Bretton Woods System Quiz
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Questions and Answers

What was a significant outcome of the Bretton Woods agreement regarding international trade?

  • It ensured fixed exchange rates while allowing for monetary policy autonomy. (correct)
  • It restricted movements of capital across borders.
  • It mandated the use of the gold standard for all member countries.
  • It eliminated all tariffs between member countries.

    • Which of the following was NOT a characteristic of the Bretton Woods system?

  • Fixed but adjustable exchange rates.
  • Use of the U.S. dollar as the primary reserve currency.
  • Complete freedom of capital mobility. (correct)
  • Implementation of capital controls.

    • What was a major influence of the Bretton Woods system on monetary policy?

  • It mandated that countries relinquish control of their currencies.
  • It forced countries to adopt a balanced budget approach.
  • It empowered governments to independently use fiscal policies to address crises. (correct)
  • It led to greater reliance on gold reserves.

    • What role did the U.S. dollar play in the Bretton Woods system?

    <p>The dollar became the single reserve currency against which other currencies were fixed. (D)</p> Signup and view all the answers

    How did capital controls function within the Bretton Woods system?

    <p>They were implemented to stabilize exchange rates and manage capital flows. (D)</p> Signup and view all the answers

    What was the primary reason for countries abandoning the gold standard during the early 1930s?

    <p>To counteract financial crises and preserve liquidity. (D)</p> Signup and view all the answers

    What primary issue did Keynesianism address as a response to the economic landscape of the 1920s and 30s?

    <p>The inadequacy of traditional economic policies to manage unemployment. (D)</p> Signup and view all the answers

    What was a significant characteristic of the Bretton Woods system?

    <p>It established fixed exchange rates with the US dollar as the benchmark. (B)</p> Signup and view all the answers

    What impact does capital mobility have in the context of the trilemma?

    <p>It limits a country’s ability to control its monetary policy if it maintains a fixed exchange rate. (A)</p> Signup and view all the answers

    How does speculation affect currency markets in a scenario of fixed exchange rates?

    <p>Speculators can cause a loss of reserves for countries by betting against the fixed rate. (C)</p> Signup and view all the answers

    What was a major economic consequence of maintaining a strict gold standard?

    <p>Deflationary pressures leading to economic crises during balance of payment deficits. (C)</p> Signup and view all the answers

    What is a defining feature of the dollar's role as a reserve currency?

    <p>It facilitates liquidity and stability in the international monetary system. (D)</p> Signup and view all the answers

    What factor contributed significantly to the speculation about the devaluation of the dollar during the Bretton Woods era?

    <p>Investor concerns regarding the sustainability of the US economy (D)</p> Signup and view all the answers

    Which event marked the official end of the gold-US dollar exchange?

    <p>The closure of the gold window by President Nixon (D)</p> Signup and view all the answers

    What was one consequence of the collapse of the Bretton Woods system regarding gold trading?

    <p>Gold became freely tradeable and prices increased (C)</p> Signup and view all the answers

    What challenge did the US face in maintaining the fixed exchange rate during Bretton Woods?

    <p>Increasing capital mobility coupled with domestic monetary policy demands (A)</p> Signup and view all the answers

    Why was the adjustment of the peg to gold difficult to achieve during the Bretton Woods era?

    <p>It depended on coordinated agreement among multiple states (A)</p> Signup and view all the answers

    What action did European central banks take in response to speculation about another devaluation of the dollar in 1973?

    <p>They coordinated the sale of European currencies (D)</p> Signup and view all the answers

    Which of the following describes the US's position during the Bretton Woods system regarding enforcing cooperation?

    <p>The US lacked the position and willingness to enforce cooperation (A)</p> Signup and view all the answers

    What was one political factor that made proposed solutions to the Bretton Woods system unpopular?

    <p>The need for trade-surpluses potentially leading to economic slowdown (A)</p> Signup and view all the answers

    What general concept is illustrated by investors buying large quantities of gold due to speculation about the dollar's future?

    <p>Self-fulfilling prophecy in currency markets (A)</p> Signup and view all the answers

    What was a significant outcome of the Federal Reserve selling large quantities of gold in March 1968?

    <p>It triggered a decline in investor confidence in the dollar (D)</p> Signup and view all the answers

    Flashcards

    Bretton Woods System

    Post-World War II monetary system aimed at stabilizing exchange rates and international trade.

