PolicyandCoordination国际金融香港大学,WONG

1、Macroeconomic Policy and Coordination Under Floating Exchange RatesWONG Ka Fu19 March 2001Gold standard1870 - 1914Central banks peg the prices of their currencies in terms of gold, and hold gold as official international reserves.Exchange rates among countries are fixed due to arbitrage.Gold Country

2、 1Country 2 Country 3Advantage of gold standardLimit the extent to which the central banks can cause increase in national price levels through expansionary monetary policies. These limits make the real national monies more stable and predictable, thereby enhancing the transaction economies arising f

3、rom the use of money.Disadvantage of gold standardConstraints the use of monetary policy to fight unemploymentTying currency values to gold ensures a stable overall price level only if the relative price of gold and other goods and services is stable.Historical BackgroundGreat Depression in 1930sune

4、mploymentdeflationbank failureLack of confidence in paper moneyDemand for gold increasedbut national treasuries could not supplyGold standard collapsedUnited Kingdom and some countries forced to abandon the gold standardThe amount and frequency of monetary transactions between nations contracted bec

5、auseThe uncertainty about the value of money that no longer bore a fixed relation to goldNations hoarded gold and money that could be converted into goldReverted to barter exchange.Competitive devaluationOther governments, desperate to find foreign buyers for domestic agricultural products, made the

6、se products appear cheaper by selling their national money below its real value so as to undercut the trade of other nations selling the same products.Trading rivals retaliates through similar devaluationGold standard collapsed: ResultBetween 1929 and 1932prices of goods fell by 48 percent worldwide

7、, andthe value of international trade fell by 63 percent.LessonConvertibility of currencies from one to the other is an important element for international trade and economic developmentA proposal by Harry Dexter White in the US John Maynard Keynes in the UKNeed to establish a monetary system and an

8、 international institution to monitor the monetary systemThe system aims at encouraging the unrestricted conversion of one currency into another, establishing a clear and unequivocal value for each currency, and eliminating restrictions and practices, such as competitive devaluationThe birth of IMFJ

9、uly 122, 1944Bretton Woods, New Hampshire, U.S.A. The delegates of 44 nations negotiated for establishing the International Monetary FundDecember 27, 1945Articles of Agreement enter into force upon signature by 29 governmentsMay 6, 1946Began operation when twelve Executive Directors five appointed a

10、nd seven elected hold inaugural meeting in Washington.Gold-exchange standard orBretton Woods SystemAdopted in 1944.The value of each currency was expressed in terms of gold (par value), and members were obliged to keep the exchange rates for their currencies within 1 percent of parity. Two major ele

11、mentsConvertibility of the US dollar to gold:The United States defined the value of its dollar in terms of gold, so that one ounce of gold was equal to exactly $35. The U.S. government stood behind this definition and would exchange gold for dollars at that rate on demand. Par valuesAll other member

12、s had to define the exchange value of their money in terms of gold or in terms of the U.S. dollar (of the weight and fineness in effect on July 1, 1944). Members kept the value of their money within 1 percent of this par valueany contemplated change should be first discussed with other members in th

13、e forum of the IMF and obtained their consent before implementing the new par value.Country 1 Country 2Country 3Gold Reserve currencyBetween the end of World War II and 1973, the U.S. dollar was the main reserve currency and almost every country pegged their currency to the U.S. dollar. Exchange rat

14、es among countries are fixed due to arbitrage.The asymmetric position of the reserve center (3 countries)Assume three countries and three currencies in the worldCountry 1 is the reserve center if both country 2 and country 3 peg their currencies to country 1s. Country 1 is also peg to 2 & 3, but onl

15、y passively.I.e., countries 2 and 3 have to intervene the foreign exchange market to keep their rate fixed to country 1s. Country 1 Country 2Country 3The asymmetric position of the reserve centerBut, country 1 need do no intervention in the forex market and is free to set its monetary policy.If coun

16、try 1 expands its money supplyCountry 1s interest rate falls.To maintain the fixed rate, both countries 2 and 3 have to buy reserve assets with their own currencies, expanding their money suppliespushing their interest rate down to the level established by the reserve center.Output throughout the wo

