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POLS 1301 Midterm: Review Weeks 7-13
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Department
Political Science
Course
POLS 1301
Professor
Bonny J Wells
Semester
Fall

Description
INTERNATIONAL POLITICS TERM 2 REVIEW ACE THIS MOTHERFUCKER!! TERMS Chapter 8 Arms race: an action reaction process of acquiring arms (in this case nuclear) in response to the arms acquisitions of an adversary Gun vs butter: a way summarize the presumed trade offs between military preparedness and economic performance during peacetime Minimum deterrence: a nuclear strategy requiring only a second-strike capability that can be achieved with a relatively small nuclear stockpile Chemical weapons: weaponized chemical agents designed to attack the body’s nervous system, blood, skin, or lungs Biological weapons: biological agents instead, such as viruses and toxins designed to cause disease and death Security dilemma: when a state’s security is seen as another state’s insecurity, such as Iran acquiring nuclear weapons for their own security causing the US to freak out Prisoner’s dilemma: a game in which the best strategy for both opponents is to defect, but that yields an outcome worse than the one achieved by mutual cooperation Tit for tat: a strategy of cooperating after an opponent cooperates and defecting after the opponent defects Chapter 9 Just war tradition: set of principles that identify the circumstances justifying the resort to war (jus ad bellum) and, once begun, the requirements for just conduct (jus in bello) Discrimination: in just war doctrine, the requirement that combatants respect the immunity of noncombatants from direct, deliberate attack Proportionality: requirement that the legitimate aims sought by a state resorting to war outweigh the harm resulting from the prosecution of war Double effect: the requirement that noncombatant deaths be unintended and proportional to the legitimate and sought through military action Natural law: rights and responsibilities presumed to apply to all member of the community of humankind, irrespective of their status as citizens of states Soft law: international treaties, declarations, or covenants that are aspirational but have little or no binding force on the parties to the agreement Sovereign immunity: immunity of state leaders from prosecution by other states for their official public actions CHAPTER 10 World federalism: the idea that peace can be achieved only by establishing a world government Functionalism: the idea that international organizations should aim to solve problems arising in specific functional areas, after which those solutions may be applied in other areas Collective action/good: a good provided to the collective that cannot be consumed exclusively by those who pay for it, or denied to those who do not Responsibility to protect: an international norm affirming all states obligations to protect individuals from genocide, crimes against humanity, and other offenses CHAPTER 11 Mercantilism: economic doctrine by which states in the 16th century europe amassed trade surpluses in the form of gold and silver as a means of maximizing wealth and power Economic liberalism: support globalization by arguing for private ownership, free market and unimpeded flow of goods, capital, and labor Autarky: a policy of minimizing trade in favor of domestic production of all goods and services required by society Strategic trade: a trade policy in which the state promotes certain export industries by providing government subsidies or other forms of assistance CHAPTER 12 Common market: a grouping of national economies for which barriers to free trade have been removed Supranationalism: liberalist idea where representative of international institutions make authoritative decisions and are binding on member states Regionalism: the concentration of economic transactions, as well as the coordination of foreign economic policies, among a group of countries within a geographic region CHAPTER 13 North-South gap: the disparity in development between industrialized countries, located mainly in the Northern hemisphere, and developing countries, located mainly in the south Modernization theory: perspective that attributes underdevelopment in the global south to the features of traditional society, which will become transformed over time New international economic order: economic arrangements more favorable to the south, including commodity price stabilization, development assistance, and debt relief Contagion: process of spreading currency crises that may be driven as much by geography and trade patterns as by economic or financial weaknesses in the affiliated countries Structural violence: deprivations enforced, often subtly, by repressive social and political systems that are resistant to change. CONCEPTS TO KNOW PERPETUAL PEACE The concept of perpetual peace came about in the 18th century but then became more well known when German Immanuel Kant published an essay in which he gave different steps that should be taken in order to promote the perpetual peace between states. In this idea, all states would be republican rather than democratic, with global citizenship limited to universal hospitality. It seems as if this concept somewhat suppresses the civil society from most outside decisions and deprives them from worldwide suffrage, something that would be kind of important for world peace. When Kant argues that the law of nations should be founded on a federation of free states, however, he seems to be appealing to the idea of democratic peace, which is a little bit contradicting with the rest. He also does not believe that republican states are enough in promoting peace, and that responsible administrations will be more inclined to promote peace. SECURITY COMMUNITIES A security community is a region in which a large-scale use of violence (such as war) has become very unlikely or even unthinkable.