FLS Chapter 9 What are exchange rates and why do they matter pg 354 Exchange rates are the price of a national currency relative to other national currencies a A currency can strengthen appreciate where it increase in value compared to other currencies or weaken depreciate where is devalued compared to other currencies b If currencies go up down the prices foreigners pay for goods priced in that currency rise fall as well Ex If the US dollar is weak against other currencies then foreign goods are expensive to Americans but if it strong foreign goods are cheaper to Americans Because the attractiveness of a country s goods services investments are important the exchange rates matter and are an important part of a country s international economic relations How are currency values determined Exchange rates change with supply and demand and the most relevant influence over supply and demand is interest rates Higher interest rates make it more profitable for people to put or keep their money Therefore higher interest rates increase demand for that currency and lead to its appreciation If more people invest in that economy demand for currency will rise and it will appreciate profit less people will want that currency the demand will go down and the currency will depreciate The relationship between interest rates and currency values are important because countries lower raise interest rates as part of their monetary policy which is usually implemented by a central bank The same is true in the reserve lower interest rates will lead to less Ex For example if the government wants to stimulate demand for its products they will lower the interest rate making the products cheaper for foreigner not locals citizens which will spur exports However by making the currency weaker in this way will means citizen can by less than the money Allowing exchange rates to change 2 exchange rate policies Different Fixed government commits itself at or around a specific value in terms of another currency or commodity Gold Standard 1870 1914 system where countries tied their currency to gold at legally fixed price on the gold standard most of the world essentially shared one currency Floating government permits its currency to be traded on the open market without direct government control intervention A government can allows its currency to vary within limits current system being used for most major currencies including United States Woods System 2 a Negotiated among WW2 allies in 1944 1970 s b US dollar fixed to gold and other countries tied themselves to the US Bretton dollar allowing for an adjustable peg Adjustabl e peg fixed but adjustable rates currency values would be fixed for longer periods of time but allowed to adjust them if he government found it desirable to do so 2 Who cares about exchange rates and why 2 3 nts 3 Governme Must consider important trade offs and conflicting domestic interests Decides if currency should be fixed floating or in between Fixed 3 exchange rates i Provide government with stability predictability and is good for international trade ii Benefit businessmen investors immigrants don t have to worry about exchange rates iii Committed to value even if a change would be good cf Argentina Greece Spain Portugal pg 360 iv Reduces ability for independent monetary policy 2 3 and Businesses 3 Consumers Domestic actors favor floating because it doesn t affect them but government change it as necessary Differing desires strong exchange rate is good for domestic consumers increase national purchasing power but not foreign buyers Does not benefit farmers or manufacturers China keep currency weak to stimulate exports but this policy is controversial because citizens have low purchasing power and causes trade conflict since other countries see it as an unfair trading practice 3 3 Can there be World Money without World Government pg 363 An international monetary order provides predictability in currency values Money has to have a predicted worth on an international scale or people However there is no global institution to provide global monetary order There are still trade offs and conflict over these agreements for prices across borders won t want to travel trade invest etc but agreements have emerged to provide this global public good When and Why Do Governments agree on the Monetary Order pg 364 A global monetary system in is everyone s interest because it facilitates international exchange Governments and people often disagree on the system that should be used A functioning monetary order needs effort by national government but there is a great incentive to free ride especially by smaller countries who may feel say that their contributions are too small and not contribute A successful international monetary regime depends on interactions of the world s biggest economies However governments also face major temptations such as in a fixed rate system one country may devalue their currency to make their products more competitive International Monetary Regimes International monetary regimes are a formal or informal arrangement Characteristics of international monetary regime among governments to govern relations among their currencies the agreement is shared by most countries in a world economy a Agreement makes clear whether currency values are expected to be b Whether there will be a mutually accepted benchmark against which fixed or floating or a mix values are measured some common base or standard to which currencies can be compared i Commodity Standard ii Commodity Backed Paper Standard iii National Paper Currency Standard be exchanged freely with good s equivalent cf gold standard paper currency with fixed value tied to commodity cf Bretton Woods only backed by commitments of issues governments and their commitments cf current system based on good with value of its own and can A Short History of International Monetary Systems Gold Standard a Pre 1914 b Currency backed by gold with exchange rates that did not change c d Pro currency stability helped growth in international trade and investment In a sense common currency for entire world Con constrained domestic policy autonomy e Necessary condition consensus among leading national powers at the time Britain France f After WW1 attempts to return to gold standard didn t go well because of an atmosphere of g McKinley Republican for gold standard vs Bryan Dem Populists against gold standard Germany distrust Race of 1896 h Wizard of Oz
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