17、rld (all the countries) would expand.The asymmetric position of the reserve center (N countries)Assume N countries and N currencies in the worldCountry 1 is the reserve center if all other N-1 countries peg their currencies to country 1s.I.e., all N-1 countries have to intervene the foreign exchange

18、 market to keep their rate fixed to country 1s. If country 1 expands its money supplyCountry 1s interest rate falls.To maintain the fixed rate, all other N-1 countries have to buy reserve assets with their own currencies, expanding their money suppliespushing their interest rate down to the level es

19、tablished by the reserve center.Output throughout the world (all the countries) would expand.The asymmetric position of the reserve centerAll other countries have to passively import the monetary policy of the reserve center because of their commitment to peg their currencies to the reserve currency

20、. Country 1 can independently choose its monetary policy.The collapse of Bretton WoodsLate 1960sbalance of payments disequilibria for many countries, including the USa series of currency crisesAugust 15, 1971 United States informs IMF it will no longer freely buy and sell gold to settle internationa

21、l transactions. Par values and convertibility of the dollartwo main features of Bretton Woods systemcease to exist.Post Bretton Woodseach member chooses its own method of determining the exchange value of its moneythe member no longer base the value of its currency on gold and each member should inf

22、orm other members about precisely how it determines the currencys value, I.e., the “fixed” exchange rate.Exchange rate arrangementsfloat freely: their money is worth whatever the markets are prepared to pay for them.dirty float or managed float: manage the float by buying and selling their own curre

23、ncies to influence the marketPeg: peg the value of their money to that of a major currency or group of currenciesSnake:Within the group, the value of the currencies are not allowed to fluctuate outside a range against each otherFloating exchange ratesSince 1973: The exchange rates of the industriali

24、zed countries have adopted floating exchange rates.By mid-1980s: economists and policymakers had become more skeptical about the benefits of an international monetary system based on floating rates.The case for and against floating exchange ratesFor Monetary policy autonomySymmetryExchange rates as

25、automatic stabilizersAgainstDiscipline problemDestabilizing speculation and money market disturbancesInjury to international trade and investmentUncoordinated economic policiesThe illusion of greater autonomyFor: monetary policy autonomyUnder fixed exchange rate system, countries other than the rese

26、rve center cannot have monetary policy:Have to adjust money supply (and hence the interest rate) to maintain the exchange rate at a fixed level if they have no restriction on capital flow. Hence no control on inflation.Have to impose restriction on international payments if we want some autonomy in

27、monetary policy distorting international tradeFor: symmetryUnder fixed exchange rate, the U.S. played a leading role in determining the world money supply.All countries except the U.S. have the option of devaluing its currency against the U.S. dollars.The dollar was at last devalued in December 1971

28、, but had gone through a long and economically disruptive period of multilateral negotiation.For: Exchange rates as automatic stabilizersA temporary fall in export demandWhat if there is a permanent fall in export demand? DD1AA1E1Y1Output, YExchange Rate, EInitial equilibrium:fixed or floating?DD2DD

29、1AA1E1Y1Output, YExchange Rate, EA temporary fall in export demandDD2DD1AA1E1E2Y2Y1Output, YExchange Rate, EEffect of a temporary fall in export demandunder a floating exchange rateDD2DD1AA1AA2E1Y3Y1Output, YExchange Rate, EEffect of a temporary fall in export demandunder a fixed exchange rateDD2DD1

30、AA1AA2E1E2Y3Y2Y1Output, YExchange Rate, EEffect of a temporary fall in export demand:A comparison of floating and fixedAgainst: DisciplineGovernment might embark on over-expansionary fiscal or monetary policy, falling into the inflation bias trap because no need to worry about losses of foreign rese

31、rves.Against: Destabilizing speculation and money market disturbancesAnything that fluctuates, including floating exchange rate, can be speculated.Speculation may lead to instability in foreign exchange markets and hence negative effect on countries internal and external balances.Disturbances (tempo

32、rary) to the home money market could be more disruptive under floating than under a fixed rate.DD1AA1E1Y1Output, YExchange Rate, EInitial equilibriumDD1AA1AA2E1E2Y2Y1Output, YExchange Rate, EEffect of a temporary rise in money demand: floatingDD1AA1AA2E1Y1Output, YExchange Rate, EEffect of a tempora

