Krugman Obstfeld Ch 18

8/18/2019 Krugman Obstfeld Ch 18

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Chapter 18Chapter 18

The International Monetary System, 1870-1973The International Monetary System, 1870-1973

Prepared by Iordanis Petsas

To Aompany

International Economics: Theory and PolicyInternational Economics: Theory and Policy, Sixth Edition

by Paul R. Krugman and Maurice Obsteld


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Chapter 'r"ani(ation

Maroeonomi Poliy )oals in an 'pen $onomy

International Maroeonomi Poliy *nder the )old

Standard, 1870-191+

The Interar ears, 1918-1939

The .retton /oods System and the International

Monetary %nd

Internal and $ternal .alane *nder the .retton/oods System

Analy(in" Poliy 'ptions *nder the .retton /oods

System


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The $ternal .alane Problem o2 the *nited States

/orldide In2lation and the Transition to loatin"

ates

S%mmary

Chapter 'r"ani(ation


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Introd%tion

The interdependene o2 open national eonomies has

made it more di22i%lt 2or "o4ernments to ahie4e 2%ll

employment and prie stability&

5 The hannels o2 interdependene depend on themonetary and ehan"e rate arran"ements&

This hapter eamines the e4ol%tion o2 the

international monetary system and ho it in2l%ened

maroeonomi poliy&


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Maroeonomi Poliy )oals

in an 'pen $onomy

In open eonomies, poliymaers are moti4ated by

to "oals

5 Internal balance

It re:%ires the 2%ll employment o2 a o%ntry;s reso%resand domesti prie le4el stability&

5 External balance It is attained hen a o%ntry;s %rrent ao%nt is neither

so deeply in de2iit nor so stron"ly in s%rpl%s&


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Internal .alane %ll $mployment and Prie-=e4el

Stability

5 *nder-and o4eremployment lead to prie le4el

mo4ements that red%e the eonomy;s e22iieny&5 To a4oid prie-le4el instability, the "o4ernment m%st

Pre4ent s%bstantial mo4ements in a""re"ate demand

relati4e to its 2%ll-employment le4el&

$ns%re that the domesti money s%pply does not "ro

too :%ily or too sloly&


in an 'pen $onomy


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in an 'pen $onomy

$ternal .alane The 'ptimal =e4el o2 the C%rrent

Ao%nt

5 $ternal balane has no 2%ll employment or stable

pries to apply to an eonomy;s eternal transations&5 An eonomy;s trade an a%se maroeonomi

problems dependin" on se4eral 2ators

The eonomy;s parti%lar ir%mstanes

Conditions in the o%tside orld

The instit%tional arran"ements "o4ernin" its eonomi

relations ith 2orei"n o%ntries


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5 Problems !ith Excessi"e #urrent $ccount %eicits: They sometimes represent temporarily hi"h

ons%mption res%ltin" 2rom mis"%ided "o4ernment

poliies& They an %ndermine 2orei"n in4estors; on2idene and

ontrib%te to a lendin" risis&


in an 'pen $onomy


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in an 'pen $onomy

5 Problems !ith Excessi"e #urrent $ccountSur&luses:

They imply loer in4estment in domesti plant and

e:%ipment& They an reate potential problems 2or reditors to

ollet their money&

They may be inon4enient 2or politial reasons&


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Se4eral 2ators mi"ht lead poliymaers to pre2er that

domesti sa4in" be de4oted to hi"her le4els o2 domesti

in4estment and loer le4els o2 2orei"n in4estment

It may be easier to ta

It may red%e domesti %nemployment&

It an ha4e bene2iial tehnolo"ial spillo4er e22ets


in an 'pen $onomy


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International Maroeonomi Poliy

