Transcript The Modern Ad Hoc System

Construction of an Ad Hoc
International Financial
System
Policy Coordination
Structural Interdependence
• Structural interdependence is the reason
that policymakers might consider the joint
determination of economic policies.
• Structural interdependence refers to the
interconnectedness of nations’ markets for
goods and services, financial markets and
payments systems.
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International Policy Externalities
• Structural interdependences can results in international
policy externalities: a benefit or cost for one nation’s
economy owing to a policy undertaken in another
economy.
• A locomotive effect occurs when an increase in real income
in one economy spurs an increase in real income in
another.
• A beggar-thy-neighbor effect occurs when a policy action
benefits the residents of the home country at the expense of
residents in another nation.
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International Policy Cooperation
and Coordination
• There are two ways that nations may work
together to achieve their economic objectives.
• International Policy Cooperation is the adoption
of institutions and procedures by which
policymakers can inform each other of their
objectives and share data.
• International Policy Coordination is the joint
determination of economic policies within a group
of nations, intended to benefit the whole.
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Potential Benefits of Coordination
1. Take account of and minimize policy
externalities
2. Achieve a larger number of policy
objectives with available instruments
3. Policymakers may present a “united front”
in the face of home political pressures that
could push them to adopt harmful policies.
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Potential Drawbacks to
Policy Coordination
1. Must sacrifice or forego some domestic
interests
2. Must trust that counterparts are willing to
make sacrifices
3. Coordinated policies may have negative
consequences such as higher inflation
(e.g., Bonn Summit of 1978)
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Important Meetings, Events,
and Organizations
Bank for International Settlements: An
Overlooked Institution
• Created in 1930 by private U.S. banks and
the governments of 10 advanced economies.
• Based in Basle, Switzerland.
• Serves as an international loan trustee, as an
agent of central banks, center of economic
cooperation (e.g. Basle Agreement).
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Economic Summits
• November 1975 French President, Valery Giscard
d’Estaing hosts the first economic summit.
• France, US, UK, Germany, Japan (G5).
• Italy added to represent the EU (G6).
• Agreed to a system of flexible exchange rates.
Countries would intervene when needed to
ensure stability.
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Jamaica Accords
• January 1976 meeting of IMF member
country nations.
• Amended the articles of agreement of
the IMF to recognize flexible exchange
rate systems.
• Member nations could adopt an
arrangement of their own choice.
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Summits “Institutionalized”
– Summits made an annual event.
• 1976 President Ford hosts the second
summit.
• Invites Canada (G7).
• Summits now occur ever summer,
rotating from country to country.
• British PM, Tony Blair, adds President
Yeltsin (Russia) as a “full member” for
the 1998 Birmingham Summit (G8).
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Plaza Agreement
– September 1985.
• Meeting of the G5 central bankers and finance
ministers.
• Had been meeting quietly for a number of
years.
• Discussed the value of the US dollar.
• Announced a belief that the dollar was
overvalued and that the nations would
intervene on a coordinated basis to drive
down the value of the dollar.
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Louvre Accord
– February 1987
• Meeting of the G7 (less Italy) central bankers
and finance ministers.
• Announced that the dollar was now
“consistent with economic fundamentals.”
• Would only intervene when required to
ensure stability.
• Managed float system emerges.
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Groups
– The main G’s
• G7 refers to the meetings of the central
bankers and finance ministers of the G7
nations.
• G8 refers to the heads of state of the G8
nations meeting at the economic
summits.
• G10, G7 plus Belgium, the Netherlands,
and Sweden.
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The Gold Standard and the
Bretton Woods System
The Gold Standard
• Came into effect in the mid-1870s when
most of the major economies unilaterally
pegged to gold.
• Nations fixed the value of their currency
relative to gold via a mint parity rate.
• They also established convertibility, or the
ability to exchange the currency for gold.
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The Gold Standard
• Pegging the value of each currency to gold,
established an exchange rate system by
indirectly establishing exchange rates.
• The mint parity rates could be used to
determine the exchange rate.
