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Domestic Politics and Money
Learning output of the class:
- better understanding of the current international
monetary system
- better understanding of the interaction between
international monetary system and domestic
economy
- government monetary instuments (interest rates,
exchange rate, monetary base)
- trade v capital flows
History of monetary system: from fixed to
floating exchange rates

Gold standard (dismantled in the 1930s)
–

Bretton-Wood system (1944-1971)
–

Fixed exchange rates in terms of gold, Limited gov.
monetary tools
Fixed-but-adjustable exchange rates, Central role
of the dollar, Government interventions used to
peg the exchange rate (autonomous monetary
policies), Limits on capital flows, Creation of IMF
Floating rates system (since 1971)
–
“unlimited” capital flows
Keynesian revolution


John Meynard Keynes, 1936 The General Theory
of Employment, Interest and Money
Rationale for government macroeconomic policies
Fiscal
 Monetary
Government role of stabilizer of the unstable market
economy



1946 Employment Act (formerly proposed as Full
Employment Act)

Fixed rates

Pegged rates

Floating rates
Monetary policy: definition
The Federal Reserve`s (the Fed) actions to
influence the availability and cost of money
and credit. Because the expectations of market
participants play an important role in
determining prices and economic growth,
monetary policy can also be defined to include
the directives, policies, statements, and
actions of the Fed that influence future
perceptions.
- Regulates/controls the supply of money
Monetary policy: tools
- through open market operations involving the
purchase and sale of U.S. Treasury
securities
- by setting the Discounte rate - interest rate
that banks pay on short-term loans from Fed
(cost of credit)
- by setting Reserve Requirements - amount of
physical funds that depository institutions are
required to hold in reserve against deposits in
bank accounts
- Foreing Exchange Interventions
Impossible or “unholy” trinity


http://www.youtube.com/watch?v=oLbfAfCVG_
4
Tradeoff between domestic economic autonomy
and exchange rate stability

Fixed exhchange rate

Independent monetary policy

International Capital mobility
» Gov. can use only 2 of them at the same time
Inflation rates 1960-1971
US budget deficits 1960-1971 (% of
GDP)
Current Account Balance (19602010)
Monthly Change in the Deutsche Mark–U.S. Dollar Real Exchange
Rate, February 1960–March 1994
Federal Funds Nominal Target Rate
The Target Federal Funds Rate and
Taylor (1993) Rule Prescriptions
Currency Distribution in
Foreign Exchange Transactions
World payment currencies vs trade
Discussion
Is the dollar`s dominance under the threat? Is the
dollar as a dominant reserve currency going to
collapse?
Different determinants of USD/EUR
echange rate 1999-2013
- International portfolio choices (1999-2001, 20028)
- Foreign trade (2002-8)
- Risk aversion and preference for liquidity (200812)
- Monetary creation (2013)