copyright © 2000 addison wesley longman slide #13-1 chapter thirteen the international financial...
TRANSCRIPT
Copyright © 2000 Addison Wesley Longman Slide #13-1
Chapter Thirteen
THE INTERNATIONAL FINANCIAL SYSTEM
Copyright © 2000 Addison Wesley Longman Slide #13-2
Exchange Market InterventionUnsterilized:
Fed sells $10 billion of $, buys $10 billion of foreign assets Federal Reserve
Assets Liabilities
Foreign Assets + $10 b Currency or Reserves + $10 b
(international reserves) (Monetary Base)
Results:
1. International reserves, +$10 billion
2. Monetary base, + $10 billion
3. Then analysis in Fig. 1, Et
Copyright © 2000 Addison Wesley Longman Slide #13-3
Sterilized: To lower MB back to old level, Fed sells $10 billion of
government bonds
Federal Reserve
Assets Liabilities
(Foreign Assets) (Monetary Base)
International reserves + $10 b Currency or Reserves $0 b
Government Bonds - $10 b
Results1. International reserves, +$10 billion2. Monetary base unchanged
3. Et unchanged: no shift in RETD and RETF
Exchange Market Intervention
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Exchange Rate Intervention, Sell $
1. Sell $, buy F: MB , Ms
2. Ms , P , Eet+1 ,
expected appreciation of F , RETF shifts right in Fig. 1
3. Ms , i D , RETD shifts left, Ggo to point 2 and Et
4. In long run, iD returns to old level, RETD shifts back, go to point 3
Exchange rate overshooting
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The Balance
of Payments
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The Gold Standard
Currency convertible into gold at fixed value
Example of how it worked: U.S.: $20 convert into 1 ounce of gold
U.K.: £4 convert into 1 ounce of gold
Par value of 1£ = $5.00
If £ to $5.25, importer of £100 of tweed has two alternatives:
1. Pay $525
2. Buy $500 gold (500/20 = 25 ounces), ship to U.K., convert into £100 (= 25x £4) and buy tweed
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If shipping cheap, do alternative 21. Gold flows to U.K.
2. MB in U.K, MB in U.S.
3. Price level U.K., U.S.
4. £ depreciates back to par
Two Problems:1. Country on gold standard loses control of Ms
2. World inflation determined by gold production
The Gold Standard
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Fixed Exchange Rate Systems
Bretton Woods1. Fixed exchange rates
2. Other central banks keep exchange rates fixed to $: $ is reserve currency
3. $ convertible into gold for central banks only ($35 per ounce)
4. International Monetary Fund (IMF) sets rules and provides loans to deficit countries
5. World Bank makes loans to developing countries
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European Monetary System1. Value of currency not allowed outside "snake"
2. New currency unit: ECU
3. Exchange Rate Mechanism (ERM)
Key weakness of fixed rate systemAsymmetry: pressure on deficit countries losing
international reserves to Ms, but no pressure on surplus countries to Ms
Fixed Exchange Rate Systems
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Intervention in a Fixed Exchange Rate System
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Analysis of Figure 2: Intervention in a Fixed Exchange Rate System
Since Eet+1 = Epar with fixed exchange rate, RETF
doesn't shift
Overvalued exchange rate (panel a)1. Central bank sells international reserves to buy
domestic currency
2. MB , Ms , iD , RETD shifts to right to get to point 2
3. If don't do this have to devalue
Copyright © 2000 Addison Wesley Longman Slide #13-12
Analysis of Figure 2: Intervention in a Fixed Exchange Rate System
Undervalued exchange rate (panel b)1. Central bank sells domestic currency and buys
international reserves
2. MB , Ms , iD , RETD shifts to left to get to point 2
3. if don't do this have to revalue
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Exchange Rate Crisis of September 19921. At Epar, RETF right
of RETD because Bundesbank tight money keeps German interest rates high
2. Bank of England buys £, iD , RETD shifts right
3. When speculators expect devaluation, Ee
t+1 , RETF shifts right
4. Requires much bigger intervention
5. When UK pulls out of ERM, £ 10%, big losses to central bank
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Profiting from a FX Crisis
Sept. 1992, £ overvalued; Once traders know central banks can't intervene enough, £ only head one direction, 1. One-sided bet, "heads I win, tails I win"
2. Traders sell £, buy DM
3. £ 10% after Sept. 16
A. Citibank makes $200 million
B. Soros makes $1 billion
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Monetary Policy: International Considerations
1. Direct Effects of FX market
When intervene, MB changes
2. Balance of Payments Considerations
When B of P is in deficit need Ms 3. Exchange Rate Considerations
When want lower E, need Ms