Week Fourteen. Bretton Woods, New Hampshire

Transcription

1 Week Fourteen Linus Yamane Bretton Woods, New Hampshire July 1944 Delegates from 44 Allied nations meet Create the IMF and World Bank Establish the Bretton Woods System Lord Keynes addresses conference meeting Mount Washington Hotel Harry White & John Maynard Keynes 1

2 Bretton Woods Exchange Rates pegged rates fixed but adjustable U.S. $ 35 = 1 oz gold Japanese 360 = $ 1 German DM 4.2 = $ 1 British = $ 1 French FRF 4.9 = $ 1 Italian 625 = $ 1 Swiss SF = $ 1 Greek Drachma 30 = $1 Bretton Woods System 1944 Bretton Woods, N.H. Established fixed but adjustable exchange rates 1961 creation of gold pool 1968 established two tier gold market Official transactions $35/oz Free market (US no longer supports a $35 free market price) 1971 US closes official gold window Bretton Woods is declared dead US puts the world on a dollar standard & imposes capital controls Devalues dollar to $38/oz 1973 floating exchange rates (managed float) Dollar devalued 10% 2

3 Managed Float 1974 U.S. capital controls eliminated 1975 U.S. moves to floating exchange rates 1978 dollar rescue package 1985 Plaza Accord to depreciate dollar 1987 Louvre Accord to support dollar 1998 support Japanese yen 2000 support Euro 2011 restrain Japanese yen Reserve Currencies Currency 2013 US dollar 61.2% Euro 24.4% Pound sterling 4.0% Japanese yen 3.9% Canadian dollar 1.7% Australian dollar 1.6% Swiss franc 0.2% Other 2.9% 3

4 Fixed Exchange Rates Under Bretton Woods, countries would peg their currency at a constant exchange rate and stand ready to defend them One way street problem Foreign central banks can always print more of their own currency to depreciate their currency But will eventually run out of US dollars when it has to support an overvalued currency Fixed Exchange Rates Devaluation a reduction in the price at which the central commits itself to buying and selling its currency 1967 British pound is devalued from $2.80 to $2.40 Revaluation an increase in the price at which the central bank commits itself to buying and selling its currency 1969 German DM is revalued from 25 to 27.2 Sterilization when the central bank neutralizes the effect of its intervention in the FX market on its own money supply thru open market operations. 4

5 Artificially Strong Exchange Rates Some countries fix their exchange rates to have an artificially strong currency Imports are cheaper Lower domestic price level Debt denominated in US$ can be paid back more easily National pride in a strong currency Artificially Strong Exchange Rates To maintain an artificially strong exchange rate the central bank must buy up excess currency with US$ If BOP deficit is chronic, it will eventually run out of US$ Central bank must then Sell gold or other assets to buy US$ Use tariffs or quotas to make it harder for citizens to buy foreign goods Impose capital controls to prevent citizens from buying assets abroad Engineer a recession so citizens import less Devalue the currency 5

6 Artificially Weak Exchange Rates Falling Renminbi in 2014 As China s central bank has reduced the midpoint of the trading range, the changes have prompted an exaggerated move in the currency markets. The daily trading band doubled as of March 17, 2014, to plus or minus 2 percent. 6.0 renminbi per dollar Daily spot close Trading band midpoint Trading band Artificially Weak Exchange Rates $1 = 6.25 Chinese Yuan (renminbi) Makes Chinese exports cheaper in the U.S. Makes imported goods more expensive in China Chinese central bank is spending $2 billion every trading day buying FX with renminbi China has $3.95 trillion in FX reserves 6

7 Mundell Fleming Model (1962) Assumptions 1. Small country vs the rest of the world What we do has no impact on rest of the world 2. Perfect capital flows No restrictions to the flow of capital 3. Interest rates are equalized Capital flows to country with highest interest rates Summary Fixed Exchange Rates Flexible Exchange Rates Monetary Policy Ineffective Effective Fiscal Policy Effective Ineffective Monetary Policy Fixed Exchange Rates No effective monetary policy Central bank must adjust money supply to maintain the fixed exchange rates Fiscal Policy Fiscal policy is effective Increase in G or cut in T leads to higher GDP through the multiplier 7

8 Flexible Exchange Rates Fiscal Policy Less effective Expansionary fiscal policy tends to raise interest rates and domestic prices Higher interest rates increase the value of the $ Stronger currency weakens NX Monetary Policy More effective Expansionary monetary policy lowers interest rates Lower interest rates decrease the value of the $ Weaker currency leads to higher NX How does Fiscal Policy work?, but When G increases, Y increases, money demand increases, and interest rates rise Higher interest rates lead to $ appreciation Stronger $ makes US goods more expensive abroad NX go down Spending multiplier is smaller if Marginal propensity to save is higher Marginal tax rate is higher Marginal propensity to import is higher 8

