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IPE > History of the International Monetary System > Flashcards

History of the International Monetary System Flashcards

1
Q

Pure gold standard in theory

A
  • Country A imports from Country B
  • Gold moves from A to B (re-coined/minted)
  • Less money in A -> lower prices
  • More money in B -> higher prices
  • Country B imports more from Country A
  • Balance is restored
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2
Q

What is discipline (fixed XR), and its consequences?

A

Central bank has to cause deflation in times of deficit to lower prices
What do lower prices in Country A mean?
- Supply of money down
- If you expect prices to fall in the future, you don’t buy anything today
- More expensive to borrow
- BAD economic crisis
- Jobs cut, poverty, people don’t eat, people die

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3
Q

Why is the gold standard inherently deflationary?

A
  • World’s supply of gold is fixed
  • With economic growth, eventually more goods chase less money -> prices fall, growth constrained
  • The gold standard was able to persist pre-WW1 partly because of new gold discoveries
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4
Q

Keynesianism

A
  • Based on observation of high unemployment in Britain 1920s and 1930s
  • Alternative to neoclassical economics (“the market will fix it”
  • Governments can (should) use monetary and fiscal policy to help the economy out of crises
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5
Q

What was Bretton Woods? What did it allow for? What was it solving?

A

Agreement on the post WW2 monetary system
- A monetary system is a public good
- Coordinating on a common system allowed for:
– Increased international trade and finance
– A way to managed crises so they didn’t spread
- Attempted to solve a global problem
– How to keep monetary policy autonomy and a fixed XR?

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6
Q

How did Bretton Woods achieve exchange rate stability and monetary policy autonomy?

A

Four innovations
- Fixed but adjustable XR
- Capital controls
- Stabilization funds
- The IMF

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7
Q

Fixed but adjustable XR (Bretton Woods)

A
  • The US had a hard peg to gold ($35 an ounce)
  • Other countries were fixed to the US dollar but could adjust within a band to correct imbalances
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8
Q

Capital controls (Bretton Woods)

A
  • Not total control, but allowed governments to impose controls when faced with speculative threats
    – Current accounts (no controls)
    – Capital accounts (controls)
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9
Q

Stabilization funds (Bretton Woods)

A
  • Provide a fund to help governments avoid controls or devaluation when faced with short-term imbalances
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10
Q

The IMF (Bretton Woods)

A
  • Created to monitor state behavior (XR rate changes) and manage stabilization fund
  • Loans were conditional on policy actions
  • Made sure governments didn’t undermine system by devaluing for an export advantage
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11
Q

Why did the Bretton Woods system fail?

A

The institutions didn’t work
- The IMF lacked true authority over XR policy
– Governments didn’t comply, they did what they wanted
- Governments didn’t like conditionality (still dont)
- The stabilization fund wasn’t large enough to deal with the new imbalances caused by globalization

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12
Q

Why is the US privileged in the Bretton Woods system?

A

Country holding currency used as reserve ($US) has an “exorbitant privilege”
- Federal Reserve could run BoP deficits and conduct monetary policy to influence aggregate demand, output and employment
- But US monetary policy influenced economies of other countries, especially as capital mobility rose

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13
Q

What would happen if the USA increased its money supply? (Bretton Woods)

A

Suppose USA increased its money supply:
- Lower US interest rates, putting downward pressure on the value of the US dollar
- If other central banks maintain their fixed exchange rates, need to buy dollar-denominated (foreign) assets, increasing their money supplies

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14
Q

Why did the Bretton Woods system fail? (USA reasons)

A

US unwilling/unable to maintain system
- Bretton Woods depended on the US to exchange $ for gold
- US was spending more money than was entering the country
– Expansionary Macroeconomic Policy: More spending Vietnam War + social spending, without higher taxes
– US dollar left the country (high imports + US investors invest more abroad)
– Increased claims on US gold by foreigners who received dollars
– Eventually dollars > actual gold
- If confidence in peg was in question, investors would rush to sell dollars (speculation), heightened by newly dynamic capital markets

