International Monetary Relations
International Monetary Relations PSC 204- Dr. Chyzh
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This 6 page Class Notes was uploaded by Erica Kugler on Friday March 13, 2015. The Class Notes belongs to PSC 204- Dr. Chyzh at University of Alabama - Tuscaloosa taught by Dr. Chyzh in Spring2015. Since its upload, it has received 164 views. For similar materials see International Relations in Political Science at University of Alabama - Tuscaloosa.
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Date Created: 03/13/15
International Monetary Relations History of Monetary Relations 0 18601930 Gold Standard 0 Currencies back by gold I What does this mean 0 The value of the currency was proportional to the value of gold 0 People could exchange gold for currency and currency for gold 0 Pricevalue of gold thus affected the pricevalue of currency 0 19305 WW2 currencies off the gold standard 0 WW2 1973 Bretton Woods system gt currencies rebacked to gold 0 Many currencies became pegged to the US dollar which was backed to gold 0 1973 now paper currency 0 Currency is backed by faith in what the government says it is worth 0 Ex 1 is worth 1 because that is what the government says it is worth Monetary Relations of Countries 0 there are 3 paths that governments can choose in regards to monetary relations 1 Give up their own currency and adopt the currency of another country a Some Latin American and South American countries have adopted the US b Some countries in Europe have adopted the euro as their common currency 2 Peg the currency to the currency of another country a quotpeggingquot the value of country A s money is fixed against the exchange rate of country B s currency 3 Use own currency wits value determined by the supply and demand of the market a Ex USA has own currency whose value is determined by supplydemand Exchange Rates 0 Exchange rates price of a national currency relative to other national currencies o The price at which one currency is exchanged for another 0 Exchange rates can change gt appreciate or depreciate a country s currency o If the value of the US goes up it appreciates I The dollar in effect grows stronger relative to other currencies I Ex 1 for 2 euros and then rate changes to 1 to 5 euros I Ex 1 for 2 euros and then rate changes to 075 to 2 euros 0 Get more out of other currency I Appreciation benefits US tourists in foreign countries o If the value of the US goes down it depreciates devalues I The dollar in effect grows weaker relative to other currencies I Ex 1 to 2 euros and then the rate changes to 1 to 1 euro I Ex 1 to 2 euros and then the rate changes to 150 to 2 euro 0 Get less out of other currency I Depreciation hurts US tourists in foreign countries How are Currency Values Determined o The supply and demand of currency determines the exchange rates and thus the currency value 0 Higher interest rates make it more profitable for investors to putkeep money in a country 0 High interest rates more profitable return off the interest 0 Governments can raiselower their interest rates as part of their monetary policy 0 Higher interest rate and exchange rates appreciation of a currency 0 Lower interest rates and exchange rates depreciation of a currency 0 Lowering the interest rate Depreciation Policy weaken the currency I People take out loans gt low IRs make it easier for people to borrow money I Consumers and businesses spend more 0 Money supply in the market increases 0 Economy growsexpands o Unemployment decreases because businesses can hire people I Exports increase because foreign governments can buy more US things with sameless money since their currency is stronger compared to the dollar 0 US S is weak relative to other currencies so demand for US S decreases 0 Less expensive for foreigners to buy goods from US 0 Depreciation leads to an increase in exports and decrease in imports I Eventually inflation occurs 0 Combat inflation govts appreciate the currency see next bullet point 0 Raising the interest rate Appreciation Policy strengthen the currency I People take out less loans gt higher IRs make it harder to borrow money I Consumers and businesses spend less because they have less money 0 Money supply in the market decreases 0 Economy slowsshrinks o Unemployment increases bc businesses have less money to pay people I Exports decrease because foreign governments have to pay more for US products since the dollar is stronger than their currency 0 US S is stronger than other currencies so demand for US S increases 0 More expensive for foreigners to purchase goods from the US 0 Appreciation leads to a decrease in exports and increase in imports I Eventually deflation occurs 0 Combat deflation govts depreciate the currency 0 Depreciation policies would be used as a way I To stimulate the economy after an economic downturn I For politicians to gain favor with the public right before elections 0 Appreciation policies would be used to combat inflation caused by depreciation policies 0 AppreciationDepreciation policies produce winners and losers I Appreciation 0 Winners foreign investors foreign govtspeople buying US goods 0 Losers domestic consumers and businesses I Depreciation 0 Winners domestic consumers and businesses 0 Losers foreign investors foreign govtspeople buying US goods Exchange Rates changeable or fixed 0 Can have fixed or floating exchange rates 0 Fixed exchange rate government promises to keep the national currency at a constant value 0 Currency is measured against another currency or precious metal such as gold 0 Also known as pegging a currency 0 Countries that trade a lot use fixed rates I Fixed rates allow you to know what your profits will be when trading 0 Helping with planning and budgeting 0 Developing countries or countries wlow GDP usually operate on a fixed exchange rate I Fixed exchange rate reduces the risks associated wfloating rates I Developing countries want least risky options so that their economies can grow 0 Floating exchange rate currency value fluctuates freely o Fluctuation impacts the valueprice of the currency relative to other currencies o Floating rates is more risky because a currencies value changes from day to day I Profits aren t constant economy can drastically change in an instant I Countries with strong economies developed countries use floating rates 0 Their economies are strong enough to overcome daily price changes 0 Ex US operates on a floating currency 0 Adjustable peg government fixes its currency value for long periods of time but allows for adjustments to the currency value if necessary