CH 9 International Monetary Funds VOCABULARY EXCHANGE RATE the price at which one currency is exchanged for another APPRECIATE In terms of a currency to increase in value in terms of others currencies DEPRECIATE in terms of a currency to decrease in value in terms of other currencies DEVALUE to reduce the value of one currency in terms of other currencies MONETARY POLICY an important tool of national governments to influence broad macroeconomic conditions such as unemployment inflation and economic growth FIXED EXCHANGE RATE an exchange rate policy under which a government commits itself to keep its currency at or around a specific value in terms of another currency or a commodity such as gold GOLD STANDARD the monetary system that prevailed between about 1870 and 1914 in which countries tied their currencies to gold at a legally fixed price FLOATING EXCHANGE RATE an exchange rate policy under which a government permits its currency to be traded on the open market without direct government control or intervention BRETTON WOODS MONETARY SYSTEM the monetary order negotiated among the WWII allies in 1944 which lasted until the 1970s and which was based on a US dollar tied to gold I Monetary Social Functions Social role of money Medium of exchange Store of value money Unit of account o Instead of having 5 cows you have it s value turned into II Choice of Exchange Rate Regimes and Currency Policies Exchange rate the price of a national currency relative to other national currencies o It can go up and down o When dollar goes up down in value against some other currency it is said to appreciate depreciate or strengthen devalued Currency values respond to several conditions o Exchange rate goes up or down in response to changes in supply and demand The most relevant is national interest rates how much you re getting for your dollar Higher interest rate more profitable for people to put keep their money in the country Leads to appreciation o Current account aka trade balance Low trade low currency o Prices of majority exports o Instability When there s significant instability lowers currency Monetary Policy o When government effect the interest rate and amount of money in circulation in a country Change of interest rate to influence low interest rate stimulates economy o Government attempts to affect macroeconomic conditions Unemployment inflation and overall economic growth by manipulating monetary conditions Who wants strong overvalued currency o Tourists allows them to buy more in foreign countries Who wants a weak currency o Those who want tourists to come to their country Floating Regime or a Fixed Regime pegged o A floating rate global market establishes rate o Fixed rate government promises to keep the value of the o Exporters dollar Only change when government chooses to change Russia is an example III Exchange Rate Regimes and Currency Preferences Why fix the exchange rate o Stability is the major reason This benefits international trader and international investors large banks and businesses Benefits those who want government to manipulate Why not fix o Reduces government flexibility macroeconomic conditions Why float the exchange rate o More government autonomy Why not float o Less stability certainty in the rate Who tends to favor a fixed rate o International businesses o Consumers IV International Monetary Regimes International monetary regime an arrangement that is widely accepted to govern relations among currencies and that is shared by most countries in the world economy These regimes help facilitate international economic exchange o National currency paper standard global The Classical Gold Standard 1870 1914 o Great Britain started it and eventually the rest of the world o Major economies have to be willing to let gold leave their followed country and enter it o Provided currency stability which greatly facilitated international trade investment finance migration and travel o The gold standard controversy Bryan made a case for going off the gold standard in hard times and putting silver Democratic party known as silver party Opposed by N E Industrialists and bankers Farmers and Midwest didn t like gold standard Floating Rates 1914 44 o After WWI go off gold standard and try to go back The attempt of going on and off may have been reason for Depression Bretton Woods 1944 73 o Driven by US and GB trying to establish new monetary system o Come up with commodity paper standard US Dollar is as important as gold Everyone else s money can be relative to US Dollar or gold 35 for 1 ounce of gold o To add to the stability they created the IMF o Bretton Wood System collapses in 73 This was good for the US Off the gold standard and no longer constrained American economic policy Managed Float 1973 present o Purely floating system no real drive by world economic system o Large countries usually allow their currencies to float freely while smaller countries often link their currency to that of a larger nation bloc V Currency Collapse Why do currency sometimes collapse o Investors no longer believe the commitment of a government to it s budget or currency They begin to sell your currency because no one wants to hold on to something that will lose value o Collapse means value of currency drops dramatically o Happens when countries have fixed exchange rate Major world currencies float from each other Who gains o Exporters Who loses o Domestic consumers and bankers Speculative attacks on currencies have been more frequent in o International borrowers recent years o Mexico 1994 Peso Crisis o S E Asia Assume a spectator goes to a Thai bank and borrows 24 billion baht which at the original exchange rate can be converted into 1 billion dollars o Thus the exchange rate is 24 baht to one dollar o Sell o One week later the exchange rate falls o Now its 40 baht to one dollar o Use the 1 billion dollars to buy Repay the loan 600 million Profit 400 million International cooperation and currency crisis o The IMF typically comes in and tries to stabilize the currency They can give money and a lot to the government to change value of currency o Benefits prevention of contagion Contagion currency crisis spread from one country to another Your neighbors are your biggest traders and because of that currency economies are usually linked o Costs free riding and policy reform lead to IMF riots VI Conclusion Different exchange rates system benefits different interests o Fixed vs Floating International
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