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The Gold Standard
Gold
At Center of System
US Dollar
20.646
UK Pound
4.252
4.856 $/pound
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The Gold Standard
•
•
•
•
Long-run price stability
Short-run price instability
Numerous financial crises
Suspended in 1914 after the beginning of
WWI.
• Return to gold standard in 1925 led to
collapse.
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The Bretton Woods System
1944-1971
• Forty-four nations participated in the conference.
• Primary architects were Harry White of the U.S.
and John Maynard Keynes of the U.K.
• Ratified in 1944
• Though known as the Bretton Woods Conference,
it was officially called the International Monetary
and Financial Conference of the United and
Associated Nations.
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The Bretton Woods Conference
Organizations Created
International Monetary Fund
IMF
International Bank for Reconstruction and Development
IRBD
World Bank
General Agreement on Tariffs and Trade
GATT
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Bretton Woods System
• System of adjustable pegged exchange
rates.
• U.S. dollar was the anchor of the system
because it was pegged to gold.
• All other participating nations could peg to
gold or to the dollar.
• All chose to beg to the dollar, a dollarstandard exchange rate system was created.
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The Dollar-Standard System
Gold
U.S. Dollar
$35.00
Pound
2.80 $/pound
Mark
4.20 DM/$
11.76 DM/pound
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The 1960s
Trouble for the Dollar
• Glut of dollars due to Vietnam war and programs of the
“Great Society.”
• Dollar believed overvalued relative to the currencies of
Japan and some Western European economies, e.g.,
Germany.
• Dollar becomes target of foreign exchange speculators.
• U.S. and European countries intervene in the gold
market.
• Britain devalues in 1967 and holders of the pound
experience a 15 percent capital loss.
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The Dollar and the Mark
(from Grabbe, 1999)
• On May 4, 1971, the Bundesbank buys $1 billion
on the exchange market to maintain the parity
value.
• On the next day they buy $1 billion in the first
hour of trading.
• Bundesbank abandons the parity rate and lets the
mark float upward relative to the dollar.
• Austria, Belgium, the Netherlands, and
Switzerland follow suit.
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End of the System
• Faced with a major run on the dollar,
President Nixon suspends convertibility of
the dollar.
• The system falls into disarray.
• Market is closed on extremely volatile days.
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Smithsonian Agreement
• In an attempt to restore order to the exchange market,
10 leading nations meet at the Smithsonian institution
on December 16 and 17, 1971.
• A new system of exchange parity values determined.
Dollar, however, is still not convertible to gold.
• Nixon hails the agreement as the “most significant
monetary agreement in the history of the world.”
• System collapses in 15 months and a de facto system
of floating rates emerges.
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The Ad Hoc Exchange Rate
System
The Various Types of Arrangements
Today
Current Arrangements
20%
26%
4%
15%
21%
5%
3%
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Dollarized
Currency Board
Pegged
Pegged w/Bands
Crawling Peg
Crawling w/Bands
Managed Float
Floating
6%
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Dollarization
• Dollarization is the replacement of the domestic
currency with the currency of another nation.
• Two possible problems are the loss of seigniorage
revenues and the loss of discretionary monetary
policy.
• Seigniorage is the revenue created through the
manufacturing of money, and can be quite
important to developing nations.
• Examples are Panama, El Salvador and Ecuador.
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Currency Board
• Establishes and maintains a hard peg between the
domestic currency and another currency.
• Issues domestic notes.
• Notes issued depend on the value of the exchange
rate and the amount of foreign reserves.
• Hence, monetary base is determined by the stock
of foreign reserves.
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Currency Board - Continued
• Replaces central bank
– Cannot hold domestic debt.
– Not a lender of last resort
– Does not set reserve requirements
• Theoretically shielded from political
pressure.
• E.g.: Argentina, Estonia, and Bulgaria.
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Pegged and Pegged with Bands
• Parity value established relative to another
currency.
• Central bank must conduct monetary policy to
maintain parity.
• “Parity band” allows limited flexibility on either
side of the parity rate.
• Band can be very narrow or very wide.
• E.g.: Bangladesh, China, and Egypt.