9 Spending Multiplier with NX Y = C + I + G + NX Y = C + I + G + (EX IM) C = (Y T) I = 20 G = 40 T = 40 EX = 20 IM = 0.25Y 200 How does Monetary Policy work? Federal Reserve buys bonds through open market operations Money supply increases Interest rates fall Increase in gross investment Stock and bond prices rise, wealth increases, consumption increases $ depreciates causing NX to rise AD shifts out as C, I and NX increase GDP and price level increase 9

10 TABLE 21.1 Indicators of Economic Development Gross National Income per Capita, 2011 (dollars) Literacy Rate, 2010 (percent over 15 years of age) Infant Mortality, 2011 (deaths before age 5 per 1,000 births) Internet Users per 1,000 People, 2011 Population, 2011 Country Group (billions) Low-income Lower middleincome 2.5 1, Upper middleincome 2.5 6, High-income , While the developed nations account for only about one-quarter of the world s population, they are estimated to consume three-quarters of the world s output. This leaves the developing countries with about three-fourths of the world s people but only one-fourth of the world s income. Economic Development Harrod Domar Model (1939) min, 1 1 Growth rate of GDP depends on the savings rate s and the level of technology 10

11 Economic Development Improve growth rates by Increase savings rate s (and thus investment) Improve level of technology (decrease Vicious cycle of poverty Low savings low investment low capital stock slow growth low savings low investment Break Vicious Cycle Borrow from commercial banks Borrow from microfinance institutions Foreign aid (loans, grants) IMF: short run balance of payments crises World Bank: long run structural change development projects Foreign direct investment (multinationals) Technology transfer 11

12 Barriers to Development Insufficient Capital formation Vicious cycle of poverty Capital flight Political stability Human Resources Health (Malaria, diarrhea, HIV ) Literacy Rates Brain Drain Entrepreneurship Social Overhead Capital Potable water, roads, power, irrigation, clean air, rail transport Property rights, accounting system Tax evasion, corruption Strategies for Development Balanced Growth vs Imbalanced Growth Sectors are interdependent ( Big Push ) Dynamic economies move from one shortage to another Agriculture vs Industry Primary goods vs manufactured goods Price volatility, export concentration, falling terms of trade Import substitution vs Export expansion Domestic firms are often not competitive Singapore, Hong Kong, South Korea, Japan have been more successful Government vs Markets Industrial policy vs market mechanism 12

13 Dynamic Comparative Advantage Years Phase In Mature Phase Phase Out 1940 s Labor Intensive Industries 1970 s Capital Intensive Industries 2000 s Knowledge Intensive Industries Labor Intensive Industries Capital Intensive Industries 2030 s Knowledge Intensive Industries Labor Intensive Industries Capital Intensive Industries Labor intensive industries Capital intensive industries Knowledge intensive industries Textiles, toys Steel, ships, autos, petroleum, agricultural products Engineering, programming, intellectual property services, pharmaceuticals, airplanes, advanced electronics, medical equipment Micro Development Policies Microfinance Muhammad Yunus, Grameen Bank, Bangladesh Health Bed nets for malaria, chlorine to sanitize water In US most decisions are made for us Education Teacher and child absentee rates are high Need to deliver basic skills to a large number Population Poor control fertility decisions quite well Children are insurance policy, savings product, and lottery ticket 13

14 Transition Economics A transition economy is an economy which is changing from a centrally planned economy to a free market economy Market forces set prices rather than a central planning organization State owned businesses and resources are privatized Trade barriers are removed Former Soviet Union and Communist bloc countries of Europe, China, Vietnam, India Transition Economics Six Basic Requirements for Successful Transition 1. Macroeconomic stabilization. 2. Deregulation of prices and liberalization of trade. 3. Privatization of state-owned enterprises and development of new private industry. 4. Establishment of market-supporting institutions such as property and contract laws and accounting systems. 5. A social safety net to deal with unemployment and poverty. 6. External assistance. 14

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16 Transition Economics Why Do People Make Fun of Economists? 16

17 Why Do People Make Fun of Economists? We bring bad news there are opportunity costs no such thing as a free lunch We are geeks there are worse things we could be We make inaccurate forecasts forecasting is inherently difficult most economists do not do it Why Do People Make Fun of Economists? We never agree positive vs normative economics economics is still a young science We make lots of assumptions value of a theory can not be judged by the accuracy of its assumptions only valid response to a silly assumption is a better assumption 17

18 Why Do People Make Fun of Economists? We are too technical the world is really complicated, so we need math to simplify things since we can t do lots of experiments, we rely much more on careful thinking than other fields Why Do People Make Fun of Economists? We study economics because we want to make this world a better place. we want to best satisfy the unlimited wants and desires of our society given the limited available resources Some evidence of our success Microeconomics Macroeconomics 18

19 Stage 1 Ozone Episodes James Tobin, Asset Accumulation and Economic Activity,

20 Recommended Summer Readings 20