Week 8

Question 1

What are the 3 tasks of the monetary system ?

Answer 1

Monetary systems look to fulfill three tasks:

1. Liquidity: a monetary system needs to provide enough liquidity funds to finance trade and investment, and to serve as a lender of last resort in times of crisis.
2. Confidence: monetary systems need to provide low uncertainty about future stability in order to make it Investment-attractive, and therefore need to have limited volatility.
3. Adjustment: monetary systems need to push for adjustments in order to reduce imbalances destabilizing the system.

Question 2

What are the 2 different adjustment mechanism ?

Answer 2

1. In the case of fixed exchange rates, recession hits, and decreases wages affecting workers most. Central banks don’t interfere in this process, they can only speed it up.
2. Here there is no recession. Foreign producers (and capital owners) are the ones bearing the costs of the adjustment.

Question 3

When there are flexible exchange rates, what are the effects of the increasing current amount deficit on:

• the money outflow
• exchange rate
• domestic and foreign prices
• exports and imports
• current acount deficit

Answer 3

• the money outflow increases
• exchange rate decreases
• domestic and foreign prices decrease
• exports increase
• imports decrease
• current acount deficit decreases

Question 4

When there are fixed exchange rates, what are the effects of the increasing current amount deficit on:

• the money outflow
• money supply
• domestic prices
• exports and imports
• current acount deficit

Answer 4

• the money outflow increases
• money supply decreases
• domestic prices decrease
• exports increase
• imports decrease
• current acount deficit decreases

Question 5

What are the key monetary systems ?

Answer 5

pre-1914 period = Gold standard
interwar period = return to gold and collapse
post-1945 period = Bretton woods and collapse
post-1973 period = hybrid (non-)system

Question 6

Why did England move to the Gold standard ?

Answer 6

When Britain moved to the Gold standard, it led to the diffusion of it. The Gold Standard relied on a fixed exchange rate system, a priority for external stability, and capital mobility.

Question 7

Explain the stability of the Gold standard

Answer 7

When Britain moved to the Gold standard, it led to the diffusion of it. The Gold Standard relied on a fixed exchange rate system, a priority for external stability, and capital mobility.
As external stability was considered crucial, adjustments had to be made on the internal level via compression of domestic demand. This is illustrated by David Hume’s Price-Specie-Flow model.

Question 8

Explain the theory of the Great Transformation by Polanyi

Answer 8

Polanyi describes the slow death of the Gold Standard, the international disintegration of that system as a consequence of Britain’s declining power, and the raising costs it had to pay in order to defend the Gold Standard.
Domestic pressure increased, and there was unwillingness of policymakers to subordinate questions of social organization to the restoration of currency. The reasons for that are rising labor interests, and shifts in economic beliefs and values.
In her analysis, the Dependent Variable is the Stability of the monetary system, and the Independent variable either confidence, or hegemony. Other explanations include new governments, namely social democratic ones, democratization, or domestic/international changes.

Question 9

The underlying question when developing a monetary system is who will bear the costs of adjustments? What are the different adjustment interests ?

Answer 9

1. Asset owners: Asset owners become their income from investment returns, therefore, their interest relies in a stable, low inflation system.
2. Working class: The working class receives its income from employment; the demand for countercyclical fiscal and monetary policies leads them to prefer a flexible monetary system.

Question 10

Why did the working class demand became stronger after 1918 in England ?

Answer 10

Institutional changes in England after 1918 explain why this demand became stronger. There was universal male suffrage, and empowerment of parliaments. This meant a strong political resistance to internal adjustments during the interwar period.
Consequently we observe an empowerment of parliaments ant theincrease of the labor power. Thus they want a flexible XR.

Question 11

Explain the theory of keynesianism

Answer 11

Keynes observed in the interwar period persistent unemployment, and strong commercial competition (tariffs etc.). He interpreted it as a failure of internal adjustments, and the use of commercial policy as a way to bypass these adjustments.
Keynes pleaded for the priority of internal stability. His view was widely unpopular, as it was inconsistent with the Gold Standard. It is only when the Gold Standard collapsed that that Keynes served as a framework to make sense of the new situation.