*nder the )old Standard, 1870-191+

'ri"ins o2 the )old Standard

5 The "old standard had its ori"in in the %se o2 "oldoins as a medi%m o2 ehan"e, %nit o2 ao%nt, and

store o2 4al%e&5 The es%mption At >1819? mars the 2irst adoption o2

a tr%e "old standard&

It sim%ltaneo%sly repealed lon"-standin" restritions on

the eport o2 "old oins and b%llion 2rom .ritain&

5 The *&S& )old Standard At o2 1900 instit%tionali(edthe dollar-"old lin&


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$ternal .alane *nder the )old Standard

5 Central bans Their primary responsibility as to preser4e the o22iial

parity beteen their %rreny and "old& They adopted poliies that p%shed the nonreser4eomponent o2 the 2inanial ao%nt s%rpl%s >or de2iit?into line ith the total %rrent pl%s apital ao%ntde2iit >or s%rpl%s?&

A o%ntry is in balance o &ayments e'uilibrium hen thes%m o2 its %rrent, apital, and nonreser4e 2inanial ao%ntse:%als (ero&

5 Many "o4ernments too a laisse(-2aire attit%de toardthe %rrent ao%nt&


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The Prie-Speie-lo Mehanism

5 The most important poer2%l a%tomati mehanismthat ontrib%tes to the sim%ltaneo%s ahie4ement o2

balane o2 payments e:%ilibri%m by all o%ntries The 2los o2 "old aompanyin" de2iits and s%rpl%ses

a%se prie han"es that red%e %rrent ao%nt

imbalanes and ret%rn all o%ntries to eternal balane&


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The )old Standard @%les o2 the )ame Myth and

eality

5 The praties o2 sellin" >or b%yin"? domesti assets in

the 2ae o2 a de2iit >or s%rpl%s?& The e22iieny o2 the a%tomati adB%stment proesses

inherent in the "old standard inreased by these r%les&

In pratie, there as little inenti4e 2or o%ntries ith

epandin" "old reser4es to 2ollo these r%les& Co%ntries o2ten re4ersed the r%les and sterili(ed "old

2los&


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Internal .alane *nder the )old Standard

5 The "old standard system;s per2ormane inmaintainin" internal balane as mied&

$ample The *&S& %nemployment rate a4era"ed


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/ith the er%ption o2 //I in 191+, the "old standard

as s%spended&

5 The interar years ere mared by se4ere eonomi

instability&5 The reparation payments led to episodes o2

hyperin2lation in $%rope&

The )erman Dyperin2lation

5 )ermany;s prie inde rose 2rom a le4el o2 !

Feember 19!3 >a 2ator o2 +81&6 billion?&


17/45

The leetin" et%rn to )old

5 1919 *&S& ret%rned to "old

5 19!! A "ro%p o2 o%ntries >.ritain, rane, Italy, and Eapan?

a"reed on a pro"ram allin" 2or a "eneral ret%rn to the

"old standard and ooperation amon" entral bans in

attainin" eternal and internal obBeti4es&



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5 19!6 .ritain ret%rned to the "old standard

5 19!9

The )reat Fepression as 2olloed by ban 2ail%resthro%"ho%t the orld&

5 1931 .ritain as 2ored o22 "old hen 2orei"n holders o2

po%nds lost on2idene in .ritain;s ommitment tomaintain its %rreny;s 4al%e&



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International $onomi Fisinte"ration

5 Many o%ntries s%22ered d%rin" the )reat Fepression&

5 MaBor eonomi harm as done by restritions on

international trade and payments&5 These be""ar-thy-nei"hbor poliies pro4oed 2orei"n

retaliation and led to the disinte"ration o2 the orld

eonomy&

5 All o%ntries; sit%ations o%ld ha4e been betteredthro%"h international ooperation

(retton )oods agreement



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*igure +-+ Ind%strial Prod%tion and /holesale Prie Inde Chan"es,

