Transcript Lecture 12 - uni

Lecture 12
THE INTERNATIONAL
FINANCIAL SYSTEM (2)
Paul Bernd Spahn, Goethe-Universität Frankfurt/Main
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The ECU and the ERM
• The ECU was a weighted average of the
currencies of all (initially 9, then 12) member
states of the (now) European Union.
• The ERM (“exchange-rate mechanism”) was
an arrangement that compelled governments
to keep the exchange rate of their currencies
within predetermined corridors (± 2.25% or ±
6%) relative to the ECU rate.
• Participation in the ERM was voluntary.
Paul Bernd Spahn, Goethe-Universität Frankfurt/Main
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The composition of the ECU (1989)
Luxemburg (0,30%)
France (18,99%)
Germany (30,08%)
Ireland (1,10%)
UK (12,99%)
Italy (10,14%)
Netherlands (9,40%)
Paul Bernd Spahn, Goethe-Universität Frankfurt/Main
Portugal (0,80%)
Spain (5,30%)
Denmark (2,50%)
Belgium (7,60%)
Greece (0,80%)
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The exchange-rate mechanism (ERM)
• The national currency is fixed to the ECU.
• A variation of the exchange rate within the
pre-defined “corridor” is allowable.
• Once the exchange rate tends toward the
margins of the “corridor”, the central bank is
encouraged to intervene (“infra-marginal
interventions”).
• Once the exchange rate moves out of the
“corridor”, a central bank intervention is
mandatory to bring it back into the “corridor”.
Paul Bernd Spahn, Goethe-Universität Frankfurt/Main
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The “dual solution” to the ERM
• There could be an alternative to the ERM
whereby the central bank is relieved from
exchange-rate interventions.
• This would protect its foreign reserves and
allow it to concentrate on its primary role:
combating inflation.
• The mechanism is basically the same as for
the ERM, but instead of sustaining markets
by supplying international reserves, deviations
from the corridor are penalized by a tax:
the ERND (exchange-rate normalization duty).
Paul Bernd Spahn, Goethe-Universität Frankfurt/Main
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The dual solution to the ERM
Paul Bernd Spahn, Goethe-Universität Frankfurt/Main
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Differences with the ERM
• The ERM is a fixed-exchange-rate regime
based on an average (the ECU-rate) as a
fixed target within a well-defined „corridor“.
• The ERND works
– also with a „corridor“, but
– with moving averages (of bilateral exchange
rates) as a flexible target (“crawling peg”).
• It is an automatic, rules-based policy that
can be anticipated by market participants.
• It activates fiscal (not monetary) policies,
with built-in (and not discretionary) stabilizers.
Paul Bernd Spahn, Goethe-Universität Frankfurt/Main
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The tax can
not
• not solve structural problems of a
currency zone
• not sustain a policy of „leaning against
the wind“, i.a. an exchange rate.
• It is suitable for smaller countries that
intend to „anchor“ their currencies.
The concept is suitable, in principle,
also for the dollar-euro market,
but there might be an alternative:
policy coordination.
Paul Bernd Spahn, Goethe-Universität Frankfurt/Main
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International monetary policy coordination
• There were two (failed) attempts to coordinate
exchange-rate policies to stabilize the US dollar in
the 1980s: the “Plaza” and the “Louvre” accords.
Paul Bernd Spahn, Goethe-Universität Frankfurt/Main
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Capital controls
• Capital controls (particularly those on outflows)
are typically rejected by economists.
• Controls on capital inflows receive some support
and have also been used rather successfully in
some countries (Chile and Colombia).
• Reason: Capital inflows can cause an excessive
lending boom, … entailing a painful reversal.
• But controls of capital inflows could also block
funds for economic development. It calls for
differential treatment according to maturity.
Paul Bernd Spahn, Goethe-Universität Frankfurt/Main
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The international policy focus is now on …
.. improving
banking regulation
and supervision,
and on greater
transparency.
Paul Bernd Spahn, Goethe-Universität Frankfurt/Main
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The role of a nominal anchor
• Adherence to a nominal anchor forces
a monetary authority to conduct “disciplined”
monetary policy.
• A priori publicized self-binding rules
– imply a strong auto-commitment;
– can relieve from short-term political pressures;
– contribute to the predictability of policy and hence
stabilize economic behavior;
– foster confidence building in monetary authorities.
Paul Bernd Spahn, Goethe-Universität Frankfurt/Main
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The time-consistency problem
• Economic behavior is influenced by what
economic agents expect monetary authorities
to do in the future.
• If expectations were to remain unchanged
there is the temptation to abuse this fact
by attempting to boost the economy through
discretionary expansionary monetary policy.
• If expectations will incorporate the expected
outcome of such a policy, output will not be
higher, but inflation will!
• A monetary anchor acts as self-binding rule.
