Outline for 10/31: International Money II

The Impossible Trinity

The Bretton Woods Institutions

Collapse of the Bretton Woods System

Monetary Diversity in the Post-Bretton Woods Era

The International Monetary Fund

The Impossible Trinity

3 Desirable Monetary Conditions

1. International Capital Mobility (ICM)

2. Fixed Exchange Rates (FER)

3. Domestic Monetary Policy Autonomy (MPA)

But countries can have only 2 of these 3 conditions at any one time.

∆e = i – i*

e is the exchange ratei is the domestic interest ratei* is the external interest rate

ICM

FER MPA

The Bretton Woods System

Background: Economic Problems in the 1930s

Great Depression: 25% unemployment in the United States, 44% in Germany

Collapse of international trade: Smoot-Hawley tariffs

Rise of fascism in Europe

WWII

Bretton Woods Conference in July 1944

Led by the United States, attended by delegates from 44 countries

Goal was to create a set of institutions to avoid a repeat of the 1930s

What institutions were created?

The Bretton Woods Institutions

1. GATT

2. Fixed exchange rate system

US dollar fixed to gold

Other national currencies fixed to the US dollar

3.International Monetary Fund (IMF)

– short-term loans to increase foreign exchange reserves

4. Capital Controls (restrictions on flows of speculative capital, but not on capital flows related to trade)

5.International Bank for Reconstruction and Development (IBRD or World Bank)

– longer-term loans for development projects

Where does the Bretton Woods System fit on this triangle?

International Capital Mobility

Fixed Exchange Rates Domestic Monetary Policy Autonomy

Was this system sustainable?

Collapse of the Bretton Woods System

Nixon ended US dollar convertibility to gold in 1971

Other countries stopped fixing to the US dollar thereafter

Why?

1. Capital controls ineffective

2.Dollar overhang US$

S

gold

time

Certain Bretton Woods institutions still remain – GATT(WTO), IMF, World Bank

The Post-Bretton Woods Era

International Capital Mobility

Western Europe United States Snake EMS EMU

Fixed Exchange Rates Domestic Monetary Bretton Woods Policy Autonomy

Why did (much of)Western Europe choose Fixed Exchange Rates,While the United States chose Domestic Monetary Autonomy?

Internationally-oriented producers vs. Domestically-oriented producers

Which group benefits most from fixed exchange rates?

Which group benefits most from domestic monetary autonomy?

Western Europe and United States

Which country (set of countries) has a bigger share of internationally-oriented producers?

Which country (set of countries) has a bigger share of domestically-oriented producers?

The International Monetary Fund

Each member-countries pays a quota based on GDP

Quotas stored in special IMF currency – Special Drawing Rights (SDRs)

Member-countries borrow from combined quotas

During Bretton Woods, countries could borrow to increase their foreign exchange reserves

In the post-Bretton Woods era – countries can borrow for other reasons

IMF loans require approval from Board of Executive Directors (weighted voting)

IMF loans come in slices (tranches) with associated conditions

Why conditions?

Why slices?