[1]The term was coined by the prominent political scientist Karl Deutsch in 1957. In their seminal work Political Community and the North Atlantic Area: International Organization in the Light of Historical Experience, Deutsch and his collaborators defined a security community as "a group of people" believing "that they have come to agreement on at least this one point: that common social problems must and can be resolved by processes of 'peaceful change'". [2Peaceful change was defined as "the resolution of social problems, [2] normally by institutionalized procedures, without resort to large-scale physical force". People in a security community are also bound by the "sense of community", the mutual sympathy, trust, and common interests. [2] Deutsch divided security communities into two types: the amalgamated and pluralistic ones. [2] Amalgamated security communities are quite rare in history. They are created when two or more previously independent states form a common government. An example is the United States after the original thirteen colonies ceded much of their governing powers to the federal government. Amalgamation is not always successful [2] and can be overturned, as the failed Union between Sweden and Norway exemplifies. An alternative and less ambitious process is called integration. Integration leads to a pluralistic security community, in which states retain [2] [1] their sovereignty. The United States with Canada is an example of a pluralistic security community. Both countries are politically independent, but they do not expect to have future military confrontations, in spite of having had some in the past. Deutsch argued that the pluralistic security communities are easier to establish and maintain than their amalgamated counterparts. WHY BAND AID FAILED AND LIVE AID THRIVED The images of starving children flickered across the screen - youngsters hardly conscious, possessing not even the energy to bat away the flies descending on their emaciated bodies. BBC broadcaster Michael Buerk described the scene in Ethiopia 1984 as 'the closest thing you get to hell on earth'. The famine pictures awoke the conscience of the world. A year later, Britain was host to the biggest fundraising event of all time, Live Aid. Who can forget it? At Wembley, and in Philadelphia, pop stars including Queen, David Bowie and George Michael were part of a dazzling line-up determined to feed the world. And Bob Geldof demanded: 'Don't go to the pub tonight - please, stay in and give us the money. There are people dying NOW, so give me the money.' Money poured in. The 16-hour rock concert on July 13, 1985 raised around £65 million and was watched by a global audience estimated at 1.5 billion. It was a moment of hope. But that was then. Now the BBC has reported that substantial amounts of money - some of it raised by Band Aid - were siphoned away from relief efforts and went to fund guns for Ethiopian warlords during the Eighties. 'You couldn't help the hungry in the rebel-held areas without helping the rebels. You have to be realistic about that. It is probable that some money was diverted to buy arms. I believe a just use was made of the money. I think it fulfilled the interests of the donors. DEMOCRATIC PEACE As the Cold War was ending, Francis Fukuyama argued that the dismal record of Soviet-style socialism had demonstrated, once and for all, that there can be no serious competitor to Western liberalism—free-market capitalism plus political democracy—as an organizing principle for modern society. Fukuyama suggested that we may have arrived at “the end point of mankind’s ideological evolution and the universalization of Western liberal democracy as the final form of human government.” He surmised that the triumph of Western liberalism—the “end of history”—would be accompanied by increasingly peaceful interstate relations, but he did not go so far as to predict the complete and total end of international conflict. Rather, when conflict does erupt, it is more likely to involve states that have not (yet) embraced Western liberalism. Conflict between non liberal states (those “still in history”) is distinctly possible, as is conflict between them and liberal states. What is unlikely is conflict between liberal states. This view is widespread, even among those who do not fully subscribe to Fukuyama’s other views on the triumph of the West, and the phenomenon has become known as the democratic peace. Few