1、Chapter 18The International Monetary System,1870-19731Chapter OrganizationMacroeconomic Policy Goals in an Open EconomyInternational Macroeconomic Policy Under the Gold Standard,1870-1914The Interwar Years,1918-1939The Bretton Woods System and the International Monetary FundInternal and External Bal
2、ance Under the Bretton Woods SystemAnalyzing Policy Options Under the Bretton Woods System2The External Balance Problem of the United StatesWorldwide Inflation and the Transition to Floating RatesSummaryChapter Organization3IntroductionThe interdependence of open national economies has made it more
3、difficult for governments to achieve full employment and price stability.The channels of interdependence depend on the monetary and exchange rate arrangements.This chapter examines the evolution of the international monetary system and how it influenced macroeconomic policy.4Macroeconomic Policy Goa
4、ls in an Open EconomyIn open economies,policymakers are motivated by two goals:Internal balance It requires the full employment of a countrys resources and domestic price level stability.External balance It is attained when a countrys current account is neither so deeply in deficit nor so strongly i
5、n surplus.5Internal Balance:Full Employment and Price-Level StabilityUnder-and overemployment lead to price level movements that reduce the economys efficiency.To avoid price-level instability,the government must:Prevent substantial movements in aggregate demand relative to its full-employment level
6、.Ensure that the domestic money supply does not grow too quickly or too slowly.Macroeconomic Policy Goals in an Open Economy6Macroeconomic Policy Goals in an Open EconomyExternal Balance:The Optimal Level of the Current AccountExternal balance has no full employment or stable prices to apply to an e
7、conomys external transactions.An economys trade can cause macroeconomic problems depending on several factors:The economys particular circumstances Conditions in the outside world The institutional arrangements governing its economic relations with foreign countries7Problems with Excessive Current A
8、ccount Deficits:They sometimes represent temporarily high consumption resulting from misguided government policies.They can undermine foreign investors confidence and contribute to a lending crisis.Macroeconomic Policy Goals in an Open Economy8Macroeconomic Policy Goals in an Open EconomyProblems wi
9、th Excessive Current Account Surpluses:They imply lower investment in domestic plant and equipment.They can create potential problems for creditors to collect their money.They may be inconvenient for political reasons.9 Several factors might lead policymakers to prefer that domestic saving be devote
10、d to higher levels of domestic investment and lower levels of foreign investment:It may be easier to tax It may reduce domestic unemployment.It can have beneficial technological spillover effectsMacroeconomic Policy Goals in an Open Economy10International Macroeconomic Policy Under the Gold Standard
11、,1870-1914Origins of the Gold StandardThe gold standard had its origin in the use of gold coins as a medium of exchange,unit of account,and store of value.The Resumption Act(1819)marks the first adoption of a true gold standard.It simultaneously repealed long-standing restrictions on the export of g
12、old coins and bullion from Britain.The U.S.Gold Standard Act of 1900 institutionalized the dollar-gold link.11International Macroeconomic Policy Under the Gold Standard,1870-1914External Balance Under the Gold StandardCentral banks Their primary responsibility was to preserve the official parity bet
13、ween their currency and gold.They adopted policies that pushed the nonreserve component of the financial account surplus(or deficit)into line with the total current plus capital account deficit(or surplus).A country is in balance of payments equilibrium when the sum of its current,capital,and nonres
14、erve financial accounts equals zero.Many governments took a laissez-faire attitude toward the current account.12International Macroeconomic Policy Under the Gold Standard,1870-1914The Price-Specie-Flow MechanismThe most important powerful automatic mechanism that contributes to the simultaneous achi
15、evement of balance of payments equilibrium by all countries The flows of gold accompanying deficits and surpluses cause price changes that reduce current account imbalances and return all countries to external balance.13International Macroeconomic Policy Under the Gold Standard,1870-1914The Gold Sta
16、ndard“Rules of the Game”:Myth and RealityThe practices of selling(or buying)domestic assets in the face of a deficit(or surplus).The efficiency of the automatic adjustment processes inherent in the gold standard increased by these rules.In practice,there was little incentive for countries with expan
