What features did the Bretton woods system had?
- A fixed but adjustable exchange rate
- Setting up of the IMF with monitoring duties and the International bank of Reconstruction and Development (IBRD)(World Bank)
Explain the fixed but adjustable exchange rates
The rates were assigned a central parity to the US dollar and was allowed to fluctuate +- 1%, moreover, the US dollar was fixed at 35$ per ounce
When was a country allowed to revalue under the Bretton woods system?
When a country faced fundamental disequilibrium and then they were allow to revalue if it was less than 10% otherwise it required the permission from the IMF
What could a country employ if it faced BOP deficits?
The IMF employed a credit mechanism that entitled them to the first 25% of the then assigned quota, the first tranche was called the gold tranche.
When did the Bretton woords commenced operation?
March 1947
When did the European Payments Union (EPU) commence operations?
1950
When was the General Arrangement to Borrow (GAB) commenced?
1962
When did Nixon announce in 1971?
That US dollar was no longer convertible to gold.
How did the joint float work against the Dollar?
IT was called the Snake in the Tunnel, were able to fluctuate 1.125% to each other (The Snake) and 2.25% against the Dollar (The Tunnel)
Where did the Bretton Woods depended on to work?
- US ran deficits
- central banks demanded confidence in the US dollar
- convertibility to gold
What was the Triffin Dilemma?
Continued US deficits would undermine the Bretton Woods system, yet if the US would curb these deficits than it would undermine the growth of world trade and exert deflationary pressures on the world economy.
What were the problems that led to the breakdown of the Bretton woods system?
- Problems of liquidity,
- Lack of an adequate adjustment mechanism
- A confidence problem
What was the goal of the Bretton Woods system?
Goal of achieving both internal and external balance and enhances both discipline and flexibility
What are the crisis commonalities?
- Fundamental before crisis: often weak and capital mobility
- Events that triggered the crisis
- Big band (breakdown of peg): peg collapses
- Role of IMF
- Spillovers to other countries
What were 4 important currency crisis?
- ERM (1992-1993)
- Mexico (1994-1995): exchange rate peg
- East Asia (1997-1998): exchange rate peg
- Argentina (2002): currency board
Analyse ERM crisis using the commonalities
- Fundamentals: Germany set a high interest rate, so Italy and Uk had to follow, problem of a policy dilemma (EB or IB) + capital mobility
- Events: Denmark rejected Maastricht Treaty
- Big ban: Several pegs collapsed and bands widened +- 15%
- Role of IMF: IMF passive
- Spillover: Crisis spread to most ERM countries
Analyse Mexico crisis using the commonalities
- Fundamentals: Current account and fiscal deficits + capital mobility
- Events: Civil unrest, assasination of president candidate -> capital outflow
- Big band: Devaluation of Peso and float
- Role of IMF: IMF package that avoided external debt default
- Spillovers: Increase in Mexico competitiveness after depreciation but cause Tequila effect (risk reassessments in other developing countries
Analyse East Asia crisis using commonalities
- Fundamentals: Structural problems: public guarantees for investments, poor evaluation -> moral hazard and adverse selection: unprofitable investments + capital mobility
- Events: No clear spark
- Big band: Thai bath and other currencies in the region fell
- Role of IMF: IMF loans to several countries
- Spillover: Increased Thai competitiveness and risk reassessments caused problem in region (Asian flu was contagious)
What are the pros and cons of a currency board?
pros:
1. CB cannot expand the money supply much
2. Government is not allowed to sell bonds to CB
3. Standard advantages of fixed rates
Cons:
1. CB is unable to lend to bank in crisis
2. How to convince market that currency board will not be suspended
3. Standard disadvantages of fixed rates
Analyse the Argentinian crisis using commonalities
- Fundamentals: CA deficit, fiscal deficit + recession + capital mobility
- Events: rumors about adjustment/suspension of currency board
- Big band: Restricted cash withdrawals, devalued peso and a float
- Role of IMF: IMF loan
- Spillover: regional impact
Is limiting Capital mobility a solution for disruptive exchange rate movements?
Well imposing a small tax on forex transaction could help prevent crisis, however this might get circumvented by financial innovation and reduce market liquidity
What are the pros and cons of getting a hard peg and giving up your own currency?
pros:
1. No devaluation possible
2. No currency risk: Es=0 and reduces Rp -> r lower
3. Standard advantages of fixed exchange rates
Cons:
1. CB cannot buy H bonds to increase money supply
2. Loss of policy flexibility
3. Fiscal deficits have to be financed by (dollar) bonds
Rogoff et al (2003) distinguished between the jure regime and facto regime. Explain his point
there is as this moment no movement toward bipolarity. Developing countries moved towards a more fixed regimes and Emerging markets have moved to managed float
What happened between 1879-1914?
Gold standard introduced that assured fixed price and stability
