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Domestic Politics and Money Learning output of the class: - better understanding of the current international monetary system - better understanding of the interaction between international monetary system and domestic economy - government monetary instuments (interest rates, exchange rate, monetary base) - trade v capital flows History of monetary system: from fixed to floating exchange rates Gold standard (dismantled in the 1930s) – Bretton-Wood system (1944-1971) – Fixed exchange rates in terms of gold, Limited gov. monetary tools Fixed-but-adjustable exchange rates, Central role of the dollar, Government interventions used to peg the exchange rate (autonomous monetary policies), Limits on capital flows, Creation of IMF Floating rates system (since 1971) – “unlimited” capital flows Keynesian revolution John Meynard Keynes, 1936 The General Theory of Employment, Interest and Money Rationale for government macroeconomic policies Fiscal Monetary Government role of stabilizer of the unstable market economy 1946 Employment Act (formerly proposed as Full Employment Act) Fixed rates Pegged rates Floating rates Monetary policy: definition The Federal Reserve`s (the Fed) actions to influence the availability and cost of money and credit. Because the expectations of market participants play an important role in determining prices and economic growth, monetary policy can also be defined to include the directives, policies, statements, and actions of the Fed that influence future perceptions. - Regulates/controls the supply of money Monetary policy: tools - through open market operations involving the purchase and sale of U.S. Treasury securities - by setting the Discounte rate - interest rate that banks pay on short-term loans from Fed (cost of credit) - by setting Reserve Requirements - amount of physical funds that depository institutions are required to hold in reserve against deposits in bank accounts - Foreing Exchange Interventions Impossible or “unholy” trinity http://www.youtube.com/watch?v=oLbfAfCVG_ 4 Tradeoff between domestic economic autonomy and exchange rate stability Fixed exhchange rate Independent monetary policy International Capital mobility » Gov. can use only 2 of them at the same time Inflation rates 1960-1971 US budget deficits 1960-1971 (% of GDP) Current Account Balance (19602010) Monthly Change in the Deutsche Mark–U.S. Dollar Real Exchange Rate, February 1960–March 1994 Federal Funds Nominal Target Rate The Target Federal Funds Rate and Taylor (1993) Rule Prescriptions Currency Distribution in Foreign Exchange Transactions World payment currencies vs trade Discussion Is the dollar`s dominance under the threat? Is the dollar as a dominant reserve currency going to collapse? Different determinants of USD/EUR echange rate 1999-2013 - International portfolio choices (1999-2001, 20028) - Foreign trade (2002-8) - Risk aversion and preference for liquidity (200812) - Monetary creation (2013)