Download Historical Monetary Overview

International Economics ECON 390
Lotta Moberg
Lecture notes – 19 November 19: Historical Monetary Overview
Macroeconomic Goals
1. Internal balance
 Obtaining potential output, full employment, and of price stability
 Volatile aggregate demand and output mean volatile prices
2. External balance
 The government can repay its foreign debts, and foreigners theirs
The Open-Economy Trilemma
3. Trilemma – You can only obtain two out of three goals
 A fixed currency and free international capital movements means no
domestic monetary policy
 To conduct monetary policy, means restricted international financial flows
 Then, the parity R = R* need not hold
4. Free international capital flows and monetary policy require a floating
exchange rate
Macroeconomic Policy under the Gold Standard 1870–1914
5. A gold standard means the currency is redeemable for gold at a certain rate
6. Prices adjusted according the amount of gold circulating in an economy
Price-specie-flow mechanism
7. The adjustment of prices as gold (“specie”) flows into or out of a country,
adjusting the flow of goods.
 An inflow of gold inflates and an outflow deflates prices
8. A current account surplus makes gold earned from exports flow into the
country
 This raises prices at home and lowers prices in foreign countries
9. Goods from the domestic country become relatively expensive
10. This reduces the current account surplus at home
11. This promotes external balance for all countries
International Economics ECON 390
Lotta Moberg
The rules of the gold standard
12. Central banks sell domestic assets to acquire money when gold exits the
country to pay for imports
 This decreases the money supply, increases interest rates, and attracts
investments to match a current account deficit.
 This reverses gold outflows
13. Problem was that countries with gold inflows did not do the opposite
 Their only incentive was the interest earned on domestic assets
The Interwar Years: 1918–1939
14. The U.S., the U.K., and others reinstated the gold standard
15. But the rules were persistently broken and the U.K. in decline
16. The Great Depression made many countries float their currencies
Bretton Woods System 1944–1973
17. A fixed exchange rate against the U.S. dollar and a fixed dollar price of gold
18. To avoid sudden changes in the financial account, countries often prevented
flows of financial assets across countries
 Currencies were gradually made convertible between member countries to
encourage trade in goods and services valued in different currencies
19. All countries but the U.S. had ineffective monetary policies
 So the principal tool for internal balance was fiscal policy
20. The IMF was constructed to lend to countries with persistent balance of
payments deficits
 And to approve of devaluations, to ensure economic stability
U.S. External Balance Problems under Bretton Woods
21. In the 1970s, rapidly increasing government purchases increased prices.
22. The U.S. dollar became overvalued in terms of gold and foreign currencies
International Economics ECON 390
Lotta Moberg
23. As foreign economies grew, they needed more official international
reserves to maintain fixed exchange rates
 So they held more dollar-denominated assets
24. Dollar-denominated assets held by foreign central banks outgrew the
amount of gold held by the Federal Reserve
 So foreigners lost confidence in the ability of the Federal Reserve to
maintain the fixed price of gold
 They wanted to redeem their dollar assets before the gold ran out
Collapse of the Bretton Woods System
25. The U.S. needed to reduce government purchases, increase taxes, or reduce
money supply growth that caused international inflation
 But did not want to
26. The perception on international markets grew that the U.S. economy
needed a devaluation
 This speculation caused investors to buy large quantities of gold
27. The Federal Reserve closed the Gold Window in 1971
 Thus decoupled the dollar from the gold
28. The main industrial countries floated their currencies in 1973
29. The expectation was that the markets would stake out new exchange rates,
at which to fix the currencies
 But no new global system of fixed rates was ever started again