observers of world politics dispute this empirical regularity: Stable democracies are unlikely to engage in militarized disputes with each other or let any such disputes escalate into war. Social scientific research suggests that democracy is indeed part of the explanation. Even when taking into account other factors contributing to the frequency with which countries have conflicts with one another—for example, geographic proximity, alliance membership, economic interdependence, well-being—democratic states show a disinclination to become embroiled in violent disputes with each other. They virtually never go to war with each other and have far fewer militarized confrontations or even serious diplomatic disputes with each other than do other kinds of states. Democracies tend to reciprocate each other’s cooperative behavior, accept third-party mediation or good offices in settling disputes, and generally resolve conflicts peacefully. It is the democratic form of government that seems to matter. If similarity of form of government alone were enough, then we would expect to have seen peace between the Soviet Union and China, between the Soviet Union and its Eastern European neighbors, and between China and Vietnam. Despite important differences in political values and organization among the communist countries, they were much more like one another, especially in values or ideology, than like the democracies or even like right-wing dictatorships. Yet war or the threat of war between these countries was commonplace. The relations between democracies seem to be qualitatively different. Woodrow Wilson expressed this conviction in his 1917 war message to Congress when he asserted that “a steadfast concert of peace can never be maintained except for a partnership of democratic nations.” MONADIC/DYADIC Democratic peace theory is a theory which posits that democracies are hesitant to engage in armed [1] conflict with other identified democracies. In contrast to theories explaining war engagement, it is a "theory of peace" outlining motives that dissuade state-sponsored violence. [2] Some theorists prefer terms such as "mutual democratic pacifism" or "inter-democracy non aggression hypothesis" so as to clarify that a state of peace is not singular to democracies, but rather that it is easily sustained [3] between democratic nations. Among proponents of the democratic peace theory, several factors are held as motivating peace between democratic states: ● Democratic leaders are forced to accept culpability for war losses to a voting public; ● Publicly accountable states people are inclined to establish diplomatic institutions for resolving international tensions; ● Democracies are not inclined to view countries with adjacent policy and governing doctrine as hostile; ● Democracies tend to possess greater public wealth than other states, and therefore eschew war to preserve infrastructure and resources. Those who dispute this theory often do so on grounds that it conflates correlation with causation, and that the academic definitions of 'democracy' and 'war' can be manipulated so as to manufacture an artificial trend. Most research is regarding the dyadic peace, that democracies do not fight one another. Very few researchers have supported the monadic peace, that democracies are more peaceful in general. There are some recent papers that find a slight monadic effect. Müller and Wolff (2004), in listing them, agree "that democracies on average might be slightly, but not strongly, less warlike than other states," but general "monadic explanations is neither necessary nor convincing." They note that democracies have varied greatly in their belligerence against non-democracies. COMPARATIVE ADVANTAGE A person has a comparative advantage at producing something if he can produce it at lower cost than anyone else. Having a comparative advantage is not the same as being the best at something. In fact, someone can be completely unskilled at doing something, yet still have a comparative advantage at doing it! How can that happen? First, let's get some more vocabulary. Someone who is the best at doing something is said to have an absolute advantage. Michael Jordan has an absolute advantage at basketball. For all I know, Michael Jordan may also be the fastest typist in the world, giving him an absolute advantage at typing, too. Since he's better at typing than you, can't he type more cheaply than you? That is, if someone has an absolute advantage in something, doesn't he automatically have a comparative advantage in it? The answer is no! If Jordan takes time out from shooting hoops to do all his own typing, he sacrifices the large income he earns from entertaining fans of basketball. If, instead, his secretary does the typing, the secretary gives up an alternative secretarial job—or perhaps a much lower salary playing basketball. That is, the secretary is the lower-cost typist. The secretary, not Michael Jordan, has the comparative advantage at typing! The trick to understanding comparative advantage is in the phrase "lower cost." What it costs someone to produce something is the opportunity cost—the value of what is given up. Someone may have an absolute advantage