1、Copyright 2002 by The McGraw-Hill Companies,Inc.All rights reserved.15-1CHAPTER 15International Economic PolicyCopyright 2002 by The McGraw-Hill Companies,Inc.All rights reserved.15-2Questions How has the world organized its international monetary system?What is a fixed exchange rate system?What is
2、a floating exchange rate system?What are the costs and benefits of fixed exchange rates vis-vis floating exchange rates?Copyright 2002 by The McGraw-Hill Companies,Inc.All rights reserved.15-3Questions Why do most countries today have floating exchange rates?Why has western Europe recently created a
3、“monetary union”-an irrevocable commitment to fixed exchange rates within western Europe?What were the causes of the three major currency crises of the 1990s?Copyright 2002 by The McGraw-Hill Companies,Inc.All rights reserved.15-4The Gold Standard Before World War I,nearly all of the world economy w
4、as on the gold standarda government would define a unit of its currency as worth a particular amount of goldthe currency was convertible could be converted into gold freelythe currencys price in terms of gold was its parityCopyright 2002 by The McGraw-Hill Companies,Inc.All rights reserved.15-5Figur
5、e 15.2-Growth of the Gold StandardCopyright 2002 by The McGraw-Hill Companies,Inc.All rights reserved.15-6The Gold Standard When two countries were on the gold standard,their nominal exchange rate was fixed at the ratio of their gold paritiesat World War II parities the U.S.dollar was equal to 1/35
6、of an ounce of gold the British pound sterling was set to equal 1/15.58333 ounces of gold the exchange rate of the dollar for the pound was 1.00=$2.40Copyright 2002 by The McGraw-Hill Companies,Inc.All rights reserved.15-7The Gold Standard Example of currency arbitragethe U.S.government is willing t
7、o buy gold at$35 per ouncethe British government is willing to buy gold at 15.58333 per ouncethe pound trades for$2.64(10%higher than the ratio of the gold parities-$2.40)Copyright 2002 by The McGraw-Hill Companies,Inc.All rights reserved.15-8The Gold Standard Someone with an ounce of gold couldtrad
8、e it to the British Treasury for 15.58333 trade those pounds for dollars in the foreign exchange market and get$38.50trade the$38.50 to the U.S.Treasury for 1.1 ounces of goldrepeat the process as quickly as possible,making a 10%profit each time the circle is completedCopyright 2002 by The McGraw-Hi
9、ll Companies,Inc.All rights reserved.15-9Figure 15.1-How to Profit in the Foreign-Exchange MarketCopyright 2002 by The McGraw-Hill Companies,Inc.All rights reserved.15-10Weaknesses of theGold Standard The gold standard tended to be deflationaryunder some circumstances,it pushed countries to raise th
10、eir interest rates which reduced output and increased unemploymentit never provided a countervailing push to other countries to lower their interest ratesCopyright 2002 by The McGraw-Hill Companies,Inc.All rights reserved.15-11Weaknesses of theGold Standard If the exchange rate is floating,foreigner
11、s domestic currency earnings must be used to buy exports or to invest in the home country The exchange rate moves up or down in response to the supply and demand for foreign exchange in order to make it so0NFINXCopyright 2002 by The McGraw-Hill Companies,Inc.All rights reserved.15-12Weaknesses of th
12、eGold Standard Under a gold standard,foreign-currency earnings can also be used to purchase gold from the foreign countrys Treasury0FG-NFINX If a countrys net exports plus net foreign investment are less than zero,its Treasury will find itself losing goldthe countrys gold reserves shrinkCopyright 20
13、02 by The McGraw-Hill Companies,Inc.All rights reserved.15-13Weaknesses of theGold Standard If a countrys gold reserves are shrinking,it has a choiceabandon the fixed exchange rate systemmake it more attractive for foreigners to invest by raising domestic interest rates puts contractionary pressure
14、on the economy Countries gaining gold face no incentive to lower interest rates in order to stay on the gold standardCopyright 2002 by The McGraw-Hill Companies,Inc.All rights reserved.15-14Collapse of the Gold Standard The gold standard was suspended during World War I After the war ended,politicia
15、ns and central bankers sought to restore itthey believed it was an important step in restoring prosperity After the Great Depression began,the gold standard broke apartCopyright 2002 by The McGraw-Hill Companies,Inc.All rights reserved.15-15Collapse of the Gold Standard Four factors made the gold st
16、andard a less secure monetary systemeveryone knew that governments could abandon their gold parities in an emergencyeveryone knew that governments were trying to keep interest rates low enough to produce full employmentCopyright 2002 by The McGraw-Hill Companies,Inc.All rights reserved.15-16Collapse
17、 of the Gold Standard Four factors made the gold standard a less secure monetary systemafter World War I,countries held their reserves in foreign currencies rather than goldthe post-war surplus economies did not lower interest rates as gold flowed inCopyright 2002 by The McGraw-Hill Companies,Inc.Al
