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Macroeconomics II
Summersemester 2004
Prof. Dr.
Paul Bernd Spahn
Dipl.-Volkswirt
Jan Werner
The
Bretton Woods System
and its End
Case Study
presented by
Judit Papp
Olga Sedova
Alesja Stellwag
Yevgeniya Yarmanova
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Contents
1.
Historical events preceding the Bretton Woods
system
2.
Establishing of the Bretton Woods system
3.
The Bretton Woods chronology
4.
Reasons for collapse
5.
Discussion
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1. Historical Events Preceding the BW System
1870-1914: Gold standard
 Creation of central banking systems as note source and
legal tender
 Currencies backed by gold
 Liberalized export and import of gold
 Collapsed with the beginning of the World War I
3 main problems that led to collapse:
(1) adjustment
(2) liquidity
(3) confidence
1919-1939: Interwar period
a) Floating exchange rates: 1919-1925
b) Gold exchange standard: 1926-1931
 Initiated by Great Britain
 Return to the pre-war gold price instead of adoption a
higher gold conversion rate → deflationary effect
c) Managed float: 1932-1939
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1. Historical Events Preceding the BW System
1930s: Shared experiences of the Great Depression
 Deflation and competitive devaluations (“beggar-thyneighbour” policies) → dropping national income, shrinking
demand, mass unemployment, decline in world trade
 Trade and exchange rate controls
Early 1940s: Developing a new monetary system
 Acknowledged need for a stable international monetary
system
 A small number of states holding political power
→ easier to negotiate
 Two major powers: Great Britain and the U.S.A.
 Leadership role of the U.S.
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2. Establishing of the Bretton Woods System
In the first three weeks of July 1944,
delegates from 45 nations gathered
at the United Nations Monetary and
Financial Conference in Bretton
Woods, New Hampshire.
Goal:
To establish a postwar international monetary system
of convertible currencies, fixed exchange rates and
free trade.
But!
Different preferences
2 rival plans
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2. Establishing of the Bretton Woods System
I. The Keynes Plan: (Great Britain)
Goals: - world trade expansion
- international liquidity
- protection of the domestic economy from foreign
disturbances
Essence:

Focus on adjustment of real economy
→ wide fluctuation band

Focus on world trade expansion and international liquidity

„Bancor” with nominal value fixed in terms of gold

Surplus nations (U.S.A): credit balances earning interest

Deficit nations (GB): overdrafts bearing interest to surplus
nations

Assigned quota determines the limit on resources to obtain,
if over quoted → penalties: devaluation, capital control
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2. Establishing of the Bretton Woods System
II. The White Plan: (U.S.A)
Goal: Exchange rate stability
Essence:
- Focus on purchasing power of currencies → deviations from
parity only in case of fundamental imbalances
- Deficit nations: draw resources by selling their own currency
for that of other members
- Establishment of stabilizing fond → IMF, IBRD
Penalties: appropriate domestic policies & exchange controls
Compromise between I and II = BW Agreement
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2. Establishing of the Bretton Woods System
2 main features:
a) Exchange rate mechanism
b) Set of institutions to safeguard international monetary
stability
a) Exchange rate mechanism:
 Par value system: 35 USD per
ounce gold
 „Snake”: +/- 1% wide corridor for
exchange rate fluctuations
 Adjustable peg
 Obligation to convert only for
central banks
 Current account liberalization
(capital accounts NOT liberalised)
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2. Establishing of the Bretton Woods System
b) Bretton Woods institutions:
IMF
Major functions:
1. Regulatory (administering the rules governing
currency values and convertibility)
2. Financial (supplying supplementary liquidity) H. D. White &
3. Consultative (providing a forum for
J. M. Keynes, 1946
cooperation among governments)
IBRD
- Fighting poverty
- Improving living standards in the developing
countries
ITO → GATT → WTO
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2. Establishing of the Bretton Woods System
Excursus(1):
Classical gold standard vs. Floating exchange rates
 Exchange rate stability
 Monetary sovereignty
 Long-run price stability
 Insulation from foreign shocks
 Loss of national
monetary authority
 Destabilization and free rider
problems
 Lack of disciplining effects of
fixed exchange rate regimes
The Bretton Woods System –
an attempt to combine the advantages of both systems
Question: Is it theoretically possible?
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2. Establishing of the Bretton Woods System
Excursus(2): The Inconsistent Trinity: Only 2 of 3
following objectives can be achieved
simultaneously
Fixed
Free capital
exchange mobility
rates
Democratic
policies aimed
toward full
employment
YES
YES
NO
= Gold
Standard
YES
NO
YES
= Bretton
Woods
NO
YES
YES
= 1971- today
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3. The Bretton Woods Chronology
1. The Period of “dollar shortage" (1945-1958):
The U.S. serves as a stabilizing force
- The U.S. trade surplus and global liquidity – the dollar "gap“
- Accommodating role of the U.S. foreign aid programs
(i.e. Marshall Plan), and overseas military expenditures (e.g.
the Korean War)
- Foreign aid and macroeconomic discipline at home supports
world economy
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3. The Bretton Woods Chronology
2. The Period of “dollar glut" (1958-1971):
The U.S. serves as a destabilizing force
Expansionary domestic (Great Society) and foreign
(Vietnam) policies are financed by inflation
Key Status of the dollar meant that the U.S. could export
inflation and avoid macroeconomic adjustment
Confidence crisis: doubtful convertibility of the dollar into
gold → runs on the gold
"Nixon shocks" of 1971
March 16, 1973 - COLLAPSE
- Switch to flexible exchange rates
- End of the official gold price
- Gold-peg abolished at peace time
It was clear that it as NOT a temporary break
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4. Reasons for Collapse
1. The Triffin Dilemma:
Relies on the U.S. deficits to avert world liquidity shortage
-
After 1958, the U.S. dollar overhang was growing larger than
its gold stock → erosion of America’s net reserve position
-
To forestall speculation → U.S. deficits have to go down
→ liquidity problem
-
To forestall liquidity problem → U.S. deficits have to grow
Confidence problem
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4. Reasons for Collapse
Attempts to save BW:
a) Mid-1960: SDR
b) 1961-67: Gold Pool:
U.S.A:
50.00%
GB, F, I:
D:
11.12%
CH, B, NL:
c) “Split market” for gold March 1968:
Official price: 35 USD / ounce gold
Private investors: gold price flexible
9.26% (each)
3.70% (each)
2. Rigidity of Exchange Rates
- Fears of potential world liquidity shortage
- Irresistible incentives for speculative currency shifts
- Global confidence problem
3. Growing concerns in Europe and Japan about America’s use
of its privilege of liability financing
(“Exorbitant Privilege” – C. de Gaule)
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4. Reasons for Collapse
4. Inflation
- BW assumption of a
stabile economic policy
in the U.S.
- After 1965 – the U.S.
behaviour became
increasingly destabilizing
→ Inflation
→ Members had to buy
the growing surfeit of
dollar to defend their
pegged rates
→ Accelerating inflation everywhere
Evident incapability of coping with widening of
payments imbalances & worsening of confidence
problem (speculators)
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5. Discussion
Wall Street Journal, 3rd February 1998:
„The IMF is ineffective, unnecessary, and obsolete.“
George Schulz* & William Simon**
* Ex-Secretary of the State under
the U.S. President Roland Reagan
** President of the John M. Olin
Foundation, ex-secretary of
the Treasury under President
R. Nixon and G. Ford
Thank you for your attention!
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