoodsSystem:
Maintaining External Balance:
XX Schedule: Upward sloping
To the right of XX: CA deficit
To the left of XX: CA surplus
-
8/11/2019 Chapter 19ESV S2.1314 - The International Monetary System
44/61
The BWS and the IMF
Policy Options Under the Bretton WoodsSystem:
Maintaining External Balance:
-
8/11/2019 Chapter 19ESV S2.1314 - The International Monetary System
45/61
The BWS and the IMF
Policy Options Underthe Bretton WoodsSystem:
At Point 1: Both internaland external balancehold
At Zone 1, 2, 3, 4: Zonesof economic discomfort
-
8/11/2019 Chapter 19ESV S2.1314 - The International Monetary System
46/61
The BWS and the IMF
Policy Options Under the Bretton WoodsSystem:
Fiscal policy: Expenditure changing policy
Changing the levelof the economys totaldemand for goods and services
Exchange rate adjustment: Expenditure
switching policyChanging thedirection
ofdemand between domestic output and imports
-
8/11/2019 Chapter 19ESV S2.1314 - The International Monetary System
47/61
The BWS and the IMF
Policy Options Under the Bretton WoodsSystem:
Exchange rate adjustment: happened
infrequently Fiscal policy: insufficient to attain the two goals
-
8/11/2019 Chapter 19ESV S2.1314 - The International Monetary System
48/61
The BWS and the IMF
Policy Options Under the Bretton WoodsSystem:
Exchange rate adjustment: happened
infrequently Fiscal policy: insufficient to attain the two goals
-
8/11/2019 Chapter 19ESV S2.1314 - The International Monetary System
49/61
The BWS and the IMF
Policy Options Under the Bretton WoodsSystem:
-
8/11/2019 Chapter 19ESV S2.1314 - The International Monetary System
50/61
The BWS and the IMF
United States Under the Bretton Woods:
Constraints: Confidence Problem
Consequences: Bring down the BWS
Solution: Increase the official price of gold Worsen confidence problem
-
8/11/2019 Chapter 19ESV S2.1314 - The International Monetary System
51/61
The BWS and the IMF
The Mechanics of Imported Inflation:
Suppose:
(abroad inflation)
( ) :
-
8/11/2019 Chapter 19ESV S2.1314 - The International Monetary System
52/61
Analyzing Policy Options Under
the Bretton Woods System
The Mechanics of Imported Inflation:
-
8/11/2019 Chapter 19ESV S2.1314 - The International Monetary System
53/61
Analyzing Policy Options Under
the Bretton Woods System
The Mechanics of Imported Inflation:
U.S. inflation -> Global inflation
Increasing trade off between exchange rate
stability and domestic monetary goals Collapse of the BWS
-
8/11/2019 Chapter 19ESV S2.1314 - The International Monetary System
54/61
Analyzing Policy Options Under
the Bretton Woods System
-
8/11/2019 Chapter 19ESV S2.1314 - The International Monetary System
55/61
The Case for Floating
Exchange Rates05
2. Description of the contents
-
8/11/2019 Chapter 19ESV S2.1314 - The International Monetary System
56/61
The Case for Floating Exchange Rates
Major Claims for Floating Exchange Rates:
Exchange rates asautomatic stabilizers
Monetary policyautonomy
Exchange rates andexternal balance
Symmetry
-
8/11/2019 Chapter 19ESV S2.1314 - The International Monetary System
57/61
The Case for Floating Exchange Rates
Major Claims for Floating Exchange Rates:
Monetary policy autonomy:
Under BWS: Central banks imposes restrictions on
international payments Strengthen the monetary policy but distort international
trade
Under floating exchange rates: Restore monetarycontrol to central banks
Prevent countries from passively imported inflation ratefrom abroad
-
8/11/2019 Chapter 19ESV S2.1314 - The International Monetary System
58/61
The Case for Floating Exchange Rates
Major Claims for Floating Exchange Rates:
Symmetry:
Under BWS - 2 main asymmetries:
U.S. Federal Reserve determined the world money supply,central banks abroad had little scope to determine theirown money supplies
Other central banks but the U.S. could devalue theircurrencies in condition of fundamental disequilibrium
Under Floating Exchange rates: Same opportunities for the US and other countries
-
8/11/2019 Chapter 19ESV S2.1314 - The International Monetary System
59/61
The Case for Floating Exchange Rates
Major Claims for Floating Exchange Rates:
Exchange rates as automatic stabilizers:
-
8/11/2019 Chapter 19ESV S2.1314 - The International Monetary System
60/61
The Case for Floating Exchange Rates
Major Claims for Floating Exchange Rates:
Exchange rates and External balance:
CA surplus (deficit) Require appreciate
(depreciate) currency
-
8/11/2019 Chapter 19ESV S2.1314 - The International Monetary System
61/61
The Open Economy Trilemma