International Monetary System.pdf

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The International Monetary System

Transcript of International Monetary System.pdf

Page 1: International Monetary System.pdf

The International Monetary System

 

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What  Is  The  International  Monetary  System?  

Ø  International monetary system - the institutional arrangements that govern exchange rates Ø A floating exchange rate system exists when a

country allows the foreign exchange market to determine the relative value of a currency

Ø A pegged exchange rate system exists when a country fixes the value of its currency relative to a reference currency

Ø A dirty float exists when a country tries to hold the value of its currency within some range of a reference currency such as the U.S. dollar

Ø A fixed exchange rate system exists when countries fix their currencies against each other at some mutually agreed on exchange rate

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What  Is  The  International  Monetary  System?

Ø  From 1880s until today v  1880s – 1914 : Gold Standard v  1918 – 1939 : Interwar years v  1944-1971 : Bretton Woods System v  1976 – Today : New exchange rate System

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What  Was  The  Gold  Standard?  Ø The Gold Standard refers to a system in

which countries peg currencies to gold and guarantee their convertibility Ø in the 1880s, most nations followed the gold

standard Ø $1 = 23.22 grains of “fine” (pure) gold

Ø the gold par value refers to the amount of a currency needed to purchase one ounce of gold

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Ø For example, suppose •  1 unit of currency A = 10 ounce of gold •  1 unit of currency B = 20 ounce of gold Then

EA/B = 20 ÷ 10 = 2 = price of currency B in terms of currency A

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Ø BOP < 0 ⇒ outflow of gold ⇒ the central bank reacts by reducing its domestic credit holding ⇒ MS↓ •  ⇒ P↓ ⇒ EP*/P ↑ ⇒ CA↑ ⇒ BOP>0 ⇒ inflow of gold ⇒ MS↑ ⇒ P↑ ⇒ EP*/P ↓ ⇒ CA↓ ⇒ BOP = 0

•  ⇒ i↑ ⇒ capital inflow ⇒ BOP = 0

Ø The great strength of the gold standard was that it contained a powerful mechanism for achieving balance-of-payment equilibrium by all countries (i.e. BOP = 0).

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Why  Did  The    Gold  Standard  Make  Sense?    

Ø The gold standard worked well from the 1880s until 1914 Ø but, many governments financed their World War I

expenditures by printing money and so, created inflation

Ø People lost confidence in the system

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Interwar years: 1918 - 39

Ø During WWI, the gold standard was abandoned by many countries.

Ø 1919: US returned to the gold standard ← little inflation during the war

Ø 1925: Britain returned to the gold standard at the parity prevailing before the war

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Britain’s case MS↑ during and after the war ⇒ P↑ So, Britain had to have contractionary monetary

policies ⇒ unemployment↑ ⇒ economic stagnation in 1920s ⇒ London’s decline as int’l financial center ⇒ Pound holders lost confidence in pounds and

began converting their pound to gold → a run on British gold reserves

⇒ 1931 Britain was forced to abandon the gold standard

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US’s case

Ø 1931: A run on US gold → 15% drop in US gold holdings

Ø 1933: US left the gold standard. Ø 1934: US returned to the gold standard at

$35 per ounce (devaluation from $20.67).

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1930s

Ø Great depression ⇒ Int’l economic disintegration

Ø A period of competitive devaluations: In trying to stimulate domestic economies by increasing exports, country after country devalued.

Ø FX controls Ø Trade barriers → int’l monetary warfare

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What  Was  The    Bretton  Woods  System?  

Ø In 1944, representatives from 44 countries met at Bretton Woods, New Hampshire, to design a new international monetary system that would facilitate postwar economic growth

Ø Under the new agreement Ø a fixed exchange rate system was established Ø all currencies were fixed to gold, but only the U.S.

dollar was directly convertible to gold Ø devaluations could not to be used for competitive

purposes Ø a country could not devalue its currency by more than

10% without IMF approval

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German mark British

pound French franc

U.S. dollar

Gold

Pegged at $35/oz.

Par Value

What  Was  The    Bretton  Woods  System?  

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What  Institutions  Were  Established  At  Bretton  Woods?  

Ø  The Bretton Woods agreement also established two multinational institutions

1.  The International Monetary Fund (IMF) to maintain order in the international monetary system through a combination of discipline and flexibility

2.  The World Bank to promote general economic development Ø  also called the International Bank for Reconstruction

and Development (IBRD)

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Why  Did  Bretton  Woods  System  Collapse?  