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Currency Basket Peg
• Currency is pegged to a “basket” currencies.
• Parity value is the weighted average of a
basket of currencies in various quantities.
Each currency has an implicit weight
assigned to it.
• Provides some degree of flexibility against
individual currencies.
• E.g.: Poland and Chile.
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Crawling Peg
• Parity value is changed on a periodic basis.
• Crawl is typically designed to compensate for
differences between the economic performance of
the pegging country and the country being pegged
to.
• Bands may be established around the crawling
parity rate. Bands may be symmetric or
asymmetric.
• E.g: Chile, Hungary, and Poland.
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Managed Float
• Currency value is determined in the
interbank market.
• Monetary authority may intervene
periodically to maintain stability.
• Sometimes referred to as a “dirty float.”
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Floating
• Value of domestic currency is determined in
the foreign exchange market.
• Forces of supply and demand are the sole
determinants of currency value movements.
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Alternative Exchange Rate
Systems
Monetary Unions
• An extreme type of coordination is for a
nation to give up its own currency and
adopt a currency common to it and a
coalition of other nations.
• That is, form a monetary union.
• For a monetary union to succeed, the
coalition must represent an optimal
currency area.
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Optimal Currency Area
• The theory of optimal currency areas is a means of
determining the size of a geographic area within
which residents’ welfare is greater if their
governments fix exchange rates or adopt a
common currency.
• An optimal currency area is on in which labor is
sufficiently mobile to permit speedy adjustments
to payments imbalances and regional
unemployment so that exchange rates can be fixed
or a common currency adopted.
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Exchange Rate Target Zones
• A target zone is a “intermediate” approach to
exchange rate management that limits exchange
rate volatility while still permitting some variation
in countries currency values.
• Specifically, a target zone is a range of permitted
exchange rate variation between upper and lower
exchange rate bands that a central bank defends by
purchasing or selling foreign exchange reserves.
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International Debt
Debt Relief for the Poorest Nations?
Debtor / Creditor Status
• Net Debtor Nation
– A nation whose total claims abroad are less than
the total foreign claims on the nation.
• Net Creditor Nation
– A nation whose stock of foreign financial assets
is greater than the stock of foreign-held
domestic financial assets.
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The US and Net Debtor Status
• It is neither necessarily good nor bad to be a
net debtor.
• The US is the world’s largest net debtor,
primarily because of record FDI inflows.
• The US has been a net debtor in the past,
and it spurred an industrial revolution.
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Debt Relief
• Debt relief for the poorest nations is one of
the most pressing international economic
policy issues today.
• Beginning in the early 1980s, the stock of
international debt became so large that
many developing nations could no longer
make all of their debt service payments.
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Debt Relief / Institutions
• Paris Club
– Forum for multilateral negotiations between
debtor and creditor nations.
• London Club
– Forum for negotiations on private debt owed to
commercial banks.
• Millennium Fund
– Private sector donations for debt relief
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Debt Relief
• Despite the efforts undertaken in these
organizations, during the 1990s, the debt
stock of the poorest nations doubled in 5
years.
• At the start of 2000, less than half of the
debt obligations were being fulfilled, with
$US60 billion in arrears.
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Debt Relief
• In 1996, the leaders of the G7 nations
agreed upon the HIPC (Heavily Indebted
Poor Countries) Initiative, intended as a
means to qualify nations (originally 26) and
deliver debt relief.
• The HIPC initiative failed to deliver relief
after 3 years, as only seven nations qualified
and none saw any debt relief.
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Debt Relief
• In 1999, public pressure lead to the Cologne
Debt Initiative (CDI). The CDI was
intended to deliver faster and deeper relief.
• Expanded list of countries.
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Problems
• 15 percent of debt stock owned by nations
not part of the CDI negotiations.
• 50 percent of the debt stock not being
serviced as is. Hence, forgiveness of stock
may not help that much.
• Public financing issues.
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Current Status
• For current information on HIPC, visit the
web sites of the International Monetary
Fund and the World Bank.
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Balance of Payments Accounting
• Balance of Payments Accounting I
• Balance of Payments Accounting II
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