33、ry rise in money demand: fixedDD1AA1AA2E1E2Y2Y1Output, YExchange Rate, EEffect of a temporary rise in money demand:A comparison of floating and fixedAgainst: Destabilizing speculation and money market disturbancesWhat is the effect of a permanent shift of money demand under both fixed and floating e

34、xchange rates?Against: Injury to international trade and investmentFluctuating exchange rates implies more uncertain returns on investment and prices of goods traded internationally.Theoretically, exchange rate risk may be avoided through a transactions in the forward exchange market. May be costly

35、to use.Against: uncoordinated economic policiesUncoordinated economic policies may result in competitive macroeconomic policies which hurt all countries and, in the end, help noneI.e., prisoners dilemma.Against: illusion of greater autonomyPolicymakers may have to consider the effect of monetary pol

36、icies on exchange rate also.Floating rates may lead to a quicker adjustment of price levels and hence reduces the effect of monetary policy on real economic variables.Monetary policy Exchange rateForeign countriesDomestic economy Floating or fixed?Exchange Rate Experience Between the Oil Shock 1973-

37、1980The First Oil Shock and Its Effects, 1973-1975BackgroundMarch 1973: the industrialized countries exchange rate is allowed to float Fall 1972: Committee of Twenty to design a new fixed rate system free of asymmetryJuly 1974: “Outline of Reform”Energy prices and the 1974-75 recessionThe war betwee

38、n Israel and Arab countriesBefore October 1973: $3 per barrelOctober 1973: war between Israel and the Arab countries was brokenIsrael was supported by the U.S. and the NetherlandsTo protest against this support, Arab members of OPEC (Organization of Petroleum Exporting Countries) imposed an embargo

39、on oil shipments to these two countries.Effect of the war on oil pricesBuyers stock up inventoriesOPEC raised pricesMarch 1974: $12 per barrelI.e. oil shock Effect of the oil shockThe oil shock raised the energy prices paid by consumers and the operating costs of energy-using firmsand also fed into

40、the prices of non-energy petroleum products, such as plastics.Effect of the oil shockLike a large tax on oil importers imposed by the oil producers of OPEC and alsolike an increase in consumer and business taxesConsumption and investment slowed down everywhereThe world was thrown into recessionEffec

41、t on current accountCA of non-oil exporting countries worsenedCA of oil exporters improved(Table 22-2)Current Account Balances, 1973-1997 (billions of dollars), (KO, Table 22-2)Effect on inflationOil shock raised prices of petroleum products and the costs of energy-using industriescaused price level

42、 to jump upwardInflation expectation drove up contract wages (despite already high unemployment rate)speculators built up stocks of those commodities whose prices are expected to riseOther factors causing inflation 1972 on: poor harvest in the U.S. and the Soviet Unionshortage of sugar and cocoadisa

43、ppearance of the Peruvian anchovies from their customary feeding groundsMonetary policiesAfter 1973: The move to floating rate allows monetary policy autonomyIndustrialized countries adopted a more restrictive monetary and fiscal policies aimed at restraining the accelerating inflationdeepened the r

44、ecessionMonetary growthStagflation: 1974-75Output stagnatedinflation remained highRegaining Internal and External BalanceAs recession deepened over 1974 and early 1975, most governments (in particular, the industrialized) shifted to expansionary fiscal and monetary policies. Second half of 1975: str

45、ong output recovery.CA became surplusIs floating good?Yes! Floating allows autonomy in monetary policy and help to regain internal and external balanceNon-oil-developing countriesDid not (and cannot) cut their spending as sharply as industrial countriesGDP growth did not become negative in 1975Devel

46、oping countries financed their oil deficits in part by borrowing funds that the OPEC countries had deposited in the industrial countries financial centers.Revising IMFs CharterJanuary, 1976: revised the fourth IMF Article of Agreement, which covered exchange rate agreementimplicitly endorse floating

47、 rates by freeing each member country to choose any exchange rate system it preferred.Weak U.S.Dollar 1976-19791975: recovery due to expansionary monetary and fiscal policyunemployment rate = 8.3%1976: recovery slowed down and unemployment remained high1978: unemployment rate = 6.0%re-ignited inflat

