Chapter 11
currency crisis
(when currency depreciates rapidly) when a speculative attack on thee exchange value of a currency results in a sharp depreciation in the value of the currency of forces authorities to expend large volumes of international currency reserves and sharply increase interest rates to defend the prevailing exchange rate
banking crisis
(when people lose confidence that they can get money out of the bank) loss of confidence in the banking system that leads to a run on banks, as individuals and companies withdraw their deposits
the bretton woods system im pretty sure fixed the us dollar to gold then they fixed all other currencies to the us dollar. in order for this to work to us dollar needed to be stable
-what happened was we started to increase gov spending to finance vietanm war and welfare programs -we registered a trade deficit in 1971 This lead to inflation in the US and a devaluation and effected other countries that were fixed to the US dollar. The US went off the gold standard in 1971 Jamaica Agreement (1976) led to floating exchange rates for many countries
what causes currency crises
Anything that causes the currency to depreciate rapidly Examples: inflation current account deficit excessive domestic borrowing Inability of the government to uphold the currency via its international reserves
WW2 to bretton woods agreement
By end of WW2, European and Japanese economies devastated Former colonies (Asia, Africa, Middle East, South America) very poor Productive infrastructure around the world in poor shape Only the U.S. was in a good position economically U.S. needed to sell to the rest of the world All this sets the stage for the Bretton Woods Agreement of 1944
the role of the IMF
Conditions: Increase taxes, privatize, cut public spending, raise interest rates, more exports, less imports, foreign direct investment, etc. Criticisms: One-size-fits-all prescription too powerful too little expertise moral hazard problem New initiatives to counteract IMF: BRICS Development Bank AIIB
post bretton woods era
Increasing frequency and depth of financial crises in countries Caused by rapid decline in currency value 188 member countries, more than 60 with IMF programs in place The current role of the IMF has greatly expanded beyond its original role The IMF has become an extremely important and powerful organization in the world
how did the international monetary system work prior to 1944?????????
Up to 1800s: Mostly barter or countertrade 1880s: the Gold Standard became prevalent -Paper currency started to be used -Currency backed by gold -Worked reasonably well until early 20th century 1914-1944: the Gold Standard fails -Inflation creates problems (ot finance wars, the gove printed a lot of money which lead to inflation) -More currency printed than reserves of gold -Competitive devaluations by countries -Convertibility of currency becomes a concern -A loss of confidence leads to devaluation
fixed exchange rate system
a system under which the exchange rate for converting one currency into another is fixed
floating exchange rates
a system under which the exchange rate for covertinnng one currency into another is continuously adjested depending on the laws of supply and demand. when the foreign exchange market determines the relative value of a currency, we say that the country is adhering to a floating echange rate regime
crawling peg and target-zone systems
allowed to fluctuate within established margin
pegged XRs
currency linked to a single or composite of currencies
pegged exchange rate
currency value is fixed relative to a reference currency
independent float system
demand for a country's currency is a function of the demand for the country's goods and services and financial assets
managed float system (dirty float)
gov influences currency;s price by buying and selling it in the open makrket
flexible XRs
high freedom to float according to supply and demand -this is the independent float system and the managed float system
international monetary system
instituational arrangements contries adpot to govern exchange rates
what did the bretton woods agreement do?
it created the international monetary fund and the world bank it let governments have more flexibility
currency board
means of controlling a country's currency
fixed rate
not allowed to deivate from par value
balance of trade equilibrium
reached when the income a nation's residents earn from exports eqals money paid for imports
foreign debt crisis
situation in which a counntry cannot service its foreign debt obligations, whether private-sector or gov debt
dirty float system
system where a country's currency is nominally allowed to float against other currencies, but in which the gov will intervene, buying and selling currency, if it believes that the currency has deviated too far from its fair value
gold par value
the amount of currrency needed to purchase one ounce of gold
gold standard
the practice of pegging currencies to gold and guaranteeing convertability
what is the special drawing rights
this was also created during the bretton woods agreement used to help countries maintain BOPs and increase international reserves (based on basket of currencies) -so really i don't know what this is
job of the world bank
to provide low-cost loans to help countries develop economies (economic develpoment to third world countires)
job of the IMF
we pay money to the IMF and its helps bail out gov. its the lender of last report To promote XR stability and facilitate int'l flow of currencies To upheld system of fixed XRs with par values for each currency (benchmark value quoted in terms of US $) Only US $ convertible to gold at $35/ounce Currencies could vary by 1% up or down but no more (Countries would intervene in the market by buying or selling its currency to keep its value with the 1% range.)
devaluation
when a gov reduces the value of its currency relative to that of a foreign currency -contrast with depreciation
revaluation
when gov increases the value of its currency relative to that of a foreign currency -contrast with appreciiation
moral hazard
when people behave recklessly because they know that they will be saved if things go wrongs
limited flexibility XRs
within some margin relative to a single or group of currencies