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Chapter 8-9 International
Monetary System
You should master:
(1) Features of a good international monetary system;
(2) Rules of the games, and the advantages and
disadvantages of the three international monetary
systems;
(3) The fundamental and immediate cause for the
collapse of the Bretton Woods system;(4) Some terms, like gold points,
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1.1. What is an international
monetary system?
Narrowly speaking, it refers to international
exchange rate system.
There are three international exchange ratesystems in history: the gold standard, the
Bretton Woods, and the floating exchange
rate system.
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1.2. Features of a good international
monetary systemAdjustment : a good system must be able to adjust
imbalances in balance of payments quickly and at a
relatively lower cost;
Stability and Confidence: the system must be able tokeep exchange rates relatively fixed and people must
have confidence in the stability of the system;
Liquidity: the system must be able to provide enough
reserve assets for a nation to correct its balance of
payments deficits without making the nation run into
deflation or inflation.
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1.3 Classification of international
monetary system
gold standard,
gold exchange standard
fiduciary standardFloating exchange rate system
Fixed exchange rate system
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II. The gold standard system(1880---1914)
Fixed Rate System
The world economy operated under a
system of f ixed dollar exchange ratesbetween the end of World War II and 1973,
with central banks routinely trading foreign
exchange to hold their exchange rates atinternationally agreed levels.
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Two kinds of the fixed
exchange rates
1. The fixed exchange rate system under the gold
standard
2. Notes in circulation system of fixed exchange
rate system
3. Gold Standard: provisions of the gold content of
the monetary unit.
4. The gold content of the contrast determine theexchange rate.
5. Coins can freely casting; freely convertible;
freedom of input and output.
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2.1 Rules of the game
Fix an official gold price or mint parity and allow freeconvertibility between domestic money and gold at that
price.
Impose no restrictions on the import or export of gold byprivate citizens, or on the use of gold for international
transactions.Issue national currency and coins only with gold backing,and link the growth in national bank deposits to theavailability of national gold reserves.
In the event of a short-run liquidity crisis associated with
gold outflows, the central bank should lend freely todomestic banks at higher interest rates (Bagehots Rule).
If Rule I is ever temporarily suspended, restoreconvertibility at the original mint parity as soon as
practical.
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2.2 Factors that determine or affect
the exchange rates
Factors that determine the exchange rates:
the mint parity
E.g. US$1= British
Factors that influence the exchange rates:
gold points and the demand for and supplyof foreign exchange
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2.3 Adjustment of balance of
payments deficits or surpluses
Price-specie flow mechanism:
Deficit gold flow out of the country
gold reserve decrease moneysupply decrease quantity theory of moneyprice level decrease exchange rate fixedexport go up, import go down, deficit
disappearThe adjustment of surplus is the opposite.
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2.4 Remarks and comments
An international gold standard avoids the
asymmetry inherent in a reserve cur rency
standardby avoiding the Nth currencyproblem. Under a gold standard, each
country f ixes the price of its currency in
terms of goldby standing ready to trade
domestic currency for gold whenever
necessary to defend the official price.
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The collapse of the gold standard system
It is virtually a pound standard system :
Britain and British pounds position in the
systemOutbreak of World War I.
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Advantage of the Gold Standard
Because there are Ncurrency and Nprices of gold in terms of those currencies,
no single country occupies a privilegedposition wi thin the system: each isresponsible for pegging its currencysprice in terms of the official international
reserve asset, gold. Gold standard rulesalso require each country to allowunhindered imports and exports of goldacross its borders.
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Benefits and drawbacks of the
Gold Standard
Benefits:
1. Symmetry
2. Price level and value of national moneyare more stable and predictable
3. Enhance international transactions
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The Gold Exchange Standard
Halfway between the gold standard and a pure
reserve currency standard is the gold exchange
standard. Central banks reserves consist of gold
and currencies whose prices in terms of gold arefixed, and each central bank fixes its exchange
rate to a currency with a fixed gold price.
More flexibilityin the growth of internationalreserves.
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3. The Bretton Woods System1944-1973
3.1 How this system came into being
The harms and disasters that the two Wars
brought the world.
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3.2 Rules of the game
Fix an official par value for domestic currency interms of gold or a currency tied to gold as anumeraire.
In the short run, keep the exchange rate peggedwithin 1% of its par value, but in the long-runleave open the option to adjust the par valueunilaterally if the IMF concurs.
Permit free convertibility of currencies for currentaccount transactions, but use capital controls tolimit currency speculation.
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Fixed Exchange Rates under
currency-circulation system
Notes in circulation under the Bretton Woods
system. 1944 Bretton Woods agreement
The result of a compromise by the UnitedKingdom to the United States "double hook"
system.
dollar
National
currenciesYen ...
