04 13 2015 Chapter 9 Globalization Money s Social Functions Social role of money Medium of exchange Store of value Unit of account Exchange Rate Regimes and Currency Policies Exchange rate the price of a national currency relative to other national currencies The exchange rate can go up or down response to supply and demand Exchange rate is an important part of international economic relations When the dollar goes up down in value against some other currency it is said to appreciate depreciate or strengthen be devalued In general the U S dollar has depreciated since 1975 A strong exchange rate allows consumers to buy more of the world s products thereby increasing national purchasing power The trade off a strong exchange rate makes domestic goods more expensive to foreigners which harms national producers who compete with foreigners on local world markets This is why manufacturers and farmers typically complain about a strong currency Developing countries that are trying to encourage exports have a weak currency Exchange Rate Regimes and Currency Policies Currency values respond to several conditions National interest rates Higher interest rates make it more profitable for people to put their money in the country so higher interest rates increase the demand for the currency and lead to its appreciation Current account Instability Prices of major exports Macroeconomic conditions unemployment inflation economic growth Fixed Pegged Floating Strong vs Weak Currency PROS STRONG Lower import prices Foreign goods are inexpensive Higher export prices Increases national purchasing power Boosts foreign demand More tourism WEAK CONS More expensive for tourists Domestic goods more expensive to foreigners Foreign goods are expensive Reduces national purchasing power Makes consumers worse off WHO DESIRES Domestic consumers Foreign consumers National producers CONTROVERSY IN RECENT DECADES The tendency of some governments in certain countries to keep their currency very weak over long periods of time to stimulate their exports China since 1979 Exchange Rate Regimes and Currency Preferences A government s interest in exchange rate policy depends on the structure of its economy its interest groups and its political system EXAMPLES Gold standard FIXED Stability PROS predictability CONS Reduces government flexibility Reduces government ability to have its own independent monetary policy FLOAT More Less stability government autonomy freedom Current regime for most major currencies dollar yen euro WHO FAVORS Investors Those engaged in international trade investment etc Those who want to keep inflation low Domestic businesses Those concerned with their nation s economy Monetary Policy Monetary Policy important tool of national governments to influence broad macroeconomic conditions unemployment inflation economic growth Governments alter their monetary policies by changing national interest rates or exchange rates In most developed countries the monetary policy is implemented by the central bank ex The federal reserve in the U S Central bank institution that regulates monetary conditions in an economy typically by affecting interest rates and the quantity of money in circulation raising or lowing interest rates If the central bank wants to stimulate the economy it lowers interest rates If the central bank wants to restrain the economy it raises them International Monetary Regimes International Monetary Regime Formal or informal arrangement among governments to govern relations among their currencies International Monetary Regime is a public good Facilitates international economic exchange FEATURES 1st Fixed or floating The present day regime is based on floating rates 2nd Agreement on a common base to compare currencies Commodity standard uses a good with value of its own as the basic monetary unit ex Gold standard Commodity backed standard national governments issue paper currency with a fixed value in terms of gold or some other commodity ex Bretton Woods National paper currency standard national currencies are only backed by the commitments of their issuing governments to support them 1973 today International Monetary Regimes 1870 Present The classical gold standard 1870 1914 Made the country s currency equivalent to gold and interchangeable at a fixed rate with the money of any other gold standard country The gold standard relied on collaboration among its leading members and provided currency stability predictability Many governments believed this common monetary standard was beneficial Floating rates 1914 44 Currency value is allowed to change more or less freely driven by markets or other factors The price of currency moves around with changes in supply and demand ex The U S dollar Japanese yen the euro Bretton Woods 1945 73 Based on a fixed rate and a gold standard for the U S and on a fixed but adjustable rate for other currencies on the dollar standard This system of fixed but adjustable rates an adjustable peg required that governments keep currency values fixed for long periods of time but permitted them to adjust them if the government needed The Bretton Woods system meant that the U S dollar value couldn t change This kept currency values stables and currency markets open contributing to the growth of international trade and investment The backing of the major Western financial powers institutional support of the IMF were central to the stability of the Bretton Woods system Bretton Woods system ended when President Nixon declared that U S currency would not be fixed to gold Like the gold standard the Bretton Woods system relied on collaboration from its leading members Managed float 1973 present National paper currency standard Government acts to ensure that the national currency continues to be valuable International monetary relations have been based on floating exchange rates among a small number of major currencies typically those of the principal industrial and financial nations U S Japan Germany Great Britain Large countries typically allow their currencies to float freely Today most international exchange is measured and conducted with the dollar and the euro The Gold Standard Controversy William Jennings Bryan democrat and populist made a case for going off the gold standard in hard times Anti gold movement was due to the bad economic conditions of the 1890 s You shall not crucify mankind upon a cross of gold Bryan Bryan wanted to replace the gold standard with an alternative
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