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15
Q

The end of Bretton Woods sequence

A

First
- Speculation about devaluation of the dollar caused large purchase of gold by investors
– Federal Reserve sold huge quantities of gold in March 1968
– US President Nixon “closes the gold window” on August 15th 1971 = no more gold-$US exchange
Second
- Speculation about devaluation of dollar caused investors to purchase large quantities of foreign currency assets
– Coordinated devaluation of the dollar against foreign currencies of about 8% occurred in December 1971
– Speculation about another devaluation occurred: European central banks sold huge quantities of European currencies in February 1973
– Japan and Europe stopped selling their currencies and purchasing of dollars in March 1973, allowing the value of the dollar to fall
End of Bretton Woods monetary system

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16
Q

Characteristics of post Bretton Woods world

A
  • Post BW most major economies floated their currency
  • Europe tried to organize a regional monetary cooperation around German policy
    – Eventually, adopt a monetary union (the Euro)
    – More on this week
  • Other countries floated or pegged to the $US/European currencies
  • Dollars remain world’s reserve currency
  • Despite floating XR, global imbalances still pose a threat to the global economy
  • Uncoordinated macroeconomic policy still has the potential for large problems
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17
Q

3 different models of XR policy

A
  • Electoral model
  • Partisan model
  • Sectoral model
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18
Q

Electoral model (XR policy) general + assumption

A

Politicians have two major ways to influence the state of the economy
- Fiscal policy (taxes and spending)
- Monetary policy (adjust interest rates, if available)
– Monetary policy is determined by a leader’s desire to control their own fate
Assumption:
- Policymakers want monetary policy autonomy, only maintain fixed XR if compatible with monetary policy they want to implement

19
Q

Electoral model (XR policy) and regime type

A

Democracies are more sensitive to the state of the domestic economy therefore monetary policy autonomy is important (but not irrelevant in non-democracies)

20
Q

Electoral model (XR policy) and institutional heterogeneity

A
  • Electoral rules in different democracies (non-democracies) might alter these incentives
  • Veto players
    – The more fiscal constraints, the more monetary policy autonomy is valued
    – eg. Obama and the Republican Congress
21
Q

Electoral model (XR policy), institutions and credibility

A
  • Fixed XR requires a commitment to uphold the peg
  • Democracies might not be the best at upholding commitments
  • Why? Elections
    – Politicians often have incentives to focus on the next election, not long-term commitments
22
Q

Partisan model (XR policy) general + left/right preferences

A
  • XR policy is determined by the ruling party’s ideology/interests
    – Philips curve: there is a trade off between inflation and employment
  • Left-wing parties are “pro-employment”
    – Tend to represent labor organizations, poor folks
  • Right-wing parties are “anti-inflation”
    – Tend to represents business interests, rich folks
23
Q

Partisan model (XR policy) predictions + connection with electoral model

A

Predictions:
- Right-wing governments are more likely than left-wing governments to establish and maintain a fixed XR
- Right-wing governments are more likely than left-wing governments to promote a “strong currency” (as it requires taming inflation)
Connection with electoral model:
- Voters choose left-wing parties during recessions and right-wing parties under inflation

24
Q

Which model of trade politics does the partisan model (XR policy) reflect?

A

The factor model
- Left - labor-oriented - parties
vs
- Right - business-oriented - parties

25
Q

Sector model (XR policy) general

A
  • Interest groups have different preferences toward the trade-off:
    – Some prefer XR stability
    – Others like monetary policy autonomy
  • The “sector” of employment determines preferences
26
Q

4 interest groups of sector model (XR policy)

A
  • Export-oriented producers
  • Import-competing producers
  • Nontraded-goods producers
  • Financial services industry
27
Q

Export oriented producers (sector model (XR policy)) preferences

A
  • Fixed XR: stability for international transactions
  • Weak XR: lowers prices of products abroad
28
Q

Import-competing producers (sector model (XR policy)) preferences

A
  • Floating XR: prefer monetary policy to address recessions/inflation
  • Weak XR: keeps imports high, they are more competitive
29
Q

Non-traded goods producers (sector model (XR policy)) preferences

A
  • Floating XR: prefers monetary policy to address recession/inflation
  • Strong XR: consumes more traded goods, travel more, pay for tuition
30
Q

Financial services industry (sector model (XR policy)) preferences

A
  • XR stability for international transactions
  • But XR volatility can be profitable
    – Currency trade
  • Monetary policy autonomy maintains stable domestic banking system
  • WEAK preference for floating XR
  • No preference for strength of currency
    – Buy foreign assets when XR is strong, repatriate investments when XR is weak (win/win)
31
Q

