Outline for 10/31: International Money II The Impossible Trinity The Bretton Woods Institutions Collapse of the Bretton Woods System Monetary Diversity.

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Outline for 10/31: International Money II The Impossible Trinity The Bretton Woods Institutions Collapse of the Bretton Woods System Monetary Diversity in the Post-Bretton Woods Era The International Monetary Fund

The Impossible Trinity 3 Desirable Monetary Conditions 1. International Capital Mobility (ICM) 2. Fixed Exchange Rates (FER) 3. Domestic Monetary Policy Autonomy (MPA) But countries can have only 2 of these 3 conditions at any one time. ∆e = i – i* e is the exchange rate i is the domestic interest rate i* is the external interest rate ICM FER MPA

The Bretton Woods System Background: Economic Problems in the 1930s Great Depression: 25% unemployment in the United States, 44% in Germany Collapse of international trade: Smoot-Hawley tariffs Rise of fascism in Europe WWII Bretton Woods Conference in July 1944 Led by the United States, attended by delegates from 44 countries Goal was to create a set of institutions to avoid a repeat of the 1930s What institutions were created?

The Bretton Woods Institutions 1. GATT 2. Fixed exchange rate system US dollar fixed to gold Other national currencies fixed to the US dollar 3.International Monetary Fund (IMF) – short-term loans to increase foreign exchange reserves 4. Capital Controls (restrictions on flows of speculative capital, but not on capital flows related to trade) 5.International Bank for Reconstruction and Development (IBRD or World Bank) – longer-term loans for development projects

Where does the Bretton Woods System fit on this triangle? International Capital Mobility Fixed Exchange Rates Domestic Monetary Policy Autonomy Was this system sustainable?

Collapse of the Bretton Woods System Nixon ended US dollar convertibility to gold in 1971 Other countries stopped fixing to the US dollar thereafter Why? 1. Capital controls ineffective 2.Dollar overhangUS$ S gold time Certain Bretton Woods institutions still remain – GATT(WTO), IMF, World Bank

The Post-Bretton Woods Era International Capital Mobility Western EuropeUnited States Snake EMS EMU Fixed Exchange Rates Domestic Monetary Bretton Woods Policy Autonomy

Why did (much of)Western Europe choose Fixed Exchange Rates, While the United States chose Domestic Monetary Autonomy? Internationally-oriented producers vs. Domestically-oriented producers Which group benefits most from fixed exchange rates? Which group benefits most from domestic monetary autonomy? Western Europe and United States Which country (set of countries) has a bigger share of internationally-oriented producers? Which country (set of countries) has a bigger share of domestically-oriented producers?

The International Monetary Fund Each member-countries pays a quota based on GDP Quotas stored in special IMF currency – Special Drawing Rights (SDRs) Member-countries borrow from combined quotas During Bretton Woods, countries could borrow to increase their foreign exchange reserves In the post-Bretton Woods era – countries can borrow for other reasons IMF loans require approval from Board of Executive Directors (weighted voting) IMF loans come in slices (tranches) with associated conditions Why conditions? Why slices?