the international monetary system - an introduction

Question 1

what is the international monetary system?

Answer 1

it is a set of rules conventions and institutions that govern the conduct of monetary policies, their coordination, exchange rates and the provision of international liquidity

Question 2

what are international currencies/

Answer 2

currencies that are widely used beyond national borders and have an international status are typically called international currencies

Question 3

what are the determinents of international currency status?

Answer 3

network externalities
financial markets development
credibility

Question 4

how does an international currency derive its value?

Answer 4

it derives its value because others are using it

Question 5

how do the transaction costs vary with the size of the economy?

Answer 5

krugman showed that there are economies of scale in foreign exchange markets. transaction costs in foreign exchange markets decrease in the volume of transactions. hence only the currency of a large country with high trading volume can serve as a medium of exchange internationally.

Question 6

what is krugmans definition of the structure of payments?

Answer 6

the payment flows between the countries

Question 7

what is the structure of exchange?

Answer 7

the actual transactions in currency markets

Question 8

what is the framework to show network externalites?

Answer 8

three countries
trade is bilaterally balanced ( exports are equal to imports)
assume that exchange rates are all equal to 1 so that all exports and imports are denominated in arbitrary units
key assumption : transaction costs in foreign exchange markets are decreasing in the volume traded

Question 9

why mignt network externalities arise?

Answer 9

assume the structure of payments is such that the payments between the US and Mexico are equal to 100 and between the US AND THAILAND is also equal to 100. the payments between Mexico and thailand are equal to 10. as transaction costs decrease with volume, in equilibrium it is more convenient for Mexico and thailand to use dollars for their bilateral trade. the US dollar becomes the vehicle currency

Question 10

what are the key implications of network externalities?

Answer 10

only the currency of a country that is important in world payments ( Share of GDP, trade volume) can serve as an international medium of exchange.
once an exchange structure is established it is difficult to shift it for small changes in the structure of payments
unless the structure of payments changes enough to make the current structure of exchange unprofitable leading to a shift from equilibrium to another
history matters and habits change slowly so even if a countries trade share declines, the international currency role can persist over time

Question 11

what are the determinents of financial markets development>

Answer 11

open and free from capital controls
deep and liquid

Question 12

what are the determinents of the credibility?

Answer 12

the exhcnage rate needs to be stable ( low volatility)
exchange rate depreciation makes holding the currency unattractive and discourage its use
low inflation records

Question 13

what are the benefits of an international currency>

Answer 13

reudced transactions costs
international seigniorage
macroeconomic flexibility
political leverage
reputations

Question 14

what are the risks of international currency?

Answer 14

currency appreciation
external constraint
policy responsibility

Question 15

explain the benefit of reduced transaction costs for an international currency?

Answer 15

ordinary citizens are able to use their own money when travelling abroad.
firms can sell goods abroad in their home currency ( elimination of exchange rate risks)
domestic banks and financial institutions have a competitive advantage in dealing with currency and they can expand business abroad at a lower cost

Question 16

what is segnoirage?

Answer 16

the profit earned by a central bank from the process of money printing

Question 17

explain the benefit of seignoirage for an international currnency?

Answer 17

if a currency becomes an international currency, then there will be an increase in demand for assets denominated in home currency leading to an increase in the price of the bonds and a fall in the interest rate, which amounts effectively to an interest rate subsidy, as it decreases the cost of borrowing

Question 18

explain how exorbiant privilage is a benefit for international trade?

Answer 18

warnock and warnock (2009) estimated that absent the substantial foreign inflows into US government bonds the 10 year treasury yield will be 0.8% higher
the issuer of the international currency can borrow cheaply due to low interest rate and invest the money abroad in assets yielding a higher return
the US are increasingly a world venture capitalist

Question 19

how does exorbiant privilage relate to macroeconomic flexibility?

Answer 19

a key aspect of exorbiant privilege is that the issuer of an international currency is more able to pursue public spending objectives since the demand for its currency is very large.

Question 20

explain how political gains are a benefit to an international currenyc?

Answer 20

leverage ( hard power) - the dependence of others on the domestic currency creates opportunities to exercise leverage directly or indirectly. recent example being the US freezing the russias dollar foreign exchange rate reserves as a response to war in ukraine
reputation (soft power) - international use of currency can promote a countries reputation in world affairs

Question 21

explain how currency appreciation is a cost of internation currency?

Answer 21

an appreciation would make exporters less competitive and lead to domestic uneployment through a depression of the export sector
on the contrary, Kannan emphasised that a terms of trade improvement is beneficial from a welfare point of view because of an increase in purchasing power as the price of imports fal

Question 22

how is policy responsibility : liquidity provision a cost to international currency?

Answer 22

the global financial crisis and the covid 19 crisis have shown that providing other central banks with liquidity is one of the key attributes of an international currency
central banks swap arrangements improve liquidity conditions abroad by providing foreing central banks with the capacity to deliver the international currency to foreing banks during times of market stress

Question 23

how is exorbiant duty a cost to international currency

Answer 23

in times of global crisis, there is a valuation transfer from the US to the rest of the world
during times of global distress there is an increased demand for safe assets denominated in dollars which leads to an appreciation of the dollar, which increases the price of foreign assets denominated in dollars held by the ROW leading to a transfer of wealth from the US to the ROW