Lire ...
1=35
1%
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How to sustain the Fixed Rate
1. Use gold reserves
2. By making use of discount policies
3. Foreign exchange controls
4. Official devaluationslast resort
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3.3 Features of the system
IMF to see that this system runs on
smoothly
More flexibility in exchange ratesMore channels to correct imbalances in
balance of payments
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3.4 Adjustment of balance of
payments imbalances
Offset short-run balance of payments
imbalances by use of official reserves and
IMF credits, and sterilize the impact ofexchange market interventions on the
domestic money supply
Adjust fundamental imbalances by change
the par value permanently, provided agreed
by the IMF
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3.4 Adjustment of balance of
payments imbalances
Subordinate domestic monetary and fiscal policiesto maintain fixed exchange rate (use monetary
policy to keep price level and fiscal policy---government expenditures minus tax revenues--- tooffset imbalances between private savings andinvestment):
Deficit contractionary monetary or fiscalpolicy price level decrease exchange ratefixed
export go up, import go down, deficitdisappear
The adjustment of surplus is the opposite.
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Triffin Paradox
U.S. run deficits
U.S. run surplus
liquidity
confidence
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3.6 Collapse of the Bretton Woods
System: Process of dollar devaluationDollar
value
per
ounce
ofgold
1944 1971 1973
1 35
3842.22
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Abandoned Gold Exchange
Standard
The post-World War II reserve currency systemcentered on the dollar was, in fact, originally set upas a gold exchange standard. While foreign central
banks did the job of pegging exchange rates, theU.S. Federal Reserve was responsible for holdingthe dollar price of gold at $35 an ounce. By themid-1960s, the system operated in practice more
like a pure reserve currency system than a goldstandard. President Nixon unilaterally severed thedollars link to gold in August 1971, shortly
before the system of fixed dollar exchange rates
was abandoned.
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4. The present Floating Exchange RateSystem (1973-present)
4.1 How this system came into being
A system of no system An order of no order----Features of this system
1. No par values, between home currency and foreign
currency or gold2. No upper or lower limits of exchange rate fluctuations
3. The government has no obligation to maintain exchangerate fixed, it can choose any kind of exchange ratesystem, flexible rates are legal
4. 5.
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4.2 Rules of the game
Smooth short-term variability in the dollar exchange rate,but do not commit to an official par value or to long-termexchange rate stability
Permit free convertibility of currencies for current account
transactions, while endeavoring to eliminate all remainingrestrictions on capital account transactions
Use the U.S. dollar as the intervention currency and keepofficial reserves primarily in U.S. treasury bonds
Modify domestic monetary policy to support major
exchange rate interventions, reducing the money supplywhen the national currency is weak against the dollar andexpanding the money supply when the national currency isstrong
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4.3 Features of this system
More currencies can be used as reserveassets
Governments began to cooperate tointervene in the foreign exchange marketsand to coordinate their domestic policies toachieve common prosperity
Many different kinds of exchange ratesappear
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Types of floating exchange rates
Whether there is a dirty hand:
1. Free Float/Clean Float
2. Managed Float/Dirty FloatWhether there is a Connection with othercurrencies:
1. Single Float27
2. Pegged Float(1) (2)SDR; ECU;
3. Joint Float
4. Crawling peg
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5. Should we return to a fixed rate
system?
What kind of international monetary system
should we adopt?
What are the advantages and disadvantagesof fixed and floating exchange rate system
respectively?
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5.1 Arguments favoring floating rates
1. Better adjustment
2. Better confidence
3. Better liquidity4. Gains from freer trade
5. Avoiding the so-called Peso Problem
6. Increased independence of policy
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5.2 Arguments against floating
exchange rates: Flexible rates
1. Cause uncertainty and inhibit internationaltrade and investment
2. Cause destabilizing speculation
3. Will not work for open economies
4. Are inflationary
5. Are unstable because of small tradeelasticities
6. Cause structural unemployment
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Krugman & Obstfeld (1)
1. Discipl ine. Central banks freed from the
obligation to fix their exchange rates might
embark on inflationary policies.2. Destabi l izing speculation and money market
disturbances. Speculation on changes in
exchange rates could lead to instability in foreign
exchange markets.3. I njur y to international trade and investment.
Floating rates would make relative international
prices more unpredictable.
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Krugman & Obstfeld (2)
4. Uncoordinated economic policies. The door
would be opened to competitive currency practices
harmful to the would economy.5. The il lusion of greater autonomy. Floating
exchange rates would not really give countries
more policy autonomy. Changes in exchange rates
would have such pervasive macroeconomic effectsthat central banks would feel compelled to
intervene heavily in foreign exchange markets
even without a formal commitment to peg.
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5.3 Selection of Fixed & Floating
Exchange Rates
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