at producing every single thing, but he has a comparative advantage at many fewer things, and probably only one or two things. (In Jordan's case, both basketball and also as an endorser of Nike.) Amazingly, everyone always has a comparative advantage at something. Let's look at another example. Suppose you and your roommate want to clean the house and cook a magnificent Chicken Kiev dinner for your friends one night. The easy case is when you are each better at one activity. If you are an accomplished chef, while your roommate doesn't know the range from the oven; and if after you vacuum the carpet the dust bunnies have shifted from under the sofa to under the coffee table, while your roommate can vacuum, dust, and polish the silverware faster than you can unwrap the vacuum-cleaner cord, then you and your roommate will each be better off if you cook and your roommate cleans. It's easy to see that you each have a comparative advantage in one activity because you each have an absolute advantage in one activity. But what if your roommate is a veritable Martha Stewart, able to cook and clean faster and better than you? How can you earn your keep toward this joint dinner? The answer is to look not at her absolute advantage, but at your opportunity costs. If her ability to cook is much greater than yours but her ability to clean is only a little better than yours, then you will both be better off if she cooks while you clean. That is, if you are the less expensive cleaner, you should clean. Even though she has an absolute advantage at everything, you still each have different comparative advantages. The moral is this: To find people's comparative advantages, do not compare their absolute advantages. Compare their opportunity costs. The magic of comparative advantage is that everyone has a comparative advantage at producing something. The upshot is quite extraordinary: Everyone stands to gain from trade. Even those who are disadvantaged at every task still have something valuable to offer. Those who have natural or learned absolute advantages can do even better for themselves by focusing on those skills and buying other goods and services from those who produce them at comparatively low cost. (Even more surprising is that the absolutely disadvantaged may gain more from the resulting trade than the absolutely advantaged; but that's a different topic.) When David Ricardo first illustrated the importance of comparative advantage in the early 1800s, he solved a problem that had eluded even Adam Smith. Comparative advantage explains why a country might produce and export something its citizens don't seem very skilled at producing when compared directly to the citizens of another country! (For example, in the past few years India has become a major supplier of phone- answering services for the American market, even though their English-language skills are not up-to-par.) The explanation of the apparent paradox is that the citizens of the importing country must be even better at producing something else, making it worth it for them to pay to have work done by the exporting country. Amazingly, the citizens of each country are better off specializing in producing only the goods at which they have a comparative advantage, even if one country has an absolute advantage at producing each item. BALANCE OF PAYMENTS A statement that summarizes an economy’s transactions with the rest of the world for a specified time period. The balance of payments, also known as balance of international payments, encompasses all transactions between a country’s residents and its nonresidents involving goods, services and income; financial claims on and liabilities to the rest of the world; and transfers such as gifts. The balance of payments classifies these transactions in two accounts – the current account and the capital account. The current account includes transactions in goods, services, investment income and current transfers, while the capital account mainly includes transactions in financial instruments. An economy’s balance of payments transactions and international investment position (IIP) together constitute its set of international accounts. Despite its name, the “balance of payments” data is not concerned with actual payments made and received by an economy, but rather with transactions. Since many international transactions included in the balance of payments do not involve the payment of money, this figure may differ significantly from net payments made to foreign entities over a period of time. Does the “balance of payments” actually balance? In theory, a current account deficit would have to be financed by a net inflow in the capital and financial account, while a current account surplus should correspond to an outflow in the capital and financial account for a net figure of zero. In actual practice, however, the fact that data are compiled from multiple sources gives rise to some degree of measurement error. Balance of payments and international investment position data are critical in formulating national and international economic policy. Certain aspects of the balance of payments data, such as payment imbalances and foreign direct investment, are