Int'l Parity conditions and the Int'l Monetary System (Lecture #10) Flashcards
What are the two kinds of fixed pegs?
hard peg, soft peg
def. hard peg
extreme currency regime peg forms such as Currency Boards and Dollarization
def soft peg
fixed exchange rates where authorities maintain a set variable band about some other currency
what are the two general types of floating rates?
managed float, free floating
def. managed float
let market go, but sometimes jump in (occasional gov intervention)
def. free floating
market forces decide exchange rate with no gov intervention
def. crawling peg
intermediate peg
-start at one rate and actively manage currency to reach another rate
def. arrangement with no separate legal tender
a type of hard peg
the currency of another country circulates as the sole legal tender (formal dollarization) as well as members of a monetary or currency union in which the same legal tender is shared by the members
def. currency board arrangement
a monetary arrangement based on an explicit legislative commitment to exchange domestic currency for a specific foreign currency at a fixed exchange rate, combined with restrictions on the issuing authority. restrictions imply that domestic currency will be issued only against foreign exchange and that it remains fully backed by foreign assets
A nation’s choice as to which currency regime to follow reflects national priorities about all facets of the economy, including:
– inflation, – unemployment, – interest rate levels, – trade balances, and – economic growth
does the choice about fixed vs floating ever chane?
yes, choice between fixed and flexible rates may change over
time as priorities change
fixed rate regime pros (2):
- stability in international prices
* inherent anti-inflationary nature of fixed prices
fixed rate regim cons (2):
- Need for central banks to maintain large quantities of hard currencies and gold to defend the fixed rate
- Fixed rates can be maintained at rates that are inconsistent with economic fundamentals
When do currency boards exist? What do they mean?
-exist when a country’s central bank commits to back its monetary base, money supply, entirely with foreign reserves at all times
-This means that a unit of the domestic currency cannot be introduced into the economy
without an additional unit of foreign exchange reserves being obtained first
what is dollarization?
the use of the USD as the official currency of the country
what are arguments for dollarization?
– No currency volatility and currency crises
– Greater economic integration with dollar based markets
what are arguments against dollarization?
– Loss of monetary policy
– Loss of power of seignorage
– The central bank of the country no longer can serve as lender of last resort
what are the exchange rate regime tradeoffs
rules vs. discretionary and
cooperation vs. independence
define in terms of rules vs. discretionary and cooperation vs. independence: pre WW1 Gold Standard
rules and independence
define in terms of rules vs. discretionary and cooperation vs. independence: The Bretton Woods agreement (and to a certain extent the EMS)
rules and cooperation
define in terms of rules vs. discretionary and cooperation vs. independence: The present system
no rules with varying degrees of cooperation
define in terms of rules vs. discretionary and cooperation vs. independence: possible future systems?
may only succeed
combining cooperation with individual discretion
def. balance of payments
The measurement of all international economic transactions between
the residents of a country and foreign residents
-Double-entry book-keeping system to record all economic transactions between
the residents of a country and foreign residents in a given period
what is the BOP a reflection of?
the supply and demand of a
country’s products, services, financial assets…
why is the BOP important for government policymakers and MNEs?
it is a gauge of a nation’s competitiveness or health
– An indication of pressure on a country’s foreign exchange rate
– A signal of the imposition or removal of controls in various sorts of payments
– A forecast of a country’s market potential
debit is associated with what
payment OUTFLOWS (negative signs)
credit is associated with what
payment INFLOWS (positive signs)
What are the 3 main elements of actual process of measuring international economic activity
- Identifying an international economic transaction
- Understanding how transactions create debits and credits
- Understanding the bookkeeping procedures for BOP accounting
the BOP is composed of what to primary sub accounts
– the Current Account
• Measures the value of trade (goods and services), investment income and
unilateral transfers
– the Capital/Financial Account
• Measures financial activity (ex: associated with the activities in the
current account but also pure financial flows)
is a BOP a balance sheet or cash flow statement?
cash flow statement
examples of current account transactions
– The export of merchandise, goods such as trucks, machinery, computers
is an international transaction
– Imports such as French wine, Japanese cameras and German automobiles are international transactions
example of financial account transactions
The purchase of a US Treasury bill by a foreign resident
Examples of transactions that are counted in and captured in the U.S. BOP
– A U.S. based firm, manages the construction of a major water treatment
facility in a foreign country
– The U.S. subsidiary of a foreign firm pays profits (dividends) back to a
parent in its home (foreign) country
What is in current account?
• Goods Trade: export/import of goods
• Services Trade: export/import of services
• Income: predominately current income associated with investments
and wages & salaries
• Current Transfers: financial settlements associated with change in ownership of real resources or financial items plus gifts and grants
• Typically dominated by the export/import of goods, for this reason the Balance of Trade (BOT) is widely quoted
Capital and Financial accounts
• Capital account - transfers of fixed assets and acquisitions/disposal of
non-produced/non-financial assets
• Financial account consists of three components and uses maturity and degree of control over assets to classify them
1. Direct Investment – Net balance of long term capital which is dispersed from and into a country for the purpose of exerting control over assets.
2. Portfolio Investment – Net balance of short term capital which flows in and out of the country but does not reach the 10% ownership threshold of direct investment.
• This capital is purely return motivated
3. Other Investment Assets/Liabilities – Consists of various short and longterm trade credits, cross-border loans, currency and bank deposits and other accounts receivable and payable related to cross-border trade
Net erros and omissions
Account for statistical errors and/or untraceable monies
official reserves account
Held by official monetary authorities within a
country
– Typically comprised of major currencies and reserve accounts held at the
IMF
– The significance depends on whether the country is operating under a fixed exchange rate regime or a floating exchange rate system
What four parts makeup a BOP?
- current account
- financial and capital accounts
- net errors and omissions
- official reserves account
def. capital mobility
The degree to which capital moves freely cross-border is
critically important to a country’s BOP
what can the free flow of capital possibly do>
potentially destabilize an economy
what did the Bretton Woods Agreement promote related to capital mobility
promoted free movement of capital for current account transactions
def. capital control
any restriction that limits or alters the rate or direction of capital movement into or out of a country
def. capital flight
– Characterized as rapid outflow of capital in fear of domestic political and
economic conditions and policies
– Many heavily indebted countries have suffered capital flight, compounding
their debt service problems
– Capital can be moved via international transfers, with physical currency,
collectables or precious metals, money laundering or false invoicing of
international trade transactions
Describe China’s twin surpluses
• China’s twin surpluses aka “double surplus” in the current and financial accounts was highly unusual
• Typically, these relationships are inverses of one another
• The reason for the twin surpluses is due to the exceptional growth of
the Chinese economy
• Between 2001 – 2012 China increased foreign exchange reserves by more than a 10-fold increase (2.5 times larger than the next largest)
• China is now able to manage it currency to maintain competitiveness
worldwide
– China can also maintain a relatively stable fixed exchange rate against other major
currencies
