Chapter 8 outline.docx

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Political Science
Leslie Johns

World Politics Chapter 8 – International Monetary Relations – Outline I. Introduction a. There are many contending interests over monetary affairs within countries which leads to domestic conflict over the appropriate currency policy to pursue b. Although every country can set currency policy as it wants, the fact that exchange rates value currencies relative to one another means that outcomes are the product of interactions among countries’ policies i. As a result, may have reasons to cooperate with one another to create arrangements that are mutually beneficial c. Virtually everyone has an interest in the existence of a functioning international monetary system i. Different arrangements benefit some actors more than others, which leads to disagreement about how such a system should be organized and about how the burdens and benefits should be distributed among countries d. International monetary institutions, such as the gold standard, Bretton Woods system, or Europe’s Economic and Monetary Union, can create rules that facilitate cooperation in international monetary policy II. What Are Exchange Rates, and Why Do They Matter? i. National monetary system is a public good 1. Benefits everyone 2. Private institutions have no incentive to provide it 3. Government responsible for printing and controlling supply ii. Exchange rate – the price at which one currency is exchanged for another iii. Appreciate – in terms of a currency, to increase in value in terms of other currencies iv. Depreciate – in terms of a currency, to decrease in value in terms of other currencies v. Devalue – to reduce the value of one currency in terms of other currencies vi. Variance in currency does not just affect traveling, but also buying and selling goods across borders 1. E.g. when the dollar is weak, foreign goods are more expensive 2. Attractiveness of a country’s goods, services, and investment opportunities is very important to a country and affected by trade b. How Are Currency Values Determined? i. Rates go up and down in response to changes in supply and demand ii. Factors that affect supply and demand 1. Relative interest rates a. Higher rates are more attractive to investors which increases currency demand b. Rates determined by monetary policy – influence macroeconomic conditions such as unemployment, inflation, and economic growth c. Typically, governments alter monetary policies by changing national interest rates or exchange rates c. Allowing the Exchange Rate to Change i. Fixed exchange rate – a policy under which a government commits itself to keep itself to keep its currency at or around a specific value in terms of another currency of a commodity such as gold ii. Gold standard – monetary system that prevailed between 1870 and 1914 in which countries tied their currencies to gold at a legally fixed price 1. Made money interchangeable at a fixed rate iii. Floating exchange rate – a policy under which a government permits its currency to be traded on the open market without direct government control or intervention 1. Used by most major currencies including US dollar, euro, Japanese yen iv. Hybrid policies where a government may let some currency floating but will set limits v. Bretton Woods monetary system – order negotiated among World War II allies in 1944, which lasted until the 1970s and which based the US dollar tied to gold 1. Other currencies were fixed to the dollar but were permitted to adjust their rates vi. Adjustable peg – monetary system of fixed but adjustable rates 1. Governments are expected to keep currencies fixed for extended periods but can adjust the rate from time to time as economic conditions change 2. Changes only occurred every 5 to 7 years III. Who Cares about Exchange Rates, and Why? a. Governments i. Trade-offs and domestic interests are often in conflict ii. Fixed rates provide stability and predictability which helps facilitate trade, investment, travel, etc. 1. Gold standard sooths many business worries about changes in rates iii. Cost of fixed rates: 1. Commitment to currency value even if economy grows 2. Eliminates ability to have own independent monetary policy a. Could be a problem if recession occurs b. In poor conditions governments want to depreciate currency (increase supply) to make foreign investment more attractive 3. Argentina 2001 example a. Fixed to US dollar for 10 years b. Economic conditions led to much domestic pressure to lower interest rates and depreciate currency iv. Floating policies give governments freedom to make monetary policy 1. Cost is they can fluctuate a lot and thus impede international exchange b. Consumers and Businesses i. Those involved with domestic activities favor a floating exchange rate 1. Indifferent to fluctuations and want the government to have the ability of monetary policy ii. International interests favor fixed currency to curb volatility iii. Conflicting interests also arise over a currency’s value (strong or weak) 1. Strong rate allows consumers to buy foreign products more a. Tradeoff: exchange rate makes domestic goods more expensive for foreigners which is harmful for exporters b. Manufacturers and farmers typically complain about a strong currency since it results in cheaper imports and dampens exports 2. Weak currency boosts national producers a. Compliment those who push for exports b. Tradeoff: weak currency reduces purchasing power making consumers worse off iv. Countries with many firms and individuals engaged in international activity pressure government to stabilize currency value 1. Shows why small European economies are very open while larger ones trade less IV. Can There Be World Money without World Government? i. For the international economy to work well there need to be some predictability to currency values b. International Monetary Regimes i. A formal or informal arrangement among governments to govern relations among their currencies, and which is shared by most countries in the world economy 1. Regional monetary regimes also exist 2. Facilitates international economic exchange ii. Features: 1. Makes it clear whether a currency is fixed, floating, or a mix of both 2. Agreement on a mutually accepted benchmark against which values are measured (some common base) a. Commodity standard – a good with value of its own as the basic monetary unit (e.g. gold) b. Commodity-backed paper standard – similar to Bretton Woods, paper currency issued with a fixed value in terms of gold which governments are required to credibly stand ready to redeem 3. National paper currency standard – backed only by commitments of governments (does not require a fixed rate) V. When and Why Do Governments Agree on the Monetary Order? a. International Monetary Cooperation and Conflict i. Agreeing on a monetary regime is like a public good 1. Everyone benefits if it functions but the provision of this order is not automatic or easy 2. Requires conscious efforts by national governments to alter policies or contribute funds to stabilize currencies 3. Different to organize collaboration 4. A fixed rate system like the gold standard can result in smaller governments deciding that it can benefit more without fixing its own currency ii. Success depends on: 1. Interactions of governments 2. Set standards for the regimes as a whole and address problems as they arise 3. Governments may “cheat” by devalueing their own currency to make its producers’ goods more competitive a. Countries respond similarly and the result is a Prisoner’s Dilemma b. Result is all currencies devalued where there is no advantage for anyone b. A Short History of the International Monetary Systems i. The Gold Standard 1. Countries had gold-backed currencies with fixed exchange rates that did not change for decades (all major economies except China and Persia) 2. Stability due to Britain, France, and Germany 3. Provided stability and predictability which greatly facilitated trade 4. Costs a. No ability for independent monetary policy b. Controversy in US- 1896 with Populists led by William Jennings Bryan supporting silver instead 5. Most counties went back to gold after World War I but the international cooperation that made is successful before was no longer present 6. Failure to cooperate was exacerbated by the Great Depression where countries backed off and tried to save their economies ii. The Bretton Woods System 1. Led by US and Great Britain at the end of World War II 2. Fundamental reform of the gold standard a. Organized around the US dollar b. Dollar tied to gold at $35 per ounce at a fixed rate c. Other currencies tied to the dollar and thus, gold indirectly 3. Middle ground between gold standard and floating currency 4. Kept currency values stable and currency markets open 5. Relied on collaboration
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