IMS and financial crises

Question 1

Exchange rate regimes and how they worked

Answer 1

• classical gold standard: transfers of gold could be substituted by transfers of currencies
• gold exchange standard: US and UK could only have gold reserves while others had gold and USD or Pounds
• bretton wood: currencies pegged to USD or gold
• Post bretton: floating regime

Question 2

Why bretton woods failed?

Answer 2

• undervalued DEM and JPY
  -Fear USD would devalue
• DEM lowered its value by selling DEM to buy USD
• money supply germany increased
  -couldn’t sterilized and maintain the fixed exchange rate
  -20% increase in money supply germany

Question 3

countries with exchange rate targeting

Answer 3

argentina panama

Question 4

countires with monetary targeting

Answer 4

germany, switzerland

Question 5

countries with inflation targeting

Answer 5

australi, canada, UK

Question 6

Countries with mon. policy with implicit nominal anchor

Answer 6

USA

Question 7

Adv and disadv of monetary targeting

Answer 7

• allosw CB to adjust monetary policy quickly in response to domestic needs
• info on achieving goals is known almost immediately
  but:
• there must be a clear relation between monetary aggregate and more visible goal variable
• central bank must efficiently control the targeted monetary aggregate

Question 8

Adv disadv of inflation targeting

Answer 8

adv:
- monetary policy focused on domestic needs
- easily understood
- increases CB’s accountability
DIsadv:
- may lead to unstable output growth and unemployment
- May put stringent bounds on policy makers to respond to unforeseen economic circumstances

Question 9

Adv disadv implicit targeting

Answer 9

adv:
- demonstrated success on the us econ prior to 2008
- forward-looking
Disadv:
- lack of transparency
- strong dependence on personal skills and preferences

Question 10

Adv disadv of Quantitative Easing

Answer 10

adv: can be implemented without printing new money and when interest rates are close to zero
Disadv: can lead to inflation due to oversupply of money and misuse of additional funds

Question 11

Possibilities of fixed exchange rate regimes

Answer 11

• fixing value to a commodity
• fixing value to that of a large, low inflation country
• adopting a pegging target in which the home currency is allowed to depreciate at a steady rate

Question 12

Two possible regimes of floating currency

Answer 12

-managed float
- independent float

Question 13

Adv of fixed rate targeting

Answer 13

• fixes inflation for int traded goods, keeps inflation under control
• inflation expectations in home country tied to that of target country
• forces to have tight monetary and fiscal policy
• simplicity and clarity of the policy

Question 14

Disadv of fx rate targeting

Answer 14

• leads to loss of independent monetary policy
• directly transmits traget country’s shocks
• leaves country open to speculative attack on its currency
• increases possibility of financial crises in dev countries

Question 15

Adv disadv of floating rate regime

Answer 15

adv:
- offset cross country diff in inflation
- can stabilize nominal exchange rates if countries pursue coordinated monetary policy
Disadv:
- potentially lead to high real exchange rate volatility
- increases uncertainty about future govt policy

Question 16

Structure and purpose of eurodollars

Answer 16

-time deposits, not demand deposits
purpose:
- way of holding excess corporate liquidity
- major source of short-term bank loans

Question 17

Major trends

Answer 17

• increased collaboration among govts on fiscal and monetary policies
• increased understanding of a need for a new system of fixed exchange rates

Question 18

Major pitfall

Answer 18

• protectionnism
• instability of developping and some developed countries

Question 19

FInancial crises can occur as a result of (rank them in order of how serious they are)

Answer 19

• Currency crisis
• banking crisis
• twin crisis (both together)

Question 20

Theory of depletion of international reserves

Answer 20

unsustainable monetary-financed fiscal deficits lead to a persistent loss of international reserves and ultimately ignite a currency crisis

Question 21

Theory of governments commitment to 2 conflicting targets

Answer 21

Govt can have conflicting goals: ex decrease unemployment govt may want to devalue currency to increase comp abroad, and abandon the peg (like germany in bretton woods)

Question 22

Theory of sudden reversals in capital flows

Answer 22

• cap inflows can come to a stop and suddenly become outflows
• liberalization of cap markets may contribute to unrestricted movement of short term cap
• long term cap inflow would contribute to more foreign investment

Question 23

Teory of substantial increase in credit

Answer 23

• excess credit can fuel a prolonged expansion of economic activity
• as recession unfolds, depositors reassess the risks and withdraw large amounts of money from banks
• the banks position can be weakened if there is increase in deposit rates abroad

Question 24

Asymetric info theory

Answer 24

• hard to channel funds to best investment with moral hazard in play

Question 25

How to resolve the crises

Answer 25

• FS must be restarted as soon as possible
• BS of firms must be restored to lessen the asymmetric info prob
• moral hazard from intervention must be limited

Question 26

lessons from crises

Answer 26

• strong rationale for international lender of last resort
• this lender should impose appropriate conditions on its lending
• exchange controls cannot advert the crises

Question 27

Why a lender of last resort

Answer 27

because industrialized countries have ability to recover from crises without sparking inflation while emerging countries do not

Question 28

lending condition

Answer 28

• insolvent financial inst must be closed down
• depositors must be convinced that their funds are not at risk
• lending must be provided fast if those cond are met

Question 29

Capital movements can have an important role in producing financial instability, BUT

Answer 29

• only the result of inadequte monitoring of banks by the govt
• lack of supervision can encourage excessive capital inflows and risk taking

Question 30

dangers of pegged exchange rates

Answer 30

• devaluation is larger from a speculative attack
• can facilitate excess outflow and inflow