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IPE > Lecture 8 > Flashcards

Lecture 8 Flashcards

1
Q

Paper money

A

 Gold didn’t actually flow (would require huge transaction cost and lots of gold at bottom of ocean)
 Central banks intervene by adjusting money supply
 Gold standard -> strong discipline
* Discipline – willingness to cause hardship at home

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2
Q

Gold standard in theory

A

 If B has more gold than A, there is less money in A and more in B, leading to B importing from A, which leads to A having more gold than B

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3
Q

Discipline

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!

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4
Q

Gold standard and deflation

A

 World supply of gold is fixed
 Economic growth -> more goods chase less money -> prices fall, growth constrained
 Gold standard was able to persist because of new gold discoveries

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5
Q

Bretton Woods

A

A hotel in New Hampshire…
* Agreement on the Post WWII monetary system
* A monetary system is a public good…
* Coordinating on a common system allowed for:
* increased international trade and finance
* a way to manage 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

To fix or float

A

Trade & International capital flows lead to imbalances
* How do governments deal with imbalances, assuming free capital
flows?
* Fixed XR  sacrifice monetary policy
* OR
* Floating XR  exchange rate uncertainty
* Trade off between:
* Exchange rate stability vs.
* domestic price stability with monetary policy autonomy

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7
Q

Keynesianism

A
  • Based on observation of high
    unemployment in Britain
    1920s&30s
  • Alternative 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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8
Q

Why did bretton woods fail?

A

The institutions didn’t work:
* IMF lacked true authority over XR policy.
Governments didn’t comply, they did what they
wanted
* Governments didn’t like conditionality (still don’t)
* The stabilization fund wasn’t large enough to deal
with the new imbalances caused by globalization
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 dollars 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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9
Q

US privileged, currency used as reserve

A

“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
25
US Privileged
* 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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10
Q

Options to fix bretton woods

A

To “fix” the problem:
* The US would have to constrain US economy,
run trade-surpluses, change foreign policy
* Adjust the peg to gold (requires coordination,
can’t be done unilaterally)
* Expand economic activity in the rest of the
world (many states unwilling to experience
inflation).
* None of these options was politically popular

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11
Q

End of bretton woods

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 15 1971 = no more gold-US
dollar 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 BW monetary system

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12
Q

Core take aways bretton woods

A

Fixed exchange rate hard to maintain with increasing capital mobility +
democratic demands for domestic monetary policy
* Gold standard had been backed by the British, BW had been backed by
the US (remember hegemonic stability theory from trade lectures…)
* While it would’ve been nice to have XR stability, The US was no longer
in a position/willing to enforce cooperation.
 US acted in self-interested way
 As did other countries

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13
Q

Post bretton woods

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)
* Other countries floated or pegged to the $US/European currencies
* Dollar remains 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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14
Q

Electoral models; assumption

A
  • Help explain choice between fixed and floating exchange rate
  • Politicians have two major ways to influence the state of the
    economy
  • Fiscal policy (taxes & 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 MP they want to
    implement
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15
Q

Electoral models; regime type and institutional heterogeneity

A

Regime Type:
* Democracies are more sensitive to the state of the domestic
economy…
* Therefore, monetary policy autonomy is more important (but not
irrelevant in non-democracies).
Institutional heterogeneity:
* Electoral rules in different democracies (or non-democracies) might
alter these incentives.
* Veto players
* The more fiscal constraints, the more monetary policy autonomy is
valued
* Ex. Obama and the Republican Congress

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16
Q

Electoral models institutions and credibility

A

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

17
Q

Partisan models

A

XR policy is determined by the ruling party’s ideology/interests
* Remember the Phillips 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 represent business interests, rich folks
* The partisan model reflects the FACTOR model of trade politics

18
Q

Partisan models, prediction

A
  • Prediction of partisan model:
  • Right-wing governments are more likely than left-wing governments
    to establish & maintain a fixed XR
  • Right-wing governments are more likely than left-wing governments
    to promote a “strong currency” (because it requires taming inflation)
  • Connection with Electoral Model:
  • Voters choose left-wing parties during recessions & right wing
    parties under inflation
19
Q

Sector models

A

Interest groups have different preferences towards the trade-off:
* Some prefer XR stability
* Others like monetary policy autonomy
* The “sector” of employment determines preferences.

20
Q

Export oriented producers and XR

A

Export-oriented producers
 Fixed XR: stability for int’l transactions
 Weak XR: lowers price of products abroad

21
Q

Allies and adversaries

A

XR stability:
* Non-tradeable and import competing want flexibility
* Export oriented wants stability
* XR strength:
* Export oriented and import-competing want a weak currency
* Non-tradeables want strong currency

22
Q

Criticisms electoral model

A

Electoral Model:
* 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

23
Q

Time inconsistency 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?
  • Adopt a fixed exchange rate? Ties your hands to stop using expansionary
    monetary policy
  • This is the choice many developing countries make (remember Argentina’s
    election…)
  • Democracies don’t do well with fixed XR and free capital flows
  • Domestic price instability…
  • Inability to deal with real crises
24
Q

Solution time inconsistency problem

A

Governments might adopt an INDEPENDENT CENTRAL BANK
* Appointed for long terms
* Don’t face electoral pressures
* Or are distanced from them

25
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 economic objectives to pursue
* Inflation and/or employment
* Freedom to set monetary policy to pursue that objective
* Whether the policy can be reversed by politicians in government

26
Q

European central bank

A

European Central Bank
* 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

27
Q

US federal reserve

A
  • President appoints a Fed 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 a 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.
28
Q

Four innovations bretton woods

A
  • FOUR INNOVATIONS:
    1. Fixed but adjustable XR
    2. Capital Controls
    3. Stabilization Funds
    4. The IMF
29
Q

Criticisms sector model

A
  • Sector Model
  • Overestimates importance of fixed XR to export interests
  • They have ability to purchase insurance
  • Weak currency also increases production costs, eliminating some gains to tradedgoods sector (remember 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.
30
Q

Criticisms partisan models

A
  • Partisan Model
  • 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)
31
Q

Financial services industry and XR rate

A

Financial services industry.
 XR stability for int’l transactions
 But XR volatility can be profitable
 Currency trade
 Monetary policy autonomy maintains stable domestic banking system
 WEAK preferences for floating XR
 No preference for strength of currency
 Buy foreign assets when XR is strong, repatriate investments when XR is weak.
 Win/win

32
Q

Nontraded goods producers and XR

A

Nontraded-goods producers
 Floating XR: prefers monetary policy to address
recession/inflation
 Strong XR: consumes more traded goods, travel more, pay for
tuition….

33
Q

Import competing producers and XR

A

Import-competing producers
 Floating XR: prefer monetary policy to address recessions/inflation
 Weak XR: keeps imports high, they are more competitive.

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