key issues that a nation’s economic policies seek to address. Economic policies are often targeted at specific objectives that, in turn, impact the balance of payments. For example, a country may adopt policies specifically designed to attract foreign investment in a particular sector. Another nation may attempt to keep its currency at an artificially depressed level to stimulate exports and build up its currency reserves. The impact of these policies is ultimately captured in the balance of payments data. EMBEDDED LIBERALISM Embedded liberalism is a feature of the global economic system and the associated international political orientation as they existed from the end of World War II to the 1970s. The system was setup to support a combination of free trade with the freedom for states to enhance their provision of welfare and to regulate their economies to reduce unemployment. The term was first used by the American political scientist John Ruggie in 1982. [1] Mainstream scholars generally describe embedded liberalism as involving a compromise between two desirable but partially conflicting objectives. The first objective was to revive free trade. Before World War I, international trade formed a large portion of global GDP, but the classical liberal order which supported it had been damaged by war and by the Great Depression of the 1930s. The second objective was to allow national governments the freedom to provide generous welfare programmes and to intervene in their economies to maintain full employment. [2]This second objective was considered to be incompatible with a full return to the free market system as it had existed in the late 19th century—mainly because with a free market in international capital, investors could easily withdraw money from nations that tried to implement interventionist and redistributive policies.[3] The resulting compromise was embodied in the Bretton Woods system, which was launched at the end of [4] World War II. The system was liberal in that it aimed to set up an open system of international trade in goods and services, facilitated by semi-fixed exchange rates. Yet it also aimed to "embed" market forces into a framework where they could be regulated by national governments, with states able to control international capital flows by means of capital controls. New global multilateral institutions were created to support the new framework, such as the World Bank and the International Monetary Fund. When Ruggie coined the phrase embedded liberalism, he was building on earlier work by Karl Polanyi, who had introduced the concept of markets becoming "disembedded" from society during the 19th century. Polanyi went on to propose that the "re-embedding" of markets would be a central task for the architects of the post war world [5] order, and this was largely enacted as a result of the Bretton Woods Conference. In the 1950s and 1960s, the global economy prospered under embedded liberalism, with growth more rapid than before or since. Yet the system was to break down in the 1970s. MONETARY POLICY AUTONOMY Monetary autonomy refers to the independence of a country's central bank to affect its own money supply and, through that, conditions in its domestic economy. In a floating exchange rate system, a central bank is free to control the money supply. It can raise the money supply when it wishes to lower domestic interest rates to spur investment and economic growth. By doing so it may also be able to reduce a rising unemployment rate. Alternatively, it can lower the money supply, to raise interest rates and to try to choke off excessive growth and a rising inflation rate. With monetary autonomy, monetary policy is an available tool the government can use to control the performance of the domestic economy. This offers a second lever of control, beyond fiscal policy. In a fixed exchange rate system, monetary policy becomes ineffective because the fixity of the exchange rate acts as a constraint. As shown in section 90-1, when the money supply is raised, it will lower domestic interest rates, and make foreign assets temporarily more attractive. This will lead domestic investors to raise demand for foreign currency which would result in a depreciation of the domestic currency, if a floating exchange rate were allowed. However, with a fixed exchange rate in place, the extra demand for foreign currency will be need to be supplied by the central bank, which will run a balance of payments deficit and buy up its own domestic currency. The purchases of domestic currency in the second stage will perfectly offset the increase in money in the first stage, so that no increase in money supply will take place. Thus, the requirement to keep the exchange rate fixed, constrains the central bank from using monetary policy to control the economy. In other words the central bank loses its autonomy or independence.In substitution, however, the government does have a new policy lever available in a fixed system that is not available in a floating system, namely exchange rate policy. Using devaluations and revaluations, a country can effectively raise or lower the money supply level and affect domestic outcomes in much the same way