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Microsoft PowerPoint - IntMacroPolicyppt


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									International Economics
The International Macroeconomic History and Policy



Gold Standard and Bretton Woods (CH 18)
What economic policy goals were in place at the time and how did the monetary system in place allow the countries to pursue these goals?
• • The Gold Standard, Specie Flow and “Rules of the Game” Internal and External Balance and the Bretton Woods System

• • •

Floating post Bretton Woods (CH. 19)
The case for floating exchange rates post 1973 The case against floating rates post 1973 (We SKIP the Interdependence and Coordination part of chapter 19 – skim at home)

• •

Optimum Currency Areas and the EU (Ch. 20)
Cost/Benefit analysis of fixing the exchange rate The central role of asymmetric shocks

The Gold Standard
• Pre-WWI in most western countries, lead by UK • Gold standard: Currency was backed by (mainly) gold held by CBs • Economic policy goal: Stabilize gold price
– Needed: always enough CB gold reserves, but not too much. 2 mechanisms would ensure this: 1. Current account: Hume argued that this would happen automatically through the Price Specie Flow Mechanism
• Run down of gold reserves => contraction in real money supply => fall in prices => real exchange rate depreciation => improvement of CA => gold inflow

2. Financial account: “Rules of the Game”: As ∆R<0, CB would reduce D and contract M even further to push up interest rates, trigger financial inflows

The Bretton Woods System and the IMF
• July 1944: Meeting of 44 countries in Bretton Woods (near Washington DC) to shape post-war international financial architecture • Bretton Woods Agreement:
– IMF for exchange rate stabilization – World Bank for post war reconstruction and development – Intended ITO (GATT ratified in 1947)

Bretton Woods Exchange Rate System: The IMF
• All member currencies pegged to the dollar
– N-1 pegs, member countries’ responsibility to keep peg

• Dollar pegged to gold
– Nth currency, US responsibility

• Built-in flexibility:
– IMF lending facilities (quotas, IMF conditionality) – Adjustable pegs (fundamental disequilibrium)

• Convertibility
– Current account convertibility, 1958 (no FX controls for current account transactions) – Capital account convertibility not required (trade in assets could be restricted, capital controls)


External and Internal Balance
Policy goals under the Bretton Woods system: • External Balance
– Balance of payments: CA + ∆R = 0
• FA ≈ 0 since low capital account convertibility

– Hence, CA good measure of change in reserves. – Hence, CA = X is a policy objective

• Internal Balance
– Full employment, Y=Ŷ

Policy tools under Bretton Woods:
– Only one tool for two goals: G – Not possible to attain both goals – realignments needed…

Fundamental Disequilibrium and Realignments
• Fundamental disequilibrium:
– Persistent deviation from external and internal equilibrium – Justification for realignments

• Speculation in realignment countries
– Speculative attacks became increasingly frequent
• As controls were increasingly circumvented • As imbalances (disequilibria) built up and become more frequent


Asymmetry of the system and Transmission of Inflation
• US was not responsible for pegging exchange rate, only for price of gold.
– MsUS was freed to use for other goals – End 1960’s
• Vietnam war financing • Domestic fiscal expansion • => High money growth in US

– Inflation transmitted to rest of Bretton Woods countries – => Choice faced by member countries: – Imported Inflation or Realignment (float..)


Transition to Floating Rates
• Early 1970s:
– Worldwide inflation, highest in US – Increasing need/use of realignments (revaluations) as govs tried to avoid importing inflation – Increasing loss of credibility of pegs. – Speculative attacks increased – Realignment of the dollar in 1971 (devaluation) – High US inflation: Cut of $-peg to gold (additional loss of credibility)

• Shift to floating rates in 1973, as speculative attacks could no longer be contained. • The IMF (clearly) survived!: Borrowing facilities for BoP crises, conditionality

2. Macroeconomic Policy Under Floating
• The case for floating exchange rates post 1973:
– Monetary policy autonomy – Symmetry – Exchange rates as automatic stabilizers
• MF model: adverse shock to demand (for example a reduction in export demand) has less contractionary effects in the short term than under fixed exchange rates. • Counter-argument: This stabilizing effect is often not allowed to work anyway 10

2. Macroeconomic Policy Under Floating
• The case against floating exchange rates post 1973:
1. Does not instill discipline 2. Induces destabilizing speculation 3. Deals poorly with domestic money market disturbances 4. Causes injury to international trade and investment 5. Leaves economic policies uncoordinated (beggar thy neighbor policies) 6. Monetary autonomy is an illusion anyway


2. Macroeconomic Policy Under Floating
• Are fixed exchange rates even an option?
– According to the monetary policy trilemma: – Not if countries keep using monetary policy for internal goals – While not imposing capital controls – Realistic Options:
• Floating • Common currency • Fixed and Capital controls

2. Macroeconomic Policy Under Floating
• Macroeconomic interdependence and the game theoretic model in appendix for coordination in chapter 19: We SKIP this in the lecture. Skim over it briefly at home.


3. The EU and Optimum Currency Areas
• Post Bretton Woods Breakdown: Need for exchange rate cooperation in the (then) European Community
– The Snake (1970s) : Cooperation in mutually defending pegs – EMS (1979 – 1993)
• ERM • Credibility theory of the EMS: import of Bundesbank credibility by countries pegging to the DM

– From 1993-1999:
• EMS with widened bands • Maastricht criteria, convergence…

– EMU + ERM2 + stability and growth pact


The EU and Optimum Currency Areas (OCA)
• Are the benefits of participation in a monetary union greater than the costs? • OCA theory proposes an answer • Monetary efficiency gains (GG curve)
– Savings on hedging cost of exchange rate changes
• Greater degree of integration: higher gain

• Economic stability losses (LL curve)
– Loss of exchange rate adjustment to asymmetric product market shocks
• Greater integration: lower loss • Smaller and more infrequent asymmetric shocks: lower loss

• Gains and losses are weighed up against each other at the given degree of integration


The EU and Optimum Currency Areas
• Optimum currency area criteria:
– High degree of factor and goods market integration – Small and infrequent asymmetric shocks (i.e. similar production patterns)

• An Optimum Currency Area: A grouping of countries for which production patterns are similar and for which goods and factor market integration is high • Endogeneity of criteria…

The EU and Optimum Currency Areas
• Is the world an optimum currency area? • Is EU an optimum currency area? • Is Denmark an optimum currency area?


Summary, International Macroeconomic History and Policy
• Gold standard
– Goals: positive gold reserves – Tools/mechanisms: specie flow and rules of the game.

• Bretton Woods
– Goals: internal and external balance – Tools/mechanisms: Fiscal policy and realignments

• Post Bretton Woods Floating:
– Goals: internal and external balance – Tools/mechanisms: Monetary policy… – Arguments for and against floating

• Post Bretton Woods and fixed European rates
– Optimum Currency Area Theory, degree of economic integration and asymmetric shocks

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