Paul Bernd Spahn, Goethe-Universität Frankfurt/Main
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Exchange-rate targeting
• Exchange-rate targeting has a long history,
including the fixing of the exchange rate to the
price of gold.
• Exchange-rate targeting has clear advantages
– it links the price of traded goods to that found in the
anchor country; this might contain inflation;
– time-inconsistent monetary becomes less of an
option; this stabilizes price expectations;
– it is a simple and transparent rule (“franc fort”);
• Exchange-rate targeting has been widely
used in Europe and world-wide.
Paul Bernd Spahn, Goethe-Universität Frankfurt/Main
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Disadvantages of exchange-rate targeting
• Exchange-rate targeting might be create
serious problems because
– the country tying its currency to that of an anchor
currency can no longer respond to shocks to its
own economy;
– there could also be shocks applying to the anchor
country; these are fully transmitted (the case of
Germany after unification);
– if the anchor country opts for inflation, countries
with pegged currencies will “import inflation”
– it may present opportunities of a one-way bet for
speculators (crisis of the EMS of September 1992).
Paul Bernd Spahn, Goethe-Universität Frankfurt/Main
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The 1992 ERM crisis: the UK and France
• The UK did devalue
Paul Bernd Spahn, Goethe-Universität Frankfurt/Main
• France did not!
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The “cost” of pegging
Q uic kTim e™ and a TI FF ( U ncom pr essed)
decom p r essor
ar e nee ded t o see t his pict ur e .
Q uick Tim e™ a nd a TI FF ( Uncom pr essed)
decom pr essor ar e needed t o see t h is pict ur e .
• The UK had higher
growth and less
unemployment
• France had lower
growth and more
unemployment
• But its inflation rate
increased
• But its inflation rate
was lower
Paul Bernd Spahn, Goethe-Universität Frankfurt/Main
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Exchange-rate targeting: For whom?
• Industrialized countries might have more to
lose by exchange-rate targeting than to win.
• In some industrialized countries the central
banks is subject to political pressure.
In this case exchange-rate targeting may
prove to be beneficial.
• It also encourages economic integration.
• Contrary to industrialized countries, emerging
market countries may not lose much by giving
up an independent monetary policy, but it
leaves them open to speculative attacks.
Paul Bernd Spahn, Goethe-Universität Frankfurt/Main
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Can speculation be averted?
The currency-board approach:
• One approach is to back the domestic currency
by 100% by a foreign currency (euros, dollars).
• It means
– the money supply can only expand when international
reserves of a country increase.
– a strong commitment of monetary policy, which may
therefore work instantly in controlling inflation.
• Currency boards are however not immune
against speculation.
Paul Bernd Spahn, Goethe-Universität Frankfurt/Main
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Currency boards: Examples
• Recent examples of currency boards include
–
–
–
–
–
Hong Kong (1983)
Argentina (1991)
Estonia (1992) and Lithuania (1994)
Bulgaria (1997)
Bosnia and Herzegovina (1998)
• Argentina had to abandon the scheme in
December 2001 -- with painful social and
economic repercussions.
Paul Bernd Spahn, Goethe-Universität Frankfurt/Main
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The CFA-zone
• The CFA franc is the common currency of
14 countries in West and Central Africa,
12 of which are former French colonies.
• The CFA franc has been pegged to the
French franc since 1948. Only one
devaluation has occurred during the history
of the currency peg (January 1994).
• The French Treasury has the sole
responsibility for guaranteeing convertibility of
CFA francs into euros, without any monetary
policy implication for the ECB.
Paul Bernd Spahn, Goethe-Universität Frankfurt/Main
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CFA-zone: operations
• While the two (regional) CFA central banks
maintain an overdraft facility with the French
Treasury, the amount that can be withdrawn is
limited.
• Each CFA central bank must
– keep at least 65 per cent of its foreign assets in its
operations account with the French Treasury;
– provide for foreign exchange cover of at least 20
per cent for demand deposits (sight liabilities);
– and impose a cap on credit extended to each
member country equivalent to 20 per cent of that
country's public revenue in the preceding year.
Paul Bernd Spahn, Goethe-Universität Frankfurt/Main
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Can speculation be averted?
Dollarization:
• Another approach is to abandon a national
currency altogether and to adopt a foreign
currency (e.g. US dollars) instead.
• It means
– a euro or dollar remains a euro or dollar, whether
inside or outside the respective currency area.
– that the country adopting a foreign currency loses
potential income through seignorage.
• However a reversal to a domestic currency
always remains an option.