as it might with monetary policy. However, regular exchange rate changes in a fixed system can destroy the credibility in the government to maintain a truly "fixed" exchange rate. This in turn could damage the effect fixed exchange rates might have on trade and investment decisions and on the prospects for future inflation. Nonetheless some countries do apply a semi-fixed or semi-floating exchange rate system. A crawling peg, in which exchange rates are adjusted on a regular basis, is one example. Another is to fix the exchange rate within a band. In this case, the central bank will have the ability to control the money supply, up or down, within a small range, but will not be free to make large adjustments without breaching the band limits on the exchange rate. These types of systems provide an intermediate degree of autonomy for the central bank. If we ask which is better, monetary autonomy or a lack of autonomy, the answer is mixed. In some situations, countries need, or prefer, to have monetary autonomy. In other cases, it is downright dangerous for a central bank to have autonomy. The determining factor is whether the central bank can maintain prudent monetary policies. If the central bank can control money supply growth such that it has only moderate inflationary tendencies, then monetary autonomy can work well for a country. However, if the central bank cannot control money supply growth, and if high inflation is a regular occurrence, then monetary autonomy is not a blessing. One of the reasons Britain has decided not joined the Euro zone (as of 2005) is because it wants to maintain its monetary autonomy. By joining the Euro zone, Britain would give up its central bank's ability to control its domestic money supply, since Euros would circulate instead of British pounds. The amount of Euros in circulation is determined by the European Central Bank (ECB) and although Britain would have some input into money supply determinations, they would clearly have much less influence than they would for their own currency. The decisions of the ECB would also reflect the more general concerns of the entire euro zone area rather than simply what might be best for Britain. For example, if there are regional disparities in economic growth such that Germany France and others are growing rapidly, while Britain is growing much more slowly, the ECB may decide to maintain a slower money growth policy to satisfy the larger demands to slow growth and subsequent inflation in the continental countries. The best policy for Britain alone, however, might be a more rapid increase in money supply to help stimulate its growth. If Britain remains outside the Euro zone, it remains free to determine the monetary policies it deems best for itself. If it joins the Eurozone, it loses its monetary autonomy. In contrast, Argentina suffered severe hyperinflations during the 1970s and 1980s. Argentina's central bank, at the time, was not independent from the rest of the national government. To finance large government budget deficits, Argentina resorted to running the monetary printing presses, which in turn, led to the severe hyperinflations. In this case, monetary autonomy was a curse, not a blessing. In an attempt to restrain the growth of the money supply, Argentina imposed a currency board in 1992. A currency board is a method of fixing one's exchange rate with a higher degree of credibility. By legislating mandatory automatic currency interventions, a currency board operates in place of a central bank and effectively eliminates the autonomy that previously existed. Although Argentina's currency board experiment collapsed in 2002, for a decade Argentina experienced the low inflation that had been so elusive during previous decades. WHICH IS BETTER? FIXED OR FLOATING EXCHANGE RATES The exchange rate is one of the key international aggregate variables studied in an international finance course. It follows that the choice of exchange rate system is one of the key policy questions. Countries have been experimenting with different international payment and exchange systems for a very long time. In early history, all trade was barter exchange, goods were traded for other goods. Eventually, especially scarce or precious commodities, for example gold and silver, were used as a medium of exchange and a method for storing value. This practice evolved into the metal standards that prevailed in the 19th and early 20th centuries. By default, since gold and silver standards imply fixed exchange rates between countries, early experience with international monetary systems was exclusively with fixed systems. Fifty years ago, international textbooks dealt almost entirely with international adjustments under a fixed exchange rate system since the world had had few experiences with floating rates. That experience changed dramatically in 1973 with the collapse of the Bretton-Woods fixed exchange rate system. At that time, most of the major developed economies allowed their currencies to float freely, with exchange values being determined in a private market based on supply and demand, rather than by government decree. Although when Bretton-Woods collapsed, the participating countries