18、l rights reserved.15-17Collapse of the Gold Standard As soon as a recession hit,governments found themselves under pressure to raise interest rates and lower outputcould either stay on the gold standard and face a deep depression or abandon the gold standardthe further countries moved away from thei
19、r gold-standard rates,the faster they recovered from the Great DepressionCopyright 2002 by The McGraw-Hill Companies,Inc.All rights reserved.15-18Figure 15.3-Economic Performance and Degree of Exchange Rate Depreciation During the Great DepressionCopyright 2002 by The McGraw-Hill Companies,Inc.All r
20、ights reserved.15-19The Bretton Woods System The Bretton Woods System was the result of an international monetary conference that took place in 1944 Three principles guided this systemin ordinary times,exchange rates should be fixedin extraordinary times,exchange rates should be changedan institutio
21、n was needed to watch over the international financial system the International Monetary Fund(IMF)Copyright 2002 by The McGraw-Hill Companies,Inc.All rights reserved.15-20The Bretton Woods System The Bretton Woods System broke down in the early 1970sthe U.S.found itself with a large trade deficit an
22、d sought to devalue its currency Since then,the exchange rates of the major industrial powers have been floating exchange ratesfluctuate according to supply and demandCopyright 2002 by The McGraw-Hill Companies,Inc.All rights reserved.15-21How a Fixed Exchange Rate System Works A fixed exchange rate
23、 is a commitment by a country to buy and sell its currency at fixed,unchanging prices(in terms of other currencies)the central bank or Treasury must maintain foreign exchange reservesthese reserves are limitedCopyright 2002 by The McGraw-Hill Companies,Inc.All rights reserved.15-22How a Fixed Exchan
24、ge Rate System Works If there is a high degree of capital mobility,the real exchange rate is set by)r-(r-fr0 The higher the interest rate differential in favor of the home country,the lower is the exchange rateCopyright 2002 by The McGraw-Hill Companies,Inc.All rights reserved.15-23Figure 15.4-The R
25、eal Exchange Rate,Long-Run Expectations,andInterest Rate DifferentialsCopyright 2002 by The McGraw-Hill Companies,Inc.All rights reserved.15-24How a Fixed Exchange Rate System Works If capital is highly mobile and the fixed exchange rate(*)is lower than foreign exchange speculators will want to sell
26、 the home currency for foreign currency the government spends down its reservesto keep the exchange rate at*,the central bank must lower interest rates monetary policy no longer can play a role in domestic stabilizationCopyright 2002 by The McGraw-Hill Companies,Inc.All rights reserved.15-25Figure 1
27、5.5-Domestic Interest Rates Are Set by Foreign-Exchange Speculatorsand the Exchange Rate TargetCopyright 2002 by The McGraw-Hill Companies,Inc.All rights reserved.15-26How a Fixed Exchange Rate System Works The central bank must set the domestic real interest rate equal tor0f*-rran increase in forei
28、gn interest rates(rf)requires a point-for-point increase in domestic interest ratesan increase in foreign exchange speculators views of the long-run value of the exchange rate(0)requires an increase in domestic interest ratesCopyright 2002 by The McGraw-Hill Companies,Inc.All rights reserved.15-27Fi
29、gure 15.6-Effect of Foreign Shocks under Fixed Exchange RatesCopyright 2002 by The McGraw-Hill Companies,Inc.All rights reserved.15-28How a Fixed Exchange Rate System Works If capital mobility is lowthe exchange rate is also affected by the speed at which the government is accumulating or spending i
30、ts foreign exchange reserves(R)R)r-(r-Rfr0when the government is accumulating reserves,the value of foreign currency is higher than it would otherwise be it is increasing foreign currency demandCopyright 2002 by The McGraw-Hill Companies,Inc.All rights reserved.15-29Figure 15.7-With Limited Capital
31、Mobility a Central Bank Can Shift theExchange Rate by Spending ReservesCopyright 2002 by The McGraw-Hill Companies,Inc.All rights reserved.15-30How a Fixed Exchange Rate System Works If capital mobility is lowthe central bank can use monetary policy for domestic disturbances this is limited by the s
32、ensitivity of exchange rates to the magnitude of foreign-exchange market interventions performed by the central bank and by the amount of reservesthe domestic real interest rate will beR*-rrrRr0fCopyright 2002 by The McGraw-Hill Companies,Inc.All rights reserved.15-31Benefits of Fixed Exchange Rates
33、 Floating exchange rate systems add riskdiscourages international trademakes the international division of labor less sophisticated This is an important reason behind the decision of most of western Europe to form a monetary unionfix their exchange rates against each other irrevocablyCopyright 2002