19!9-1936

Th . / d S


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The .retton /oods System

and the International Monetary %nd

International Monetary *und IM*/

5 In E%ly 19++, ++ representin" o%ntries met in .retton/oods, Ge Dampshire to set %p a system o2 2ied

ehan"e rates& All %rrenies had 2ied ehan"e rates a"ainst the *&S& dollar

and an %n4aryin" dollar prie o2 "old >H36 an o%ne?&

5 It intended to pro4ide lendin" to o%ntries ith %rrent

ao%nt de2iits&5 It alled 2or %rreny on4ertibility&

Th . / d S


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)oals and Str%t%re o2 the IM

5 The IM a"reement tried to inorporate s%22iient2leibility to allo o%ntries to attain eternal balane

itho%t sari2iin" internal obBeti4es or 2iedehan"e rates&

5 To maBor 2eat%res o2 the IM Artiles o2 A"reementhelped promote this 2leibility in eternal adB%stment

IM lendin" 2ailities IM* conditionality is the name 2or the s%r4eillane o4er the

poliies o2 member o%nties ho are hea4y borroers o2 %nd

reso%res&

AdB%stable parities



Th . tt / d S t


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Con4ertibility

5 #on"ertible currency A %rreny that may be 2reely ehan"ed 2or 2orei"n

%rrenies& $ample The *&S& and Canadian dollars beame on4ertible

in 19+6& A Canadian resident ho a:%ired *&S& dollars o%ld

%se them to mae p%rhases in the *&S& or o%ld sell them to

the .an o2 Canada&

5 The IM artiles alled 2or on4ertibility on %rrentao%nt transations only&



I t l d $ t l . l


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Internal and $ternal .alane

*nder the .retton /oods System

The Chan"in" Meanin" o2 $ternal .alane

5 The @Follar shorta"e period >2irst deade o2 the.retton /oods system?

The main eternal problem as to a:%ire eno%"hdollars to 2inane neessary p%rhases 2rom the *&S&

5 Marshall Plan >19+8? A pro"ram o2 dollar "rants 2rom the *&S& to $%ropean

o%ntries& It helped limit the se4erity o2 dollar shorta"e&

I t l d $ t l . l


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Internal and $ternal .alane


Spe%lati4e Capital los and Crises

5 C%rrent ao%nt de2iits and s%rpl%ses too on addedsi"ni2iane %nder the ne onditions o2 inreased

pri4ate apital mobility& Co%ntries ith a lar"e %rrent ao%nt de2iit mi"ht be

s%speted o2 bein" in @2%ndamental dise:%ilibri%m%nder

the IM Artiles o2 A"reement&

Co%ntries ith lar"e %rrent ao%nt s%rpl%ses mi"ht be4ieed by the maret as andidates 2or re4al%ation&

A l i P li ' ti


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Analy(in" Poliy 'ptions


To desribe the problem an indi4id%al o%ntry >other

than the *&S&? 2aed in p%rs%in" internal and eternal

balane %nder the .retton /oods system o2 2ied

ehan"e rates, ass%me that R RJ

A l i P li ' ti


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Maintainin" Internal .alane

5 I2 both P J and E are permanently 2ied, internal balane re:%ired only 2%ll employment&

5 In4estment is ass%med onstant&5 The ondition o2 internal balane

Y f

C

>Y f

T

? K I

KG

KCA

> EP

JL P

,Y f

T

? >18-1?

The poliy tools that a22et a""re"ate demand and there2ore

a22et o%tp%t in the short r%n&



A l i P li ' ti


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*igure +-0 Internal .alane > II ?, $ternal .alane > XX ?, and the

@o%r ones o2 $onomi Fisom2ort



A l i P li ' ti


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Maintainin" $ternal .alane

5 Do do poliy tools a22et the eonomy;s eternal balaneN

Ass%me the "o4ernment has a tar"et 4al%e, X , 2or the%rrent ao%nt s%rpl%s&

$ternal balane re:%ires the "o4ernment to mana"e

2isal poliy and the ehan"e rate so that

CA> EP JL P , Y T ? X >18-!? To maintain its %rrent ao%nt at X as it de4al%es the %rreny,

the "o4ernment m%st epand its p%rhases or loer taes&



Anal in" Poli 'ptions


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$pendit%re-Chan"in" and $pendit%re-Sithin"