Question 12

Explain the theory of policy learning by Morrison

Answer 12

A study by Morrison describes the departure of Great Britain from the Gold Standard more like an accident than a choice. Before Britain exited the Gold Standard, even the Labor party was against a departure from it, even though it contradicts the interests of the workers the party represents.

Question 13

If we apply the theory of policy learning by Morrison to Britain’s adandonment what are we observing ?

Answer 13

The debate was at its highest in August 1931, and opposed the Governor Normans who wanted to increase external stability, and Deputy Governor Harvey, who was for a departure of the Gold Standard.
In September 1931, Harvey temporarily suspended Gold convertibility as a sort of experiment. What came out of this is that there was a 30% depreciation, no hyperinflation, and a growing economy.
What started as an experiment ended up being a comfortable situation for Britain, leading to its choice not to go back.

Question 14

What is Bretton woods ?

Answer 14

The Bretton Woods conference in 1944 opposed White to Keynes who had different ideas about the shape the new monetary system should have. In the end, the Bretton Wood resulted in a monetary system with a fixed but adjustable exchange rate, a gold-dollar standard, capital controls, but what changed a lot from the previous system was that it allowed for domestic autonomy. The IMF was also an introduction of the Bretton Woods system.

Question 15

How are the adjustement under the BW system ?

Answer 15

Under this regime, adjustments would be symmetric (between deficit and surplus countries). External adjustment should happen only in the case of a “fundamental disequilibrium”.

Question 16

How was the BW system in Europe at the beginning ?

Answer 16

In its early years, the geopolitical situation in Europe led to the Bretton Wood System to be fragile. European currencies were unstable, but through the Marshall plan, the system eventually stabilized by the late 50s.

Question 17

When did the destabilization of the BW system occur ?

Answer 17

Destabilization occurred with the US trade deficit. This would lead to the “Dollar glut”, an overflow of dollars in the world resulting from the creation of new money from the US to counter the trade deficit. This was seen as an exorbitant privilege for the US, and raised conflicts.
When the Gold Window was closed in 1971, it led to the collapse of the Bretton Wood system. In 1973, fixed exchange rates were abolished.

Question 18

Explain the theory of the embedded liberalism

Answer 18

The embedded liberalism is a compromise between 2 positions defended by the US and the UK: liberal democracy and economic regulations. Within this theory the governement should protect its citizens from economic recession (fixed XR) by interviening within the capitalist economy to provide full employment, social safety nets and economic growth.

Question 19

What are the 4 norms of the BW system ?

Answer 19

1. trade promotion, domestic autonomy
2. public international finance
3. symmetric adjustement
4. monetary stability

Question 20

What are the 5 rules of the BW system ?

Answer 20

1. fixed, but adjustable exchange rate
2. adjustment if fundamental disequilibrium
3. capital controls
4. emergency lending
5. surveillance

Question 21

How it the IMF fund today ?

Answer 21

The key developments that led to the transformation of the IMF are first the breakdown of the Bretton Woods system (1973). The rise of the G7 at that same time as a parallel institution and recurrent financial crises led to it changing its functions.
The fund was “revived” by taking the role of sovereign debt managers, capital account crisis managers, by pushing economic transitions and reforms, and a new element changing its nature is also conditionality.

Question 22

How was the Gold supply within the BW system ?

Answer 22

Gold Supply in the Bretton Woods system considerably shrunk over time. This was caused by the US expansionary policy, their current account. As the amount of dollars on the market increased, gold could not follow the growth of dollars. What other countries had to do to keep the system stable was buying more and more dollars as a reserve. At the time of the end of the Bretton Woods system, foreign countries held about 14 billion in US dollars, while the US had 13.8 billion dollars-worth of gold.

Question 23

What is the problem with he Gold supply within the BW system ?

Answer 23

The problem here is that confidence decreases, because everyone expected a reevaluation of the value of Gold.

Question 24

Explain the Triffin dilemma

Answer 24

The Triffin dilemma or Triffin paradox is the conflict of economic interests that arises between short-term domestic and long-term international objectives for countries whose currencies serve as global reserve currencies. Triffin pointed out that the country whose currency, being the global reserve currency, foreign nations wish to hold, must be willing to supply the world with an extra supply of its currency to fulfill world demand for these foreign exchange reserves, thus leading to a trade deficit.

