International monetary International monetary systemsystem

Chinese version for the terminology

P557 case studyThe decline and fall of the Britton Woods System. The

story of the Bretton Woods system’s breakdown is the story of countries’ unsuccessful attempts to reconcile internal and external balancereconcile internal and external balance under its rule.

1958—19651958—1965: … foreign banks converted nearly $2 billion of their holdings into gold in that year. The year 19601960 marked the end of the period of “dollar end of the period of “dollar shortage”shortage”.

1965—19681965—1968: the Vietnam military buildup→U.S. substantial fiscal expansion.

1968—19731968—1973: U.S. inflation influenced speculative sentiments. After massive gold sales by the Federal Reserve and European central banks, … the central banks announced the creation of a two-tier gold markettwo-tier gold market. … massive private purchases of DM motivated by expectations that the DM would be revalued against the dollar. As the Nth currency, the dollar could be dedollar could be devalued only if foreign governments agreedvalued only if foreign governments agreed to peg their currencies against the dollar at new rates.

• President Nixon forced the issue on August August 15, 1971.15, 1971. First, he ended U.S. gold losses by announcing the U.S. would no longer no longer automatically sell gold to foreign central automatically sell gold to foreign central bank for dollarsbank for dollars. Second, he announced a 10% tax on all imports10% tax on all imports to the U.S.

• On March 19, 1973, the currenciescurrencies of Japan and most European countries were floatingwere floating against dollar.

Page 568: macroeconomic policy & Page 568: macroeconomic policy & coordination under floating exchange ratescoordination under floating exchange rates

• The advocates of floating saw it as a way out of the conflicts between internal and external balance. However, some critics describe the post-1973 currency arrangements as an international moneas an international monetary “nonsystem,”tary “nonsystem,” a free-for-all in which national macroeconomic policies are frequently at odds.

The case for floating exchange ratesfloating exchange rates

• World exchange system after 1973• Chinese version of floating exchange r

ate

Three major claims forfor floating

1. Monetary policy autonomy. No obligation and no importation of inflation/deflation.

2. Symmetry. U.S. no longer dominate.

3. Exchange rates as automatic stabilizer. swift adjustment of market-determined exchange rates would help the countries to maintained the balance.

The caseThe case against against floating floating exchange ratesexchange rates

1. Discipline.. Central banks freed from the obligation to fix their exchange rates might embark on inflationary policies.

2. Destabilizing speculation and money market disturbances. Speculation on changes in exchange rates could lead to instability in foreign exchange markets.

3. Injury to international trade and investmentInjury to international trade and investment. Floating rates would make relative international prices more unpredictable.

4. Uncoordinated economic policiesUncoordinated economic policies. The door would be opened to competitive currency practices harmful to the would economy.

5. The illusion of greater autonomy. Floating exchange rates would not really give countries more policy autonomy. Changes in exchange rates would have such pervasive macroeconomic effects that central banks would feel compelled to intervene heavily in foreign exchange markets even without a formal commitment to peg.

Case study: no clear no clear verdictverdict

• Floating or fixed rate? endless debate.

• The commodity shocks left most oil-importing countries further from both internal and external balance than they were when floating began in 1973.

Revising the IMF’s Charter, 1975-1976

• Revising the IMF’s Charter, 1975-1976.

Because floating rates had seemed to function well in conditions of adversity, the governments of the industrialized countries acknowledged late in 1975 that they were prepared to live with live with floating exchange ratesfloating exchange rates for the indefinite future. The IMF’s directors met at Kingston, JamaicaJamaica, in January 1976 to approve a revision of the fourth IMF Article of Agreement, which covered exchange rate arrangement.

• The new Article IV implicitly endorsed floating Article IV implicitly endorsed floating rates by freeing each member country to rates by freeing each member country to choose any exchange rate system it preparedchoose any exchange rate system it prepared.. Governments were urged to follow macroeconomic policies that would promote price stability and growth and they were to avoid “manipulating exchange rates to gain an unfair competitive advantage over other members”

Turning-point of 1979

• before 1979: expansion policy (monetary and fiscal)

• after 1979: cautious towards inflation• Governments could not be indifferent tonot be indifferent to the

behavior of exchange rates and inevitably surrendered some of their policy autonomysurrendered some of their policy autonomy in other areas to prevent exchange rate movementsto prevent exchange rate movements they viewed as harmful to their economies.

Page 581Page 581

Page 590: From the PlazaPlaza to the Louvre and beyond:Trying to manage

exchange rates

• Group of Five countries—the U.S., Britain, France, Germany, and Japan—announced at New York’s Plaza Hotel on Sept. 22, 1985New York’s Plaza Hotel on Sept. 22, 1985, that they would jointly intervene n the foreign exchange market to bring about a dollar bring about a dollar depreciationdepreciation.

• Chinese version for Plaza agreement

Louvre accord—Target zoneTarget zone• On Feb. 22, 1987, finance ministers and central

bank governors from the G-5 countries plus Canada issued a statement pledging to stabilize nominal exchange rates around the levels then prevailing.