intended to resurrect a new improved system of fixed exchange rates, this never materialized. Instead countries embarked on a series of experiments with different types of fixed and floating systems. For example, the European Economic Community (now the EU) implemented the exchange rate mechanism in 1979 which fixed each other's' currencies within an agreed upon band. These currencies continued to float with non-EEC countries. By 2000, some of these countries in the EU created a single currency, the Euro, which replaced the national currencies and effectively fixed the currencies to each other immutably. Some countries have fixed their currencies to a major trading partner, others to a basket of currencies comprised of several major trading partners. Some have implemented a crawling peg, adjusting the exchange values on a regular basis. Others have implemented a dirty float where the currency value is mostly determined by the market but periodically the central bank intervenes to push the currency value up or down depending on the circumstances. Lastly, some countries, like the US, have allowed an almost pure float with central bank interventions only on rare occasions. Unfortunately, the results of these many experiments are mixed. Sometimes floating exchange rate systems have operated flawlessly. At other times floating rates have changed at breakneck speed leaving traders, investors and governments scrambling to adjust to the volatility. Similarly, fixed rates have at times been a salvation to a country, helping to reduce persistent inflation. At other times, countries with fixed exchange rates have been forced to import excessive inflation from the reserve country. No one system has operated flawlessly in all circumstances. Hence, the best we can do is the highlight the pros and cons of each system and recommend that countries adopt that system that best suits its circumstances. Probably the best reason to adopt a fixed exchange rate system is to commit to a loss in monetary autonomy. This is necessary whenever a central bank has been independently unable to maintain prudent monetary policy leading to a reasonably low inflation rate. In other words, when inflation cannot be controlled, adopting a fixed exchange rate system will tie the hands of the central bank and help force a reduction in inflation. Of course, in order for this to work, the country must credibly commit to that fixed rate and avoid pressures that lead to devaluations. Several methods to increase the credibility include the use of currency boards and complete adoption of the other country's currency (i.e., dollarization or euroization). For many countries, for at least a period of time, fixed exchange rates have helped enormously to reduce inflationary pressures. Nonetheless, even when countries commit with credible systems in place, pressures on the system sometimes can lead to collapse. Argentina, for example, dismantled its currency board after 10 years of operation and reverted to floating rates. In Europe, economic pressures recently have resulted in "talk" about giving up the Euro and returning to national currencies. The Bretton-Woods system lasted for almost 30 years, but eventually collapsed. Thus, it has been difficult to maintain a credible fixed exchange rate system for a long period of time. Floating exchange rate systems have had a similar colored past. Usually, floating rates are adopted when a fixed system collapse. At the time of a collapse, no one really knows what the market equilibrium exchange rate should be and it makes some sense to let market forces (i.e., supply and demand) determine the equilibrium rate. One of the key advantages of floating rates is the autonomy over monetary policy that it affords a country's central bank. When used wisely, monetary policy discretion can provide a useful mechanism for guiding a national economy. A central bank can inject money into the system when the economic growth slows or falls, or it can reduce money when excessively rapid growth leads to inflationary tendencies. Since monetary policy acts much more rapidly than fiscal policy, it is a much quicker policy lever to use to help control the economy. Interestingly, monetary autonomy is both a negative trait for countries choosing fixed rates to rid themselves of inflation, and a positive trait for countries wishing have more control over their domestic economies. It turns out, that the key to success in both fixed and floating rates hinges on prudent monetary and fiscal policies. Fixed rates are chosen to force a more prudent monetary policy, floating rates are a blessing for those countries who already have a prudent monetary policy. A prudent monetary policy is most likely to arise when two conditions are satisfied. First, the central bank, and the decisions it makes, must be independent of the national government which makes government spending decisions. If it is not, governments have always been inclined to print money to finance government spending projects. This has been the primary source of high inflation in most countries. The second condition is a clear guideline for the central bank's objective. Ideally, that guideline should broadly