34、by The McGraw-Hill Companies,Inc.All rights reserved.15-32Costs of Fixed Exchange Rates Under fixed exchange rates,monetary policy is tightly constrained by the requirement of maintaining the exchange rate at its fixed parity Fixed exchange rates also have the disadvantage of rapidly transmitting mo
35、netary of confidence shocksinterest rates move in tandem all across the world in response Fixed exchange rates also make large-scale currency crises more likelyCopyright 2002 by The McGraw-Hill Companies,Inc.All rights reserved.15-33Fixed or Floating Exchange Rates?Is it more important to preserve t
36、he ability to use monetary policy to stabilize the domestic economy rather than dedicating monetary policy to a constant exchange rate?Is it more important to preserve the constancy of international prices and thus expand the volume of trade and the scope for the international division of labor?Copy
37、right 2002 by The McGraw-Hill Companies,Inc.All rights reserved.15-34Fixed or Floating Exchange Rates?Economist Robert Mundell argued that the major reason to have floating exchange rates is that they allow adjustment to shocks that affect two countries differentlythis benefit would be worth little
38、if two countries suffered the same shocks and reacted to them in the same waythis benefit would also be worth little if factors of production are highly mobileCopyright 2002 by The McGraw-Hill Companies,Inc.All rights reserved.15-35The European Currency Crisis of 1992 After reunification with East G
39、ermany,the West German government undertook a program of massive public investmentthis shifted the IS curve outthe German central bank raised interest rates to keep inflation under controlCopyright 2002 by The McGraw-Hill Companies,Inc.All rights reserved.15-36Figure 15.8-German Fiscal Policy and Mo
40、netary Response in the Early 1990sCopyright 2002 by The McGraw-Hill Companies,Inc.All rights reserved.15-37The European Currency Crisis of 1992 The increase in interest rates generated a rise in the German exchange rate vis-vis the dollar and the yenexports fell Other countries in western Europe had
41、 fixed their exchange rates to the German mark as part of the European Exchange Rate MechanismCopyright 2002 by The McGraw-Hill Companies,Inc.All rights reserved.15-38The European Currency Crisis of 1992 The rise in German interest rates meant that these western European countries were required to r
42、aise interest rates as wellthe required interest rate increase threatened to send the other European countries into a recessionCopyright 2002 by The McGraw-Hill Companies,Inc.All rights reserved.15-39Figure 15.9-Effect of German Policy on Other European CountriesCopyright 2002 by The McGraw-Hill Com
43、panies,Inc.All rights reserved.15-40The European Currency Crisis of 1992 Foreign exchange speculators did not believe that these western European governments would keep this promise to maintain the fixed exchange rate parity when unemployment began to rise0 rose which caused an additional rise in th
44、e domestic real interest rate required to maintain exchange rate parityr0f*-rrCopyright 2002 by The McGraw-Hill Companies,Inc.All rights reserved.15-41The European Currency Crisis of 1992 Different governments in western Europe undertook different strategiessome spent reserves in the hope that it de
45、monstrated their commitment to maintaining the exchange rate paritysome tried to demonstrate that they would defend the parity no matter how high the interest rate needed to besome abandoned the fixed exchange rate and let their currencies float The end result was the formation of the European Monet
46、ary UnionCopyright 2002 by The McGraw-Hill Companies,Inc.All rights reserved.15-42The Mexican Currency Crisis of 1994-1995 The Mexican currency crisis was a surprise to most economic analyststhe governments budget was balancedthe governments willingness to raise interest rates was not in questionthe
47、 Mexican peso was not overvalued The peso lost half of its value in four months starting in December of 1994Copyright 2002 by The McGraw-Hill Companies,Inc.All rights reserved.15-43The Mexican Currency Crisis of 1994-1995 Concerns about political stability reduced foreign exchange speculators estima
48、tes of the long-run value of the peso and raised their assessment of 0the Mexican government spent$50 billion in foreign reserves and eventually ran out it devalued the peso and let it float against the U.S.dollar the rise in caused a further increase in 0 the value of the Mexican governments debt a
49、lso increased,which led to further increases in 0Copyright 2002 by The McGraw-Hill Companies,Inc.All rights reserved.15-44The Mexican Currency Crisis of 1994-1995 The Mexican government had two optionsit could raise interest rates the level of interest rates required would produce a Great Depression
50、 in Mexicoit could keep interest rates low and let the value of foreign currency rise much further Mexican companies and the Mexican government would be unable to pay their dollar-denominated debts Mexicos foreign trade would fall drasticallyCopyright 2002 by The McGraw-Hill Companies,Inc.All rights