Poliies

5 Point 1 >in i"%re 18-!? shos the poliy settin" that

plaes the eonomy in the position that the poliymaer o%ld pre2er&

5 Ex&enditure-changing &olicy The han"e in 2isal poliy that mo4es the eonomy to

Point 1& It alters the le4el o2 the eonomy;s total demand 2or

"oods and ser4ies&





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5 Ex&enditure-s!itching &olicy The aompanyin" ehan"e rate adB%stment

It han"es the diretion o2 demand, shi2tin" it beteen

domesti o%tp%t and imports&5 .oth ependit%re han"in" and ependit%re sithin"

are needed to reah internal and eternal balane&





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Fiscal ease

(G or T ↓)

Exchange

rate, E

XX

II

*igure +-1 Poliies to .rin" Abo%t Internal and $ternal .alane

1

3

Devaluation

that results

in internal

and external

balance2

4

Fiscal expansion

that results in internal

and external balance



Th $ t l . l


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The $ternal .alane

Problem o2 the *nited States

The *&S& as responsible to hold the dollar prie o2

"old at H36 an o%ne and "%arantee that 2orei"n

entral bans o%ld on4ert their dollar holdin"s into

"old at that prie&5 orei"n entral bans ere illin" to hold on to the

dollars they a%m%lated, sine these paid interest and

represented an international money par eellene&

The #onidence &roblem

5 The 2orei"n holdin"s o2 dollars inreased %ntil theyeeeded *&S& "old reser4es and the *&S& o%ld not

redeem them&

Th $ t l . l


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S&ecial %ra!ing Right S%R/

5 An arti2iial reser4e asset

5 SFs are %sed in transations beteen entral bans

b%t had little impat on the 2%ntionin" o2 theinternational monetary system&

The $ternal .alane


Th $ t l . l


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*igure +-2 *&S& Maroeonomi Fata, 19


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*igure +-2 Contin%ed

The $ternal .alane


Th $ t l . l


37/45

The $ternal .alane



Th $ t l . l


38/45

The $ternal .alane



/orldide In2lation and


39/45

The aeleration o2 Amerian in2lation in the late

19


40/45

Table +-+ In2lation ates in $%ropean Co%ntries, 19


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*igure +-3 $22et on Internal and $ternal .alane o2 a ise in theorei"n Prie =e4el, P J

Fiscal ease

(G

or T ↓

)

Exchange

rate, E

XX 1

II 1

1

Distance =

E P */P

*

II 2

XX 2

2


the Transition to loatin" ates



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Table +-0 Chan"es in )ermany;s Money S%pply and Internationaleser4es, 19perent per year?


the Transition to loatin" ates


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S%mmary

In an open eonomy, poliymaers try to maintain

internal and eternal balane&

The "old standard system ontains a poer2%l

a%tomati mehanism 2or ass%rin" eternal balane,the prie-speie-2lo mehanism&

Attempts to ret%rn to the prear "old standard a2ter

1918 ere %ns%ess2%l&

5 As the orld eonomy mo4ed into "eneral depressiona2ter 19!9, the restored "old standard 2ell apart and

international eonomi inte"ration eaened&


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S%mmary

The arhitets o2 the IM hoped to desi"n a 2ied

ehan"e rate system that o%ld eno%ra"e "roth in

international trade&

To reah internal and eternal balane at the sametime, ependit%re-sithin" as ell as ependit%re-

han"in" poliies ere needed&

The *nited States 2aed a %ni:%e eternal balane

problem, the on2idene problem&


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*&S& maroeonomi poliies in the late 19

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Krugman Obstfeld Ch 18