Transcript International Finance I

International
Monetary System
1
Overview of the Lecture
1. Monetary Authorities
2. Monetary Policy and Exchange Rate
Regimes
3. Conclusions for the Currency
4. A New Currency: the Euro
© 2002 by Stefano Mazzotta
1. Monetary Authorities
3
A brief history
• Classical gold standard: 1821-1914
– Essentially a managed gold standard: transfers of
gold could be substituted by transfers of currencies
• Gold exchange standard: 1925-1931
– U.S. and U.K. could hold only gold reserves, other
nations - both gold and dollars and pounds
• Bretton Woods system: 1946-1971
– Countries pegged their currencies to dollar or gold
• Post-Bretton Woods system: 1973-present
– Floating exchange rate regime
© 2002 by Stefano Mazzotta
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Monetary authorities (Central
Banks) I
• What do they do?
– Determine or impact interest rates
– Determine or impact the value of the currency
– Determine or impact inflation
• How do they do it?
–
–
–
–
–
Print money
Buy or sell local currency (bonds)
Buy or sell foreign currency
Change fiscal and monetary regulations
Change interest rates
© 2002 by Stefano Mazzotta
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Monetary authorities (Central
Banks) II
• They can try to conduct two types of interventions:
• Unsterilized intervention does not disentangle the
domestic money supply from the foreign
exchange transactions. It may lead to inflation.
• Sterilized intervention results in a change in the
country’s foreign reserves but no change in the
domestic money supply. It does not lead to
inflation.
© 2002 by Stefano Mazzotta
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International monetary - IMF
•
•
•
About the IMF
The IMF is an international organization of 184 member countries. It was
established to promote international monetary cooperation, exchange stability,
and orderly exchange arrangements; to foster economic growth and high
levels of employment; and to provide temporary financial assistance to
countries to help ease balance of payments adjustment.
see
Since the IMF was established its purposes have remained unchanged but its
operations — which involve surveillance, financial assistance, and technical
assistance — have developed to meet the changing needs of its member
countries in an evolving world economy.International Monetary Fund (IMF)
World Bank
–
Helps economic development
© 2002 by Stefano Mazzotta
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World Bank
• It was founded in 1944, the World Bank Group is one of the
world's largest sources of development assistance.
• The Bank provided US$19.5 billion in loans to its client countries
in fiscal year 2002,
• It is now working in more than 100 developing economies
• The World Bank is owned by more than 184 member countries
• Member countries are shareholders who carry ultimate decisionmaking power in the World Bank.
• The Bank uses its financial resources, its highly trained staff,
and its extensive knowledge base to individually help each
developing country onto a path of stable, sustainable, and
equitable growth.
© 2002 by Stefano Mazzotta
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World Bank cont’
• The main focus is on helping the poorest people and the poorest
countries, but for all its clients the Bank emphasizes the need
for:
– Investing in people, particularly through basic health and education
– Focusing on social development, inclusion, governance, and
institution-building
– Strengthening the ability of the governments to deliver quality
services, efficiently and transparently
– Protecting the environment Supporting and encouraging private
business development
– Promoting reforms to create a stable macroeconomic environment,
conducive to investment and long-term planning.
• Through its loans, policy advice and technical assistance, the
World Bank supports a broad range of programs aimed at
reducing poverty and improving living standards in the
developing world.
© 2002 by Stefano Mazzotta
2. Monetary Policy and
Exchange Rate Regimes
Major monetary policy
regimes
• Exchange-rate targeting
– Ex: Argentina – Before the crisis
• Monetary targeting
– Ex: Switzerland
• Inflation targeting
– Ex: BCE, UK, US
• Economic growth targeting (implicit
anchor)
– Ex: US
© 2002 by Stefano Mazzotta
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Exchange rate regimes
• Fixed. There are several possibilities:
– fixing the value of the domestic currency to a
commodity (e.g. gold),
– fixing the value of the domestic currency to that of a
large, low-inflation country,
– adopting a pegging target in which the home currency
is allowed to fluctuate within narrow margins.
• Floating. There are two main possibilities:
– managed float,
– independent float
© 2002 by Stefano Mazzotta
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Exchange rate targeting (I)
• Advantages:
– Fixes the inflation rate for internationally
traded goods keeping inflation under
control
– Inflation expectations in the home country
are tied to those of the target country
– Forces to have tight fiscal and monetary
policies
– Simplicity and clarity of the policy
© 2002 by Stefano Mazzotta
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Exchange rate targeting (II)
• Disadvantages:
– Leads to the loss of independent monetary
policy
– Directly transmits shocks from the target
country
– Leaves a country open to a speculative
attack on its currency
– Increases the possibility of a financial
crises in developing countries
© 2002 by Stefano Mazzotta
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Monetary targeting
• Advantages:
– Allows the Central Bank to adjust its monetary policy
quickly in response to domestic needs
– Information on achieving the goal of the monetary
policy is known to the public and market almost
immediately
• Disadvantages:
– There must be a clear relation between the monetary
aggregate and more visible goal variable (inflation)
– The Central bank must efficiently control the targeted
monetary aggregate
© 2002 by Stefano Mazzotta
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Inflation targeting
• Advantages:
– Allows the monetary policy to be focused on
domestic needs
– Easily understood by the public and policy makers.
