global governance of finance

Question 1

what are the factors you need to consider when deciding between fixed or floating exchange rate?

Answer 1

the circumstances of the country
the changes in circumstances over time
subjective opinion

Question 2

what are the advantages of a fixed exchange rate?

Answer 2

the first advantage is certainty as if people know the exchange rate will not change then greater international trade is facilitated. it removes risk and thus promote trade and this advantage is particularly important for close trading partners that share a lot of business
the second advantage is it imposes discipline on central banks and governments. assume a situation where the UK is losing out on trade so imports are greater than exports. this means the supply of pounds exceeds demand and therefore £ is expected to fall. the bank of england must sell of its gold reserves to buy £ to cover the difference. in the long run it is not sustainable to do this. this fauces the central authorities to address the root of the problem and prevent the country from living beyond their means. this will mean that central banks has to raise interest rates to make home currency more attractive to foreigners whilst making it harder for home people to borrow and spend. this is a defaltionary policy which reduces AD however increases unemployment

Question 3

what are the advantages of a flexible exchange rate?

Answer 3

there are no need for large foreign currency reserves
exchange rates move to eliminate deficits/surpluses
more efficient and less socially constant to change just one price the exchange rate than change all prices of goods and services and factors of production
greater sovereignty in deciding monetary policy. there is no necessary conflict between desire to maintain high employment, low inflation and stable growth (internal balance) and the simultaneous need to keep balance of payments on international trade (External trade) if floating exchange rates automatically achieve this balance

Question 4

what is the impossible triangle in having a fixed exchange rate , an independent monetary policy and a liberalised capital market?

Answer 4

Unfortunately, a country can only have two of these three
* If a country decides on the first two objectives - free capital and fixed rates – then funds will move into or out of the country as it sees fit. The supply of the money so determined in the country will thus determine the ruling interest rate; the nation’s central bank cannot. Independent monetary policy is lost.
* If a country decides on objectives 2 and 3 – fixed rates and their own monetary policy/interest rates – then they will have to impose restrictions on capital moving in and out of the country. You cannot fix the interest rate and the exchange rate without restricting the international movement of money and global integration.
* Lastly, if you allow international capital movements and determine your own interest rate, this means you will have to leave forex markets to decide what price your currency will fetch in a trade. Fixing your own money supply/the domestic interest rate means the price of your currency will have to float up and down according to how much money the markets want to put in or take out of your country at the prevailing interest rate.

Question 5

what are the advantages of having a liberalised capital market?

Answer 5

Many countries wish to allow capital to flow freely internationally - in and out of countries in pursuit of market returns. Capital-scarce nations with high marginal productivity of capital will thus attract foreign direct and portfolio investment into productive employment from capital surplus nations (which have lower marginal returns).

Question 6

what are the advantages of having an independent monetary policy?

Answer 6

Countries will always want to remain in control of their own monetary policy – increasing supplies and decreasing interest rates to stimulate growth; or decreasing supplies and pushing up interest rates if they wish to restrain spending and inflation.

Question 7

why might a country wish to fix their exchange rates?

Answer 7

Countries may also wish to fix their exchange rates so that certainty in trade is thus assured and projected high returns for foreign investors are not destroyed by a speculative movement of exchange rates.

Question 8

what are the qualities that gold has which makes it a good basis of monetary policies

Answer 8

• Instantly acceptable
• Scarce
• High value to weight (so easily portable)
• Divisible into smaller units
• Recognisable and – with the King’s head stamped upon it – it carried the authority of the state

Question 9

what was the issue with gold as a basis of monetary systems and what did this lead to?

Answer 9

it was too scarce so that the rate of growth of gold could not keep paxce with the rate of growth of world outputs. this led to the rise of silver for world trade especially after the spansih conquistadores found supply in america

Question 10

what did the gold standard imply?

Answer 10

the gold standard implied complete convertability of currencies to gold and no restrictions on the movement of capital. that is:
every paper currency could be exchanged for equivalent gold value
each monetary authority could issue no more currency than could be backed by gold
the money supply of each country and thus the international economy was directly linked to every countries gold stock

Question 11

what is fractional reserve banking?

Answer 11

gold reserves are a fraction of the banknotes circulating. this fraction depends on how often customers present their banknotes and claim the gold that each note represents. for example, assume the custom in society is for one in ten people to go back to the bank to claim their gold deposits then 100m gold reserves can back 1000m of banknotes

Question 12

what are the effects of a contraction in the domestic money supply?