17、ding gold reserves to follow these rules.Countries often reversed the rules and sterilized gold flows.14Internal Balance Under the Gold StandardThe gold standard systems performance in maintaining internal balance was mixed.Example:The U.S.unemployment rate averaged 6.8%between 1890 and 1913,but it
18、averaged under 5.7%between 1946 and 1992.International Macroeconomic Policy Under the Gold Standard,1870-191415The Interwar Years,1918-1939With the eruption of WWI in 1914,the gold standard was suspended.The interwar years were marked by severe economic instability.The reparation payments led to epi
19、sodes of hyperinflation in Europe.The German HyperinflationGermanys price index rose from a level of 262 in January 1919 to a level of 126,160,000,000,000 in December 1923(a factor of 481.5 billion).16The Fleeting Return to Gold1919 U.S.returned to gold1922 A group of countries(Britain,France,Italy,
20、and Japan)agreed on a program calling for a general return to the gold standard and cooperation among central banks in attaining external and internal objectives.The Interwar Years,1918-1939171925 Britain returned to the gold standard1929 The Great Depression was followed by bank failures throughout
21、 the world.1931 Britain was forced off gold when foreign holders of pounds lost confidence in Britains commitment to maintain its currencys value.The Interwar Years,1918-193918International Economic DisintegrationMany countries suffered during the Great Depression.Major economic harm was done by res
22、trictions on international trade and payments.These beggar-thy-neighbor policies provoked foreign retaliation and led to the disintegration of the world economy.All countries situations could have been bettered through international cooperation Bretton Woods agreementThe Interwar Years,1918-193919Th
23、e Interwar Years,1918-1939 Figure 18-1:Industrial Production and Wholesale Price Index Changes,1929-193520The Bretton Woods System and the International Monetary FundInternational Monetary Fund(IMF)In July 1944,44 representing countries met in Bretton Woods,New Hampshire to set up a system of fixed
24、exchange rates.All currencies had fixed exchange rates against the U.S.dollar and an unvarying dollar price of gold($35 an ounce).It intended to provide lending to countries with current account deficits.It called for currency convertibility.21Goals and Structure of the IMFThe IMF agreement tried to
25、 incorporate sufficient flexibility to allow countries to attain external balance without sacrificing internal objectives or fixed exchange rates.Two major features of the IMF Articles of Agreement helped promote this flexibility in external adjustment:IMF lending facilities IMF conditionality is th
26、e name for the surveillance over the policies of member counties who are heavy borrowers of Fund resources.Adjustable paritiesThe Bretton Woods System and the International Monetary Fund22ConvertibilityConvertible currency A currency that may be freely exchanged for foreign currencies.Example:The U.
27、S.and Canadian dollars became convertible in 1945.A Canadian resident who acquired U.S.dollars could use them to make purchases in the U.S.or could sell them to the Bank of Canada.The IMF articles called for convertibility on current account transactions only.The Bretton Woods System and the Interna
28、tional Monetary Fund23Internal and External Balance Under the Bretton Woods SystemThe Changing Meaning of External BalanceThe“Dollar shortage”period(first decade of the Bretton Woods system)The main external problem was to acquire enough dollars to finance necessary purchases from the U.S.Marshall P
29、lan(1948)A program of dollar grants from the U.S.to European countries.It helped limit the severity of dollar shortage.24Internal and External Balance Under the Bretton Woods SystemSpeculative Capital Flows and CrisesCurrent account deficits and surpluses took on added significance under the new con
30、ditions of increased private capital mobility.Countries with a large current account deficit might be suspected of being in“fundamental disequilibrium”under the IMF Articles of Agreement.Countries with large current account surpluses might be viewed by the market as candidates for revaluation.25Anal
31、yzing Policy Options Under the Bretton Woods SystemTo describe the problem an individual country(other than the U.S.)faced in pursuing internal and external balance under the Bretton Woods system of fixed exchange rates,assume that:R=R*26Maintaining Internal BalanceIf both P*and E are permanently fi
