Week13+ the+International+Monetary+System

8/9/2019 Week13+ the+International+Monetary+System

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Macroeconomics 1: Week 13The international Monetary system

1. Exchange Rate Systemsa) Freely floating flexible exchange rate regimesb) Fixed exchange rates

2. History of International Monetary Systemsa) The Gold Standardb) Bretton Woodsc) Managed floats

3. Australias Exchange rate history

Reading: Jackson & McIver pp. 95-98 Chapter 18


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Exchange rate systems

Two types of exchange rate system: Flexible or floating exchange rates

The exchange rate is determined by demandand supply Fixed exchange rates

Government intervention in the foreignexchange market offsets the changes inexchange rate caused by the demand andsupply factors


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Freely floating exchange rates Determined by the unimpeded forces of

supply and demand Depreciation and appreciation

Depreciation in the exchange rate is an increase

in the number of units of a countrys currencyrequired to buy a single unit of some foreigncurrency

Appreciation is a reduction in the number of unitsof a countrys currency required to buy a singleunit of some foreign currency


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Flexible rates and the balanceof payments

Flexible exchange rates automaticallyadjust so as to eliminate balance of payments deficits or surpluses


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Adjustments under flexible, fixed & the goldstandard

P

Q

Dollar price ofonepound

Pounds

3

2

1

S 1

D 0

D 1

D 0

D 1

S 1

C

B

A

X


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Flexible exchange rates (cont.)Disadvantages of floating exchange rates Instability in the macroeconomic environment

Destablising effects on the domestic economyarising from shifts in net exports brought aboutby changes in the exchange rate

Complicates the use of domestic monetary andfiscal policies


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Fixed exchange rates

Exchange rate for which the values aredetermined by government decision

Nations have often fixed or pegged theexchange rate to overcome thedisadvantages of floating exchange rates

Fixed exchange rates require adequatereserves to accommodate periodicbalance of payment deficits


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Fixed exchange rates (cont.) Trade policies

To maintain a fixed exchange rate, a countrymay enact protectionist trade policies to increasenet exports

Exchange controls: rationing Restricting imports to the amount of foreign

exchange earned by exports

Domestic macroeconomic adjustments Use fiscal and monetary policies to adjust GDPto a level consistent with the fixed exchange rate


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International monetary system:the gold standard

A system under which the value of a nationsmonetary unit was backed by gold rather thanfiat

Gold standard conditions Define the monetary unit in terms of a certain

quantity of gold

Fixed relationship between stock of gold and thedomestic currency

Allow gold to be freely exported and imported


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The gold standard (cont.) Gold flows

This would result in exchange rates that are fixed Domestic macro adjustments

The gold standard implies changes in the domestic

money supply of nations, which affects prices,real output and employment Advantages of gold standard

Stable exchange rates resulting from the goldstandard reduces uncertainty and risk The flow of gold between countries caused shifts

in the supply and demand curves and automaticallycorrects balance of payments deficits or surpluses


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The gold standard (cont.)

Disadvantages of gold standard Nations must accept domestic adjustments in

the form of higher unemployment or inflation Countries must have sufficient reserves of

gold Demise of the gold standard

During the Depression years of the 1930s


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Bretton Woods monetary system Bretton Woods conference 1944 Adjustable peg system of exchange rate

emerged A system by which members of the IMF were

obligated to define their monetary units in termsof gold (or US dollars), establishing par rates of exchange between the currencies of all other members, and to keep their exchange rates within 1per cent of these par values

US Dollar the main international currency Capital flows were believed to be destabilizing,

prewar controls were left in place.


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Bretton Woods monetary system

Fundamental imbalances: adjusting the peg Countries running persistent balance of payments

deficits ran out of reserves and were unable to

maintain its fixed exchange rate Demise of the Bretton Wood

Dilemma: dollars and the deficits Emergence of floating rates


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Managed float An exchange rate system where central banks

buy and sell foreign exchange to smooth outshort-run or day-to-day fluctuations in rates

Encourages international trade and finance,while allowing for trend or long-term exchange

rate flexibility to correct fundamental paymentsdisequilibria Liquidity and special drawing rights

Special drawing rights are bookkeeping entries

at the IMF, available to IMF members in proportionto their IMF quotas, that may be used to settle payments deficitsor satisfy reserve needs in place of foreign exchange or gold


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Managed float (cont.)

Demonetisation of gold Further reform of the international monetary

system led to the downgrading of the roleof gold

Gold has now ceased to function as aninternational money


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Managed float: an evaluation

Arguments for managed float Trade growth

Managing turbulenceArguments against Volatility and adjustment

Reinforcement of inflation


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Exchange rate history: AustraliaFrom 1931 to December 1971 the Australian currency

dollar was tied to the pound sterling. In 1971 major devaluation of the $US link between

the $Aus and Pound Sterling severed. $Aus pegged to

the US dollar 19711974 Was revalued in 1972 and 1973

Pegged to the trade-weighted index 19741976

An index of the average exchange rate comprisedof the basket of currencies of Australias major trading partners, weighted to reflect their share of trade


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Exchange rate history:Australia (cont.)

From 1976 till December 1983 operated on amanaged float with the exchange rate set bythe Governor of the Reserve Bank, theSecretary of the Treasury and the Secretaryof the Department of the Prime Minister andCabinet, rate announced every morning.

The floating of the exchange rate (1983) mostexisting exchange rate controls beingremoved, including controls on capital flows


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Exchange rate history: Australia

Floating and the current account crisis Recovery during the late 1980s

The early 1990s and the 1990 recession The late 1990s and the Asian crisis Into the 2000s

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