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Unformatted text preview: International Finance
Fixed Exchange Rates, the Gold Standard, and the IMF Recall: The Gold Standard Paper money is a promise of gold When enough nations adopted the gold standard, trade became easier – Example: $1 claims 1/500 oz. of gold – Actual price today ~$675/oz. – Tipping point reached in late 19th century Exchange Rates and The Gold Standard How much does a 1.5M yen Toyota cost? Gold standard fixes exchange rates – If $500 buys 1 oz. of gold – And 50,000 yen buys 1 oz. of gold – How many yen does $1 buy? How much does that Toyota cost in $? Trade Imbalances and Gold Flows Suppose U.S. has trade deficit w/ Japan Gold flows (net) from U.S. to Japan
– Money supply rises in Japan – Money supply falls in U.S. Real GDP rises in the short run Prices rise in the long run (recall: MV=Py) Japan imports more (including from U.S.) Real GDP and Prices fall (MV=Py) U.S. imports less (including from Japan) Trade balance is restored! The Beginning of the End of the Gold Standard Countries leave standard during WWI Prices rise during war Countries go back after the war Problems: – Governments printed money for a “quick” war – Going off gold standard eliminated limits on money – Not enough gold in world stocks to back all countries’ currencies fully – Countries never quite restored confidence in the system The End of the Gold Standard In 1931 the British pound was in crisis The U.S. Fed feared what it saw in Britain
– – – – People lost faith in its convertability into gold – People turned in pounds to the Bank of England and demanded gold – Great Britain went off gold standard: a lucky break? Raised interest rates to encourage holding $ Money supply fell by 1/3 between 1930 and 1931 Helped turn a bad downturn into disaster PostWorld War II Policy The Bretton Woods System Dollar fixed at official price to gold ($35/oz.) Other currencies fixed to dollar – Replaced gold standard with $standard – Created the IMF (and World Bank) – J.M. Keynes’ final contribution Reasons for the IMF Fixed rates had no adjustment mechanism IMF created to support fixed exchange rates
– Helped with short run and long run problems – Floating rates adjust to restore balance – Gold standard restored balance with gold flows In short run: provided loans for temporary imbalances In long run: softened impact of revaluing currency The End of Fixed Exchange Rates U.S. had persistent inflation in 1960s Market (unofficial) price of gold rose to ~$200/oz. Run on U.S. gold reserves developed (recall “carry trade”) U.S. feared it would run out of gold
– Left fixed exchange rate system 8/15/71 IMF and Floating Exchange Rates Original purpose disappeared IMF redefined its role – No short run balance problems to tide over – No need to soften effects of devaluation – Lends to developing nations (like World Bank) – Helps nations weather financial crises stemming from pegged exchange rates The Argentinean Crisis Argentina plagued by inflation Wanted to show commitment to price stability Pegged peso to $ – Central bank could not follow policy that would affect exchange rate – Would keep central bank from printing pesos Problems with the Peg 1:1 exchange rate Peso overvalued
– Written in stone P ($/peso)
D Ppeg S Central bank had to buy pesos
– – – Government failed to control inflation – $ became very strong Note difference from China Ran out of reserves Q (pesos) Argentina and the IMF IMF tried to get peso in line with peg Government refused System broke down
– Defaulted on loans from IMF – Government devalued peso severely – Devaluation caused severe recession – Let Argentinean economy sink? – Lend money to support a bad policy? – Pushed government to stop deficit spending IMF left with bad options Problems Facing IMF IMF frequently prescribes austerity Is cutting G wise during a recession? Like World Bank – IMF often faces bad options – Uncontrolled spending often a cause of problems – Cutting spending can be painful ...
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This note was uploaded on 04/28/2011 for the course ECON 1101 taught by Professor Rappoport during the Fall '08 term at Temple.
- Fall '08