Paul Bernd Spahn, Goethe-Universität Frankfurt/Main
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“Dollarization”: Examples of countries
Andor ra
East Timor
Ecuador
El Salvador
Kirib ati
Kosovo
Liechtenstein
Marshall Island s
Micronesia
Montenegro
Monaco
Nauru
Palau
Panama
San Marino
Tuvalu
Vatican City
euro (formerly French franc, Spanish peseta), own coins
U.S. doll ar
U.S. doll ar
U.S. doll ar
Australian doll ar, own coins
euro
Swiss franc
U.S. doll ar
U.S. doll ar
euro (partly "DM-ized" since 1999)
euro (formerly French franc)
Australian doll ar
U.S. doll ar
U.S. doll ar, own balboa coins
euro (formerly Italian lir a), own coins
Australian doll ar, own coins
euro (formerly Italian lir a), own coins
Paul Bernd Spahn, Goethe-Universität Frankfurt/Main
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2000
2000
2001
1943
1999
1921
1944
1944
2002
1865
1914
1944
1904
1897
1892
1929
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“Dollarization”: Exits
• Even dollarization does not guarantee a
permanent monetary anchoring.
• There is need to a continuing inflow of foreign
denominated capital to satisfy domestic
demand for money.
• This puts severe strains on the economy.
• There is a large number of exits from a
currency zone during recent years:
– Numerous exits from the ruble zone after the
breakdown of the Soviet Union
– the secession of Slovakia from Czechoslovakia
– the breakdown of Yugoslavia.
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Monetary targeting
• As already discussed, monetary targeting
became fashionable in major industrialized
countries during the 1970s (Germany,
Switzerland, Canada, Japan, the UK,
and the United States).
• It allows to focus on domestic considerations
without regard to exchange-rate developments.
• Different aggregates were chosen
–
–
–
–
“central bank money” (Germany 1974-88)
M1 (Canada, the United States)
M2 + CDs (Japan)
M3 (UK, Germany from 1988)
Paul Bernd Spahn, Goethe-Universität Frankfurt/Main
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Monetary targeting
• Monetary targeting proved to be problematical
because of
– unreliable indicators due to shifts in the demand for
money and the introduction of new technologies
(financial innovations);
– a weak relationship between monetary indicators
and inflation;
– prevalence of foreign-exchange rate considerations;
– speculative bubbles of stock and housing prices
(Japan, the United States); and
– occasionally moral hazard and banking crises.
• Monetary targeting was thus suspended, strongly
de-emphasized, if not abandoned altogether.
Paul Bernd Spahn, Goethe-Universität Frankfurt/Main
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Inflation targeting
• A number of countries has adopted inflation targeting following the lead of New Zealand (1990).
–
–
–
–
Canada (from 1991)
the UK (from 1992)
Australia (1994)
Brazil (1995)
• In 1990 the Reserve Bank of NZ became fully
independent and was committed to the sole
objective of price stability.
• The governor of the central bank is held accountable for achieving a predefined inflation goal.
Paul Bernd Spahn, Goethe-Universität Frankfurt/Main
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Inflation targeting: strategy
• The strategy consists of
– publicly announcing a medium-term numerical
target for inflation that is well defined;
– committing the central bank to price stability as the
primary (if not sole) policy goal;
– an information strategy that includes several
indicators, not just monetary aggregates
– increased communication with the public to render
monetary policy more transparent; and
– an increased accountability of the central bank for
attaining its inflation target.
Paul Bernd Spahn, Goethe-Universität Frankfurt/Main
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Inflation targeting: advantages
• Inflation targeting
– enables the central bank to focus on domestic policy
objectives, but a stable relationship between money
and the price level is not critical for its success;
– is highly transparent and easily understood;
– increases the accountability of the central bank
because of a numerical target as a benchmark;
– seems to ameliorate the effects of inflationary shocks
(introduction of a GST in Canada; exit of the British
pound from the ERM in 1992). There was a one-time
price adjustment, but no spiraling up of inflation.
Paul Bernd Spahn, Goethe-Universität Frankfurt/Main
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Inflation targeting: disadvantages
• Inflation targeting is not without problems
because
– inflation cannot be controlled directly and
policy outcomes occur only with a time lag;
– therefore the policy cannot send immediate
signals to economic agents;
– may be too rigid and limit the policy discretion
to respond to unforeseen events;
– it will even out inflation, but might increase
output fluctuations.
Paul Bernd Spahn, Goethe-Universität Frankfurt/Main
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The two pillar strategy of the ECB
• The strategy of the ECB appears to reconcile
monetary targeting with inflation targeting by
scrutinizing both monetary growth and a
bundle of economic indicators to assess the
medium-term impact on the HICP.
• Contrary to the NZ approach, the ECB may be
criticized as being less responsive to public
demands for information.
• Less transparency goes hand in hand with
less accountability.
Paul Bernd Spahn, Goethe-Universität Frankfurt/Main
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That’s it !
• Thank you for attending
this course
• I hope you enjoyed it
• All the best for you private
and professional future,
and …
• … good luck for the final
exam !
Paul Bernd Spahn, Goethe-Universität Frankfurt/Main
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