• These target zones were not made public.• the implicit zones for exchange rates had no real

force and that the authorities’ reluctance to announce the zones, rather than keeping the market guessing…

Target Zone (band) • 特点特点：确定各国货币的中心汇率中心汇率， 并在中

心汇率附近附近确定一个汇率波动的范围波动的范围。它即有浮动汇率的灵活性灵活性又有固定汇率的稳定性稳定性。

• 区别区别： (Target Zone vs. Bretton Woods )1. 它仍是一种浮动汇率形式；只不过是为几种

主要货币的波动规定一个幅度而已。2. 当汇率波动达到目标区的上下限时，有关国

家可以不承担干预的义务。但必须运用经济政策调整使汇率回到目标区内。

P592

Japan and East AsiaJapan and East Asia

• The problems of the Japanese economy spilled over to the developing countries in East Asia, with which it trades heavily.

• Many of them held their exchange rates fixed, or in target ranges, against the U.S. dollar. Japan’s slowdown in 1997 weakened Japan’s slowdown in 1997 weakened the East Asian economies directly, but also the East Asian economies directly, but also through an exchange-rate channelthrough an exchange-rate channel.

• Being tied to the dollar, East Asian currencies tended to appreciate against the yen as the yen slid against the dollar. The East Asian economies, feeling the direct effect of Japan’s slower growth on the demand for their imports, simultaneously found their exports priced out of foreign markets.

What has been learned since 1973?What has been learned since 1973?

• Does the empirical study support the views put forward by the proponents and opponents of floating rate system?

• Comparison and valuation of the Fixed and Comparison and valuation of the Fixed and the Floating performancesthe Floating performances.

Page 595: Figure 19-8Page 595: Figure 19-8

Exchange rate trends Exchange rate trends and inflation and inflation differentials, 1973-1997.differentials, 1973-1997.

Higher inflation has Higher inflation has been associated with been associated with greater currency greater currency depreciation.depreciation.

Monetary policy Monetary policy autonomyautonomy

• PPP is a major factor behind long-run nominal exchange-rate variability.

• In the short run, the effects of monetary/fiscal changes are transmitted across national borders under floating rate. →Floating rates would not →Floating rates would not insulate countries completely from foreign insulate countries completely from foreign policy shocks.policy shocks.

• No central bank can be indifferent to its No central bank can be indifferent to its currency’s value in the foreign exchange currency’s value in the foreign exchange marketmarket.

Why did central bank intervene?Why did central bank intervene?

1. stabilize output and the price level

2. fear about the loss of international competitiveness.

3. worry about temporary exchange rate shifts might have medium-term inflationary effects.

SymmetrySymmetry

• Central banks continue to hold dollar reserves and intervene, the international monetary system did not become symmetric did not become symmetric after 1973after 1973.

The exchange rate as The exchange rate as an automatic stabilizeran automatic stabilizer

• Under floating, many countries were able to relax the capital controls put in place earlier.

• Floating help to cushion disturbances for some sectors while hurting other sectors.

• Poor economic performances can not be related to the floating.

DisciplineDiscipline

• Both the fixed and the floating place no discipline on any government and central bank.

Destabilizing speculationDestabilizing speculation

• Over the longer term, exchange rates have roughly reflected fundamental changes in monetary and fiscal policies, and their broad movements do not appear to be the result of destabilizing speculation.

• No clear indication: linkage between the floating and destabilizing speculation.

International trade & International trade & investmentinvestment

• There is controversy about effects of floating rates on international trade.The use of forward markets and other derivatives expanded dramatically…. cost of avoiding cost of avoiding exchange rate risk is just like international exchange rate risk is just like international transport costtransport cost.

• It is hard to tell which factors slowdown the growth of international trade and investment.

Policy coordinationPolicy coordination• Floating exchange rates themselves have not not

promoted international policy coordinationpromoted international policy coordination.

• Governments, like people, often are motivated by their own interest rather than that of the community. However, the governments can not be penalized.

Are fixed exchange rates even an Are fixed exchange rates even an option for most countries?option for most countries?

• “TrilemmaTrilemma” will be discussed in the end of this course. Choice of the fixed exchange rate will rest on other conditions (freedom of capital flow, and autonomy of monetary policy).

• Speculative attacks on fixed exchange rate arrangement would continue …

Directions for reformDirections for reform

• No exchange rate system worksNo exchange rate system works well when countries “go it alone” and follow narrowly perceived self-interest.

• The worst problems of the floating-rate system occurred when countries failed to take coordinated action on common macroeconomic problems.

Reform of International Monetary SystemReform of International Monetary System

• Current proposals to reform the international monetary system run the gamut from a more elaborate system of target zonestarget zones for the dollar to the resurrection of fixed rates to the introduction of a single world currency. Because countries seem unwilling to give up the autonomy floating dollar rates have given them, it is unlikely that any of these changes is in the cards. With greater policy cooperation among the main players, there is no reason why floating exchange rates should not function well in the future.