32、xed,internal balance required only full employment.Investment is assumed constant.The condition of internal balance:Yf=C(Yf T)+I+G+CA(EP*/P,Yf T)(18-1)The policy tools that affect aggregate demand and therefore affect output in the short run.Analyzing Policy Options Under the Bretton Woods System27
33、Figure 18-2:Internal Balance(II),External Balance(XX),and the “Four Zones of Economic Discomfort”Analyzing Policy Options Under the Bretton Woods System28Maintaining External BalanceHow do policy tools affect the economys external balance?Assume the government has a target value,X,for the current ac
34、count surplus.External balance requires the government to manage fiscal policy and the exchange rate so that:CA(EP*/P,Y T)=X (18-2)To maintain its current account at X as it devalues the currency,the government must expand its purchases or lower taxes.Analyzing Policy Options Under the Bretton Woods
35、 System29Expenditure-Changing and Expenditure-Switching PoliciesPoint 1(in Figure 18-2)shows the policy setting that places the economy in the position that the policymaker would prefer.Expenditure-changing policy The change in fiscal policy that moves the economy to Point 1.It alters the level of t
36、he economys total demand for goods and services.Analyzing Policy Options Under the Bretton Woods System30Expenditure-switching policy The accompanying exchange rate adjustment It changes the direction of demand,shifting it between domestic output and imports.Both expenditure changing and expenditure
37、 switching are needed to reach internal and external balance.Analyzing Policy Options Under the Bretton Woods System31Fiscal ease(G or T)Exchangerate,EXXII Figure 18-3:Policies to Bring About Internal and External Balance13Devaluation that results in internal and external balance24Fiscal expansion t
38、hat results in internal and external balanceAnalyzing Policy Options Under the Bretton Woods System32The External Balance Problem of the United StatesThe U.S.was responsible to hold the dollar price of gold at$35 an ounce and guarantee that foreign central banks could convert their dollar holdings i
39、nto gold at that price.Foreign central banks were willing to hold on to the dollars they accumulated,since these paid interest and represented an international money par excellence.The Confidence problemThe foreign holdings of dollars increased until they exceeded U.S.gold reserves and the U.S.could
40、 not redeem them.33Special Drawing Right(SDR)An artificial reserve assetSDRs are used in transactions between central banks but had little impact on the functioning of the international monetary system.The External Balance Problem of the United States34Figure 18-4:U.S.Macroeconomic Data,1964-1972The
41、 External Balance Problem of the United States35Figure 18-4:ContinuedThe External Balance Problem of the United States36The External Balance Problem of the United StatesFigure 18-4:Continued37The External Balance Problem of the United StatesFigure 18-4:Continued38The acceleration of American inflati
42、on in the late 1960s was a worldwide phenomenon.It had also speeded up in European economies.When the reserve currency country speeds up its monetary growth,one effect is an automatic increase in monetary growth rates and inflation abroad.U.S.macroeconomic policies in the late 1960s helped cause the
43、 breakdown of the Bretton Woods system by early 1973.Worldwide Inflation and the Transition to Floating Rates39 Table 18-1:Inflation Rates in European Countries,1966-1972 (percent per year)Worldwide Inflation and the Transition to Floating Rates40 Figure 18-5:Effect on Internal and External Balance
44、of a Rise in the Foreign Price Level,P*Fiscal ease(G or T)Exchangerate,EXX1II11Distance=E P*/P*II2XX22Worldwide Inflation and the Transition to Floating Rates41 Table 18-2:Changes in Germanys Money Supply and International Reserves,1968-1972(percent per year)Worldwide Inflation and the Transition to
45、 Floating Rates42SummaryIn an open economy,policymakers try to maintain internal and external balance.The gold standard system contains a powerful automatic mechanism for assuring external balance,the price-specie-flow mechanism.Attempts to return to the prewar gold standard after 1918 were unsucces
46、sful.As the world economy moved into general depression after 1929,the restored gold standard fell apart and international economic integration weakened.43SummaryThe architects of the IMF hoped to design a fixed exchange rate system that would encourage growth in international trade.To reach interna
47、l and external balance at the same time,expenditure-switching as well as expenditure-changing policies were needed.The United States faced a unique external balance problem,the confidence problem.44U.S.macroeconomic policies in the late 1960s helped cause the breakdown of the Bretton Woods system by early 1973.Summary45