Ø Bretton Woods worked well until the late 1960s Ø  It collapsed when huge increases in welfare programs

and the Vietnam War were financed by increasing the money supply and causing significant inflation Ø other countries increased the value of their currencies

relative to the U.S. dollar in response to speculation the dollar would be devalued

Ø However, because the system relied on an economically well managed U.S., when the U.S. began to print money, run high trade deficits, and experience high inflation, the system was strained to the breaking point Ø the U.S. dollar came under speculative attack

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Why  Did  Bretton  Woods  System  Collapse?

Ø 1958-65: Private capital outflows from US Ø 1965-68: Johnson Administration

The bad US macroeconomic policy package caused considerable damage to the US economy and the int’l monetary system. •  Involvement in the Vietnam conflict •  “Great Society” program ⇒ G↑ ⇒ Deficit↑ ⇒ MS↑ ⇒ P↑ & CA↓ (stagflation)

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Why  Did  Bretton  Woods  System  Collapse?

Ø 1971: US CA deficit ⇒ massive private purchase of DM ⇒ Bundesbank intervened in FX market by buying huge amount of dollars, then it gave up and allowed the DM to float.

Ø August 1, 1971: Nixon’s announcement Ø Stop to sell gold for dollars to foreign central banks Ø 10% tax on all imports until revaluation of each

country’s currency against the dollars Ø Freeze on prices and wages.

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Floating Exchange Rates: 1973 - Ø Speculative attacks on the pound and the lira Ø 1972: Britain allowed the pound to float. Ø 1972-73: speculators began selling dollars

massively. Ø 1973: US devalued the dollar again ($42.22 per

ounce of gold). Ø By March 1973 major currencies were all

floating.

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What  Was  The    Jamaica  Agreement?  

Ø A new exchange rate system was established in 1976 at a meeting in Jamaica

Ø The rules that were agreed on then are still in place today

Ø Under the Jamaican agreement Ø floating rates were declared acceptable Ø gold was abandoned as a reserve asset Ø total annual IMF quotas - the amount member

countries contribute to the IMF - were increased to $41 billion – today they are about $300 billion

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What  Has  Happened  To  Exchange  Rates  Since  1973?  

Ø Since 1973, exchange rates have been more volatile and less predictable than they were between 1945 and 1973 because of Ø the 1971 and 1979 oil crises Ø the loss of confidence in the dollar after U.S.

inflation in 1977-78 Ø the rise in the dollar between 1980 and 1985 Ø the partial collapse of the EMS in 1992 Ø the 1997 Asian currency crisis Ø the decline in the dollar from 2001 to 2009

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What  Has  Happened  To  Exchange  Rates  Since  1973?  

Major Currencies Dollar Index, 1973-2010

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A  variety  of  ex  rate  system  Ø Managed Floating: MA influences ex rates through

active FX market intervention Ø (Independently) Floating: the ex rate is market

determined. No FX intervention. Ø Currency Board: A legislative commitment to

exchange domestic currency for a specified foreign currency at a fixed ex rate.

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A  variety  of  ex  rate  system  Ø Fixed Peg: The ex rate is fixed against a major

currency. Active intervention needed. Ø Crawling Peg: The ex rate is adjusted periodically in

small amounts at a fixed, preannounced rate. Ø Dollarization: The dollar circulates as the legal tender.

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Which  Is  Better  –  Fixed  Rates  Or  Floating  Rates?  

Ø  Floating exchange rates provide 1.  Independent macroeconomic policies. 2.  Countries can choose different inflation rates. 3.  Automatic trade balance adjustments

Ø  But, a fixed exchange rate system 1.  Provides monetary discipline 2.  Minimizes speculation 3.  Reduces uncertainty

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What  Type  of  Exchange  Rate  System  Is  In  Practice  Today?  

Ø Various exchange rate regimes are followed today Ø  14% of IMF members follow a free float policy Ø  26% of IMF members follow a managed float system Ø  22% of IMF members have no legal tender of their own Ø  the remaining countries use less flexible systems such as

pegged arrangements, or adjustable pegs Ø Countries with a pegged exchange rate system peg the

value of its currency to that of another major currency Ø Countries using a currency board commit to converting

their domestic currency on demand into another currency at a fixed exchange rate

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What  Type  of  Exchange  Rate  System  Is  In  Practice  Today?  

Exchange Rate Policies of IMF Members

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Choice  of  Peg  or  Float  Ø Peg

Ø Small size (GDP) Ø Open economy Ø Harmonious inflation rate Ø Concentrated trade

Ø Float Ø Large size Ø Closed economy Ø Divergent inflation rate Ø Diversified trade