International monetary systems Flashcards
What does currency manipulation mean?
The US Treasury department defines currency manipulation as when countries deliberately influence the exchange rate between their currency and the US dollar to by artificially lowering the currency value to gain “unfair competitive advantage in international trade” through the effect of cheaper export
Describe the effect of the trade war on US and chinese currencies.
The us accused china of currency manipulation, as Trump’s tariff increase has depreciated the market and weakened the chinese currency. China tried to lower interest rate to counter the slowdown.
The IMF was not involved in the currency manipulation claim and will likely not be involved, as these claims have happended before, where nothing was done.
What is purchase power parity (PPP) and how does it work?
PPP implies that exchange rate should equal the relative price level in the 2 countries and the real exchange rate should equal 1.
PPP comes in 2 forms:
- absolute PPP: exchange rate equal the level of relative average prices across countries. Means that if goods are more expensive in the US than in EU, then the EUR is stronger
- relative PPP: changes in exchange rates equal changes in prices (inflation) between two periods. Means that if US inflation is higher than EU inflation, then the dollar should depreciate
When is the PPP useful?
The PPP is useful in the long run, as the short run is affected by market frictions and imperfections that limit arbitrage and price stickiness.
This means that PPP is good at capturing movement in the long run, and that relative PPP is more consistent.
Define arbitrage.
When a currency, commodity or security is simultaneously bought and sold in different markets to gain advantage from price differences.
What is the real exchange rate as opposed to the nominal exchange rate?
The real exchange rate is the rate of exchange for goods or baskets of goods across countries. The relative value/price. A rate of 1 means that there is no advantage of purchasing a good from another country which is a prerequisite of absolute PPP
Nominal exchange is the currency value in terms of another currency.
What is the Fisher effect?
The fisher effect describes the relationaship between nominal interest rates and inflation.
A rise in the domestic inflation rate causes an equal rise in the interest rate on deposits of domestic currency in the long run when other factors remain constant.
Explain the simple monetary model.
A simple monetary model explains the price levels in terms of money supply levels and real income levels.
Because PPP can explain exchange rates in terms of price levels, combined with money supply, it can be used to develop a monetary approach to exchange rates.
To forecast future exchange rates we need to know what central banks will do (money supply) and how the economy is expected to grow in real terms (GDP)
If money supply increases faster than GDP, then we experience inflation.
Increase in in money supply should lead to equal increase in price levels and equal depreciation of currency.
What are internal and external balances?
Internal balance describes the macroeconomic goals of producing at potential output (full employment) and of price stability (low inflation).
Economies are headed for recession when there is an excess demand for resources - principal tool: fiscal policy
external balance is achieved when a current account is neither so deep in deficit that it’s unable to repay foreign debts, nor so strongly in surplus that foerigners are put in that situation.
An intertemporal budget constraint limits each country’s spending over time to levels that it can repay with interests - principal tool: borrow from IMF
What is the open economy trilemma?
states that it is impossible for a country to achieve more than two of the following:
- exchange rate stability
- monetary policy oriented toward domestic goals
- freedom of international capital movement
What is the Bretton Woods system?
The Bretton Woods system is a fixed exchange rate against the USD and a fixed dollar price of gold, which was established in 1944 by 44 countries
They also established:
- international monetary fund (IMF)
- the world bank
- General agreement on trade and tariffs (GATT) - predecessor to WTO
Why did the Bretton Woods system collapse?
was primarily caused by lances of the US during the 60s and 70s.
Another problem was that as foreign economies grew, their need for official international reserves to maintain fixed exchange rates grew as well.
Under the system, general fiscal policy could not attain both internal and external balance at the same time
Define negative/positive current account and financial account.
negative current account: consuming more from the rest of the world than they do from you and vise versa
financial account: how you pay for the negative current account.
What is monetary policy autonomy?
without a need to trade currency in foreign exchange markets, CBs are more free to influence the domestic money supply, interest rate and inflation.
This means that CBs can more freely react to changes in aggregate demand, output and prices to achieve internal balance
What is automatic stabilization?
flexible exchange rates change the prices of a country’s products and help reduce fundamental disequilibria (excessive money supply –> inflation)
Inflation causes the currency’s purchasing power to decrease both domestically and internationally, and flexible exchange rates can automatically adjust to account for this fall in value as PPP predicts