– Increases accountability of the Central Bank
• Disadvantages:
– May lead to low and unstable output growth and
employment
– May put too stringent bounds on policy makers to
respond to unforeseen economic circumstances
© 2002 by Stefano Mazzotta
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Implicit targeting
• Advantages:
– Demonstrated empirical success on the U.S.
economy in the 90’s
– Forward-looking, “preemptive” monetary
policy
• Disadvantages:
– Lack of transparency
– Strong dependence on personal skills and
preferences
© 2002 by Stefano Mazzotta
Floating vs. fixed
exchange rate regimes
• Advantages of floating regimes:
– Offsets cross-country differences in inflation, so that
employment, output, wages need not change
– Can stabilize nominal exchange rates if countries
pursue coordinated monetary policies
• Disadvantages of floating regimes:
– Potentially leads to high real exchange rate volatility
– Increases uncertainty about future government
policies
– Increases uncertainty for the private sector
© 2002 by Stefano Mazzotta
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3. Conclusions for the
Currency
19
Currency reputation
• They are many determinants of a currency
reputation. The Central Bank reputation is
one of the main ones.
• A country where the Central Bank is able to
maintain the relative stability of price levels
ends up having a strong (hard) currency,
while a country where the Central Banks is
unable to maintain the relative stability of
price levels ends up having a weak (soft)
currency.
© 2002 by Stefano Mazzotta
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The ideal currency
1) Must have fixed value with respect to major
currencies
2) Must be convertible, so that there are no
restrictions on the flow of capital from one
country to another
3) Must support independent monetary policy
which will ensure that a country can pursue
the the best economic policy
4) It is usually not possible to achieved these
three attributes at the same time though.
© 2002 by Stefano Mazzotta
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Today’s major currencies
AUD Australian Dollar
EUR Euro
GBP British Pound
NZD New Zealand
Dollar
CAD Canadian Dollar
CHF Swiss Franc
DKK Danish Krone
JPY Japanese Yen
SEK Swedish Krona
USD United States
Dollar
© 2002 by Stefano Mazzotta
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Eurocurrencies
• Definition:
– A eurocurrency is a domestic currency deposit in a
foreign country (not necessarily European!)
• Purpose:
– A way for holding excess corporate liquidity
– A major source of short-term bank loans
• Major creators of the market
– The United States and … the Soviet Union
© 2002 by Stefano Mazzotta
4. A New Currency:
the Euro
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Europe in numbers
© 2002 by Stefano Mazzotta
The European Monetary
System (EMS)
• Started in 1979
• Members in total: Austria, Belgium, Denmark,
Finland, France, Germany, Greece, Ireland,
Italy, Luxembourg, The Netherlands,
Portugal, Spain, Sweden, U.K.
• Currency unit: ECU - a composite currency
based on a weighted average of the
currencies of 15 states of the European
Union.
• Exchange rate regime: - narrow target zone
arrangement.
© 2002 by Stefano Mazzotta
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The Maastricht Treaty
(1991)
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• Fixes the single currency as the monetary
goal to achieve before the end of the decade
• Gives the necessary conditions (convergence
criteria): inflation, long-term interest rates,
deficit and debt.
• Defines the role of the new Central Bank
• Confirms the open market economy with free
competition as the economic environment
(previous step decided in 1986 for 1992)
© 2002 by Stefano Mazzotta
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A very difficult road
• Currency crises: 1992, 1993
• Economic crises: impossible
convergence criteria
• Political crises: Denmark, France, UK
• A lot of uncertainty till the end: which
countries? Which parities? Which date
of beginning?
• Conclusion: an incredible success
© 2002 by Stefano Mazzotta
The European Monetary
Union (EMU)
• Started in 1999
• Members: Austria, Belgium, Finland, France,
Germany, Ireland, Italy, Luxembourg, The
Netherlands, Portugal, Spain, Greece.
• Currency unit: EURO - a currency of the
European Monetary Union.
• Exchange rate regime: exchange
arrangement.
© 2002 by Stefano Mazzotta
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Potential benefits of sharing
a single currency
• Political:
– A building block in pan-European nation
• Economic:
–
–
–
–
–
–
No uncertainty of intra-euro exchange rates
More efficient price discovery process
Reduction in transaction costs for intra-euro trade
Lower costs of maintaining transaction balances
Increased flow of capital across EMU members
Using it instead of dollar in international
transactions
© 2002 by Stefano Mazzotta
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Current situation
• Big countries have hard time keeping their
budget deficit low: what to do?
• Large disparities in the economic situation of
the countries: which countries should the
Central Bank monitor the most?
• In economic slow down: is inflation targeting
still relevant?
• It is becoming a stable/strong currency: does
it mean anything?
• The role of Germany: from model to
obstacle?
© 2002 by Stefano Mazzotta