Answer 12

cutbacks to paper currency supply
higher interest rates
less spending
deflating incomes
a lower price level
this would result in international capital flowing into that country to benefit from higher returns and lower prices increasing the exports and reducing the imports so countries will win more gold in trade

Question 13

what are the effects of an expansion of the money supply?

Answer 13

increased paper currency
lower interest rates
more spending
a boom in incomes
a rise in price levels
this resulted in capital leaving the country to look for better returns else where and there would be more imports purchased and fewer exports so gold surplus will diminish

Question 14

what were the advantages of the gold standard?

Answer 14

it utilised the worlds most acceptable currency
it provided for certainty and stability of exchange ratrse
it embodied an automatic balancing mechanism for surplus and deficit countries

Question 15

what region of the impossibel triangle did the gold standard operate on?

Answer 15

it opted to accept fixed exchange rates and mobile international capital but it could not have an independent monetary policy

Question 16

what was required of countries that joined the gold standard?

Answer 16

they had to tie their currencies at a declared exchange rate to gold. any trade imbalance between countries were paid off at the end of the trading period by the transfer of the required amount of gold bullion. this meant countries spending more then they earned and thus losing gold in trade were forced to reduce their domestic money supply and countries gaining in gold were required to increase their money supply

Question 17

what were the characetristics of the first major boom in globalisation that took place in the 19th century?

Answer 17

there was no major international wars
no major restrictions on the movement of people and capital
improvements in transport technology (steam powered railways and shipping
there was a trustworthy international currency system

Question 18

what were the issues with the gold standard?

Answer 18

some countries would not play by the rules - one problem was that deficit countries had to deflate their incomes and spending if they lost gold but surplus countries which accumulated gold reserves had a much weaker incentive to expand. the issue was the fallacy of composition which states no equilibrium in world trade can be reached if any one country breaks the rule as if one country runs a surplus another must run a deficit. as long as gold was draining out of the world economy, countries would fight hard to keep hold on remaining supply so will deflate their economies. the system was therefore inherently deflationary with the greater hardship being forced onto deficit countries
the second issue was too much austerity - governments of deficit countries could turn a blind eye to the suffering caused by deflationary policies that were necessary to cure an imbalance. it was a time when gold was king and the ruling class were elitist so there was no media that could embaress governments. not everyone could vote either. this led to enforced hardship for poorer classes which would not bring down governments. however this all changed after the first world war

Question 19

what was the treaty of versailles?

Answer 19

it was a treaty by the leaders of the victorious nations to ensure no future war was possible. austro-hungary was torn up and Germany was made to slice up and give off parts of its territory to its neighbours, plus pay huge reparations for disaster inflicted particularly on flanders in belguim

Question 20

what was john maynard keynes view on the treaty of versailles?

Answer 20

keynes attended the versailles conference as a delegate of the UK treasury but he was outraged at the treaty that was drawn up. he disagreed with the treaty of versailles. he said it ignores the economic solidarity of Europe and by aiming at the economic life of Germany and makes impossible demands which will leave Europe more unsettled then it was. he predicted that it will cause a second world war

Question 21

what was the inflation in austria in 1922?

Answer 21

austria inflation in 1922 reached 1,462% and from 1914 to January 1923, the consumer price index rose by a factor of 11,836

Question 22

how often were prices doubling in germany?

Answer 22

prices were doubling every 2 days. it was cheaper to light fires with bank notes than to purchase coal

Question 23

what happened to britain after it returned to gold?

Answer 23

britain returned to the gold standard in 1925 with the mistake of returning the pound to its pre war parity, thinking it would restore confidence in the £. however with post war price levels now much higher, this meant severe UK deflation was required. this meant the only way to reduce industrial costs was for the government to enforce a cut in wages of the coal industry

Question 24

what was the general stike?

Answer 24

the only way for the UK to reduce the industrial costs after the return to the gold standard was to enforce a cut in wages for the coal industry. however the coal miners fiercly resisted the cut in their wages which had been falling in real terms. this led to the general strike in may 1926. the country came to a halt as energy supplies were frozen and all public transport was stopped as millions joined the strikes. this led to the government sending troops in to restart essential services. the government did not back down and wages were cut and workers resisting were starved into surrender