History of the International Monetary System Flashcards
Pure gold standard in theory
- 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
What is discipline (fixed XR), and its consequences?
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
Why is the gold standard inherently deflationary?
- 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
Keynesianism
- 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
What was Bretton Woods? What did it allow for? What was it solving?
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?
How did Bretton Woods achieve exchange rate stability and monetary policy autonomy?
Four innovations
- Fixed but adjustable XR
- Capital controls
- Stabilization funds
- The IMF
Fixed but adjustable XR (Bretton Woods)
- The US had a hard peg to gold ($35 an ounce)
- Other countries were fixed to the US dollar but could adjust within a band to correct imbalances
Capital controls (Bretton Woods)
- Not total control, but allowed governments to impose controls when faced with speculative threats
– Current accounts (no controls)
– Capital accounts (controls)
Stabilization funds (Bretton Woods)
- Provide a fund to help governments avoid controls or devaluation when faced with short-term imbalances
The IMF (Bretton Woods)
- Created to monitor state behavior (XR rate changes) and manage stabilization fund
- Loans were conditional on policy actions
- Made sure governments didn’t undermine system by devaluing for an export advantage
Why did the Bretton Woods system fail?
The institutions didn’t work
- The IMF lacked true authority over XR policy
– Governments didn’t comply, they did what they wanted
- Governments didn’t like conditionality (still dont)
- The stabilization fund wasn’t large enough to deal with the new imbalances caused by globalization
Why is the US privileged in the Bretton Woods system?
Country holding currency used as reserve ($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
What would happen if the USA increased its money supply? (Bretton Woods)
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
Why did the Bretton Woods system fail? (USA reasons)
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
The end of Bretton Woods sequence
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
Characteristics of post Bretton Woods world
- 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
3 different models of XR policy
- Electoral model
- Partisan model
- Sectoral model
Electoral model (XR policy) general + assumption
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
Electoral model (XR policy) and regime type
Democracies are more sensitive to the state of the domestic economy therefore monetary policy autonomy is important (but not irrelevant in non-democracies)
Electoral model (XR policy) and institutional heterogeneity
- 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
Electoral model (XR policy), institutions and credibility
- 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
Partisan model (XR policy) general + left/right preferences
- 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
Partisan model (XR policy) predictions + connection with electoral model
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
Which model of trade politics does the partisan model (XR policy) reflect?
The factor model
- Left - labor-oriented - parties
vs
- Right - business-oriented - parties