Question 25

Apply the Triffin dilemma with the situation of USA

Answer 25

The use of a national currency, such as the U.S. dollar, as global reserve currency leads to tension between its national and global monetary policy. This is reflected in fundamental imbalances in the balance of payments, specifically the current account, as some goals require an outflow of dollars from the United States, while others require an overall inflow.
Specifically, the Triffin dilemma is usually cited to articulate the problems with the role of the U.S. dollar as the reserve currency under the Bretton Woods system. John Maynard Keynes had anticipated this difficulty and had advocated the use of a global reserve currency called ‘Bancor’. Currently the IMF’s SDRs are the closest thing to the proposed Bancor but they have not been adopted widely enough to replace the dollar as the global reserve currency.

Question 26

How did the USA react on the economic side after the 1958 ?

Answer 26

After 1958, the US led a growing trade deficit caused by military aid and trade. This led as seen before, to the decline of US gold reserves.

Question 27

What was the reaction of the European countries after the decline of US gold reserves?

Answer 27

The French unhappy about the situation threatened to convert their Dollar reserves and offer nuclear protection to Germany, inciting it to do the same. Germany’s response was counter-intuitive, it reassured the US of its commitment to stability and to hold on to its dollar reserves.
Change occurred in the détente period of the cold war, but not before. This shows of geopolitics influence monetary systems.

Question 28

Who is the author that developped the security environment ?

Answer 28

Walter: German Bundesbank did not convert any Dollars in gold, because they had nuclear protection by US -> but this ended with international détente, etc.

Question 29

Who did study the following question: why did Nixon close the “Gold Window”?

Answer 29

Gowa

Question 30

Explain the theory of Gowa about the closure of the Gold Window

Answer 30

First, there was pressure on Nixon for the upcoming elections of 1972. The country faced rising unemployment, and Nixon’s past experience (1960) led him to his decision.
Second, but not less important, are the underlying assumptions of the effect closing the Gold Window would have. Nixon expected economic voting, and according to the Phillips-Curve, higher inflation rates would lead to less unemployment.

Question 31

What were the key debates about monetarism leading to the end of the Keynesian Norms?

Answer 31

Monetarism was the new norm. Critique of the Philips curve increased, and the argument that monetary policy, government intervention is unnecessary had strong resonance through figures like Milton Friedmann. The new standard was to focus on money supply, not demand. Restrict money supply and keep money low.
There was also neo-Keynesianism, a reformulation of Keynesianism through a neoclassical framework, which departed from Keynesianism in various ways.
Both groups departed from Keynes, and were looking for technical fixes to the situation.

Question 32

When can we trade the basis of the non system ?

Answer 32

The basis of the “non-system” post 1973 can be traced back to the G7 Jamaica meeting (1978) leading to the legalization of variations in exchange rate regimes. This was added to the IMF charter. This situation led to increasing capital openness.

Question 33

Which new system was in place after 1973 ?

Answer 33

The new system is marked by the rise of the G-7, and a mixture of cooperation and conflict. Sometimes there was little concern about the value of currencies (Bush in 1990), while now some claim that “we’re in the midst of a… currency war” (Mantega, 2010).

Question 34

Who bear the cost of the recession in a fixed rate system ?

Answer 34

The recession hits and the wages decline, the population bears the costs.

Question 35

Who bear the cost of the recession in a flexible rate system ?

Answer 35

There is no recession, as the capital owners and the foreign investors bear the costs.

Question 36

How do we adjust internally in the fixed XR system ?

Answer 36

As external stability was considered crucial, adjustments had to be made on the internal level via compression of domestic demand. This is illustrated by David Hume’s Price-Specie-Flow model.

Question 37

When were the fixed XR abolished ?

Answer 37

in 1973

Question 38

What were the 2 opposite opinions for the BWs system ?

Answer 38

• The US wanted an open trading system that would be nondiscriminatory and multilateral.
• The UK stressed on full employment, international stability, and wanted to maintain an imperial preference system.