Criticisms of electoral model (XR policy)

A
  • Limited in explanation
    – Tells us only why a government might abandon a fixed XR
  • Some governments don’t abandon fixed XRs according to its predictions
32
Q

Criticisms of partisan model (XR policy)

A
  • Monetary policy preferences aren’t always neatly distributed across parties
    – Other issues matter
  • Leftists sometimes pursue contradictory measures, rightists are sometimes expansionary
  • Can’t explain situations where monetary policy is separated from politics (independent central banks)
33
Q

Criticisms of sector model (XR policy)

A
  • Overestimates importance of fixed XR to export interests
    – They have ability to purchase insurance
  • Weak currency also increases production costs, eliminating some gains to traded-goods sector (supply chains)
    – They also use imported imports, which rise in cost as a currency weakens
  • Can’t tell us much about which sectors will prevail in political competition
34
Q

The problem for central banks

A
  • We know that democracy -> demand for monetary policy autonomy
  • However, monetary manipulation can lead to runaway inflation
    – This drags on growth and investment in the long run despite short-run benefits
35
Q

What is the upward spiral of inflation?

A
  • Keynes had assumed a stable relationship between unemployment and inflation
  • “Stagflation” in 1970s showed that that assumption could be wrong
36
Q

Time inconsistency and stagflation, and how to avoid the problem?

A
  • In the long-run, governments want price stability, but in the short-run boosting employment is tempting
  • How can we avoid this problem?
    – Adopting a fixed exchange rate, however this ties ones hands to stop using expansionary monetary policy
    —> This is the choice many developing countries make
    —> Democracies don’t do well with fixed XR and free capital flows
    —» Domestic price instability
    —» Inability to deal with real crises
37
Q

Solution to stagflation

A
  • Governments might adopt an independent central bank
  • Appointed for long terms
  • Don’t face electoral pressures (or are at least distanced from them)
38
Q

Central banks as commitment mechanisms

A
  • Political independence provides the mechanism to maintain monetary policy autonomy but not tempt politicians (too much) to abuse it
  • Central banks differ in their independence
    – Freedom to choose economy objectives to pursue
    —> Inflation and/or employment
    – Freedom to set monetary policy to pursue their objective
    – Whether the policy can be reversed by politicians in government
39
Q

European central bank (examples of central banks)

A
  • Mandate for price stability primarily
  • Each country appoints a governing member
  • An executive council sets decisions
  • Appointed to non-renewable 8-year terms
  • Appointed by “common accord” of member governments
  • Can’t be removed by politicians
40
Q

The US Federal Reserve (examples of central banks)

A
  • President appoints a Federal Chair every four years (in non-presidential election years)
    – Confirmed by the Senate
    – Can’t be removed
    – Must “report” to Congress bi-yearly
  • Now has dual mandate to pursue low unemployment and stable prices and interest rates
  • This set-up allows it to act in times of crisis but avoid political time inconsistency problems
41
Q

4 other examples of central banks

A

Swiss national bank
- No provision whatsoever for the government to influence monetary policy
- Highly independent
Reserve bank of Australia
- Highly subordinate
- Secretary of Treasury has final authority on monetary policy decisions and interest rate changes
Reserve bank of India
- Government appoints governor and board of directors to 4-year terms
- Not constitutionally independent, government can overrule
- Faces political pressure
Central bank of the Republic of Turkey
- Highly subordinate
- Three central bankers fired in 2 years

42
Q

What is cryptocurrency?

A
  • Decentralized currencies based on the “blockchain”
  • (Typically) not backed by central banks
  • Some (eg. Bitcoin) supposed to be finite in number = meant to combat inflation
43
Q

Is cryptocurrency the future of money? (three functions of money)

A
  • Medium of exchange
    – Transactions are very computationally expensive
    —> Not clear that blockchains can handle enough transactions
  • Store of value and unit of exchange
    – Shouldn’t be too volatile
  • Fixed supply of money is not a good thing
    – Fixed money supply -> lower growth and/or deflation
    – eg. gold standard
  • People willingness to use a currency to save and invest depends on trust

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