convey a sense that monetary policy will satisfy the demands of a growing economy while maintaining sufficiently low inflation. When these conditions are satisfied, autonomy for a central bank and floating exchange rates will function well. Mandating fixed exchange rates can also work well, but only if the system can be maintained, and if the country to whom one fixes one's currency has a prudent monetary policy. Both systems can experience great difficulties if prudent fiscal policies are not maintained. This requires governments to maintain a balanced budget over time. Balance over time does not mean balance in every period, but rather that periodic budget deficits be offset with periodic budget surpluses. In this way government debt is managed and does not become excessive. Also, it is critical that governments do not overextend themselves in terms of international borrowing. International debt problems have become the bane of many countries. Unfortunately, most countries have been unable to accomplish this objective. Excessive government deficits and borrowing is the norm for both developing and developed countries. When excessive borrowing needs are coupled with a lack of central bank independence, tendencies to hyperinflations and exchange rate volatility are common. When excessive borrowing is coupled with an independent central bank and a floating exchange rate, exchange rate volatility is also common. Stability of the international payments system then, is less related to the type of exchange rate system chosen than it is to the internal policies of the individual countries. Prudent fiscal and monetary policies are the keys. With prudent domestic policies in place, a floating exchange rate system will operate flawlessly. Fixed exchange systems are most appropriate when a country needs to force itself to a more prudent monetary policy course. RECESSIONARY DEFICIT SPENDING Deficit spending occurs whenever a government's expenditures exceed its revenues over a fiscal period, creating or enlarging a government debt balance. Traditionally, government deficits are financed through the sale of public securities, particularly government bonds. Many economists, especially in the Keynesian tradition, believe government deficits can be used as a tool of stimulative fiscal policy. Deficit spending is an accounting phenomenon. It is only possible to engage in deficit spending when revenues fall short of expenditures. However, nearly all of the academic and political debate surrounding deficit spending focuses on economic theory, not accounting. According to demand-side economic theory, a government can begin deficit spending after the economy falls into recession. The famed British economist John Maynard Keynes is often credited with the concept of deficit spending as fiscal policy, though most of his ideas were re-interpretations or modifications of older mercantilist arguments. In fact, many of Keynes’ spending ideas were tried before “The General Theory” was published in 1936. Herbert Hoover, for example, fought the Great Depression by increasing federal government spending more than 50% and engaging in massive public works projects during his four years in office between 1928 and 1932. What Keynes managed in 1936 was to give academic and intellectual legitimacy to deficit spending programs. He argued a drop in consumer spending during the recession could be met by a corresponding increase in government deficit spending, maintaining the correct level of aggregate demand to prevent high levels of unemployment. Once full employment was achieved, Keynes believed, the market could return to a more laissez- faire approach and the debt could be repaid. If the extra government spending were to cause inflation, Keynes believed the government could simply raise taxes and drain extra money out of the economy. Deficit spending is often misinterpreted as a pro-growth policy tool. This may be because deficit spending is positively correlated with gross domestic product (GDP). However, since one of the key components of the GDP equation is government spending, it is tautological and not empirical that the two tend to rise and fall together. As Keynes articulated, the main role of deficit spending is to prevent or reverse rising unemployment during a recession. Keynes did believe there could arise a secondary benefit of government spending, something often called “the multiplier effect.” According to the theory, a single dollar of government spending might increase total economic output by more than $1. There are plenty of theoretical and empirical challenges to the notion of the Keynesian multiplier. A huge series of econometric tests have been run, with various and inconclusive results. If left unchecked, some economists argue, the effects of deficit spending pose a threat to economic growth. Too large a debt, wrought by consistent deficits, might force government to raise taxes, pursue inflationary monetary policies, or default on their debt obligations. Additionally, the sale of government bonds crowds out private issuers and might distort prices and interest rates in capital markets. KEYNES
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