48、ion U.S. current account deficit Depreciation of U.S. dollarGermany and Japan from 1975-1978feared of inflation and would not use very expansionary policies.Low inflation rate relative to the U.S.Hence depreciation of U.S. dollar (PPP?) (Figure 19-3)Nominal and Real Effective Dollar Exchange Rate In

49、dexes 1975-1998Depreciation of U.S. dollarJuly 1978, Bonn economic summitWest Germany and Japan joined the U.S. to use relatively expansionary policies.Paul Volcker factor: 1979International investors lost confidence in U.S. dollar in view of the widening gap between U.S. and foreign inflation rates

50、.Weakening dollar fueled U.S. inflation rate by raising import pricesTo restore confidence, Carter appointed Paul A. VolckerThe Volcker factorOctober 1979, Volcker announced a tightening of U.S. monetary policy and the adoption by the Fed of more stringent procedures for controlling money supply gro

51、wthDoes floating give us autonomy in monetary policyNot really. Governments could not be indifferent to the behavior of exchange rates. surrendered some of their policy autonomy in other areas to prevent exchange rate movements they viewed as harmful to their economies Monetary policy Exchange rateF

52、oreign countriesDomestic economy The second oil shock1979: Shah of Iran felldisrupt oil exports from Iranoil prices rose1980: $32 per barrel ($13 per barrel in 1978)History repeatedhigh inflation rateslow growthCentral Banks did not repeatCBs worried that the 1978-80 upswing in inflation might be ha

53、rd to reverse later if it were allowed to be built into inflationary expectations andthe wage-setting processConsequently, use restrictive macroeconomic policieshence small output recoverydeepest recession since 1930sMacroeconomic Interdependence under a floating rateCurrent accountsPrevious chapter

54、sCA = CA(qH/F,Y-T) qH/F = (EH/F PF) / PH The units of home good basket per foreign good basket.CA/qH/F 0CA/Yd 0CA/YHd 0Goods market equilibriumYH = C(YH-TH) + IH + GH + CA(qH/F,YH-TH, YF - TF) CAF = - CAH(qH/F,YH-TH, YF - TF) qH/F Note that qH/F = (EH/F PF) / PH The units of home good basket per for

55、eign good basket.YF = CF(YF-TF) + IF+ GF -CAH(qH/F,YH-TH, YF - TF) qH/F HH curveHH curve: a relation of Home and Foreign output levels at which aggregate demand equals aggregate supply in home.Fixed YF - TF , find YH such thatYH = C(YH-TH) + IH + GH +CA(qH/F,YH-TH, YF - TF)= ADH(qH/F,YH-TH, YF - TF)

56、Higher YF means higher ADF and hence higher YH Hence upward sloping HH curveEffect of an increase in YF on short-run home output equilibriumOutput (real income), YAggregate demand, DD=YADH(qH/F,YH-TH, YF2 - TF)YF2YF1Y1Y2ADH(qH/F,YH-TH, YF1 - TF)HHHome output, YHForeign output, YF45o line1 unit chang

57、e in foreign output will cause less than 1 unit change in home output.Factors that shifts HHAnything that changes aggregate demandGH, TH, IH, GF, TF, IF,E and anything that affects E.Effect of an increase in YF on short-run home output equilibriumOutput (real income), YAggregate demand, DD=YADH(qH/F

58、,YH-TH, YF1 - TF; GH2)GH2 GH1Y1Y2ADH(qH/F,YH-TH, YF1 - TF; GH1)HHHome output, YHForeign output, YFAn increase in GHFF curveFF curve: a relation of Home and Foreign output levels at which aggregate demand equals aggregate supply in Foreign.Fixed YH - TH , find YF such thatYF = CF(YF-TF) + IF+ GF -CAH

59、(qH/F,YH-TH, YF - TF) qH/FHigher YH means higher ADH and hence higher YF Hence upward sloping FF curveHHHome output, YHForeign output, YFFFOutput determinationin a two country worldDisinflation, Slump, and Recovery, 1980-1995Disinflation and the 1981-1983 recessionOctober 1979: Federal Reserve Chair

60、man Volcker announced an abrupt change in U.S. monetary policy aimed atfighting domestic inflation andstemming the dollars fallVolckers monetary slowdown convinced the marketNovember 1980 election, Reagan campaigned an anti-inflation platformUS short-term interest rate nearly doubled their 1978 leve