such as in econ downturns o Middleway between fixed and floating exchange rates 0 Bretton Wood system of 19451973 Who Cares about Exchange Rates and Why o Fixed exchange rates provide stability and facilitate international tradeinvestment 0 However fixed rates reduceeliminate a govt s ability to how control over its own monetary policies since its money is dictated by the actions of other countries in terms of how they value their currency 0 Floating exchange rates offer more freedom over one s monetary policies 0 Government can revalue the exchange rate and thus the currency as it pleases Consumers and Businesses 0 Consumers and businesses wdomestic economic activity favor a floating rate 0 They want the government to be able to manipulate the economy freely so that they earn more profit I Fixed rate would subject consumersbusinesses to the actions of others 0 People who invest abroad favor a fixed exchange rate 0 Floating exchange rate runs too high of a risk in regards to investment returns and profit 0 Strong exchange rate appreciation consumers can buy more of the world s goods 0 Weak exchange rate depreciation purchasing power decreases domestic consumers hurt o All domestic actors favor a currency policy that ensures stable prices World Money without a World Government 0 International monetary regime accepted arrangement governing relations among currencies o 2 key features 0 Must identify currencies as fixed floating or mixed 0 Must establish a common base or benchmark for currency comparison I commodity standards I commoditybacked paper standard I national paper currency standard International Monetary Cooperation and Conflict 0 Successful international monetary regimes depend on interaction among govts of world s major economies o Collective action problem freeride I All governments want to benefit from currency regulations but no one wants to put resourcesmoney towards operating IMRs o Governments face incentives to cooperate and enter into conflict 0 Competition and Prisoner s Dilemma I Can lead to devaluation of currencies I Each country has an incentive to depreciate its currency to make it more competitive on the world market Gold Standard 18701914 0 Stability of the gold standard system was tied to 3 leading financial powers 0 Great Britain 0 France 0 Germany 0 Gold standard was controversial in the US because it made exports less competitive 0 Being on the gold standard made the dollar appreciate relative to other currencies I Foreign governments couldn t afford to buy as much US products 0 Losers of this situation farmers and exporters o Wizard of 02 contains elements of US goldsilver debate I Dorothy US citizen caught between choosing goldsilver monetary policy I Tin man industrial worker I Scarecrow farmer I Lion William Jennings Bryan prosilver presidential candidate in 1896 I 02 William McKinley progold presidential candidate in 1896 I Dorothy s slippers book version silver 0 Silver slippers to get home silver policy solves economic problems 0 PostGreat Depression govts tried floating rates based on paper international currencies Bretton Woods System o PostWW2 Great Britain was main force behind Bretton Woods monetary system 0 Monetary system that was established was tied to the US S which was pegged to gold 0 Later the IMF was created to oversee currency relations 0 1970s US broke from the gold standard in favor of a floating currency economic freedom International Monetary System Today 0 Few major currencies in global market 0 These few currencies operate under a floating rate system I Exchange rates therefore fluctuate regularly o Bc exchange rates float govts must work together to avoid crises and to fix crises Euro Regional Monetary Policy 0 History of the Euro 0 EU member countries at first fixed their currencies exchange rates to Germany s Deutsche mark I What Germany does to affect its domestic economy would have positivenegative implications on the other EU bloc countries 0 When Germany raised its interest rates the other countries raised their interest rates I High interest rates less money in the economy economy slows down I This action drove many countries into a recession o It became obvious that pegging currencies to the Deutsche mark wasn t working 0 EBC or European Central Bank was then established I Created the Euro gt began circulation in 2002 0 Not all European countries use the Euro 0 Yes France Italy Greece No Great Britain Currencies and Collapse 0 Currency crises result from governments failing to credibly commit to a fixed exchange rate 0 The typical currency crisis cycle Government faces pressure to devalue This scares investors who sell off their currencies Government eventually devalues It is more difficult for citizens to pay off foreign debts o This increases defaults and banks collapse triggering a recession 0 The currency crisis can spread through contagion o Uncertainty about one country s currency can feed uncertainties about others 0 Cases of currency collapse or near collapse 0 Europe I After reunification the German Central Bank increased interest rates I This threatened to throw other European nations into recession because their currencies are pegged to the mark I Eventually most of Europe devalues their currency 0 Mexico I Mexican government wanted to hold the peso steady against the US dollar I 1994 the government struggled to maintain its commitment to the peso I The government was ultimately forced to devalue its currency throwing the country into a financial panic o The crisis affected all of Latin America 0000 0 East Asia I In 1997 East Asian economies were booming I Inflation was rising and banks were taking on debt I This led to currency speculation 0 Speculation selling off currency bc loss of faith in its value 0 Causes a decrease in the demand for the currency which causes the currency to depreciate o the values of currencies collapsed o Containing currency collapses 0 Major economic powers have common interest in containing currency crises I Economic stability Public good nonrivalrous nonexclusionary o IMF and other international institutions support governments going through a crisis I Provide money loans economic policies 0 Question is Should governments with a crisis be bailed out Currencies Conflict and Cooperation 0 Exchange rate s impact differs among groups firms regions and individuals 0 Some are winners and some are losers 0 An international monetary regime is a public good but must overcome freeriding 0 Some argue that we may be heading towards a world of regional currency blocs
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