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