    Fixed but adjustable exchange rates

    Exchange rates are fixed but can be adjusted if necessary to support a country's economy.

    Capital Controls

    Rules and regulations limiting the flow of money across borders.

    Classical Gold Standard (1900-1914)

    Monetary system where currencies were tied to a specific amount of gold.

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    Floating Rates (1971- )

    Exchange rates are determined by market forces, not fixed by governments.

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    Keynesianism

    Economic theory suggesting that governments should use monetary and fiscal policy to manage economies.

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    The Trilemma

    The challenge of achieving fixed exchange rates, independent monetary policy, and capital mobility simultaneously.

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    How does the Gold Standard work?

    Countries fix their currency's value to gold. When a country imports more than it exports, gold flows out, causing deflation. This lowers prices, encouraging exports and restoring balance.

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    What is the 'discipline' of the Gold Standard?

    Central banks must reduce the money supply (deflation) to lower prices when a country has a trade deficit. This can lead to economic hardship.

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    What are the downsides of a Gold Standard?

    It can lead to deflation, economic recession, and slower growth. This is because the world's gold supply is fixed, which can restrict the money supply as the economy expands.

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    Why did the Gold Standard end?

    The Gold Standard was abandoned after World War I. After World War II, the Bretton Woods system was created, offering a more flexible way to manage international finance.

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    What is the Trilemma?

    The idea that a country can't simultaneously have fixed exchange rates, independent monetary policy, and free capital movement.

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    Demand for Dollars Decreases

    When the demand for US dollars decreases, the value of the dollar falls compared to other currencies.

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    Gold-Dollar Exchange Rate

    The price of gold in terms of US dollars. Under Bretton Woods, the US dollar was pegged to gold, meaning the price was fixed.

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    Self-Fulfilling Prophecy

    A prediction that, by being made, actually causes itself to come true. In finance, this can happen when a belief in a currency's depreciation leads to actual selling, causing the predicted decline.

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    Bretton Woods System (BW)

    A post-WWII system designed to stabilize exchange rates and promote international trade by pegging currencies to gold, with the US dollar serving as the anchor.

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    Why did Bretton Woods Fail?

    The US faced a dilemma to either constrain its own economy, adjust the gold peg, or promote inflation globally - none of these options were palatable politically.

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    Gold Window Closing

    In 1971, President Nixon ended the convertibility of the US dollar to gold, effectively ending the Bretton Woods fixed exchange rate system.

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    Gold's Free Trade

    After Bretton Woods collapsed, gold trading was no longer restricted, leading to a surge in its price.

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    Hegemonic Stability Theory

    The idea that a strong and stable world power (hegemon) is necessary to maintain international order and economic stability.

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    Bretton Woods Takeaways

    The system proved difficult to maintain due to increasing capital mobility and demands for domestic monetary control, highlighting the difficulty of balancing fixed exchange rates, independent monetary policy, and free capital movement.

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    Study Notes

    Review Questions

    • What is NOT a way a Central Bank can react to balance of payments imbalances under fixed exchange rates?

      • Introduce tariffs on trade
      • Impose capital controls

    • Match the type of international transaction with the correct account in the Balance of Payments:

      • Trade in goods – Current Account
      • Foreign Direct Investment – Capital and Financial Account

    Review Questions (Trilemma)

    • One more time: the trilemma

      • [Diagram showing a triangle with vertices: Fixed exchange rates, Independent monetary policy, Financial integration (capital mobility)]

    • Why are capital controls difficult (today)?

    Game Plan

    • The Gold Standard
    • Bretton Woods and its Fall
    • Central Bank Independence
    • Will Crypto replace Central Bank-backed currencies?

    A bit of history

    • 1870-1914: Gold Standard (fixed) + Open Capital Flows
    • 1919–1939: Gold Standard reestablished briefly, but abandoned in the Great Depression
    • 1944-1971: Bretton Woods: US-backed fixed (but adjustable) + Low capital flows
    • 1971-Today: Floating XR + High capital flows in most developed countries, peg to dollar/Euro in many developing countries
    • The Puzzle: What Caused The Changes?

    Fixed Versus Floating Exchange Rate Regimes

    • [Graph showing the proportion of countries using different exchange rate regimes from 1870-2010]

    The Unholy Trinity/Trilemma

    • [Diagram of a triangle showing the relationships between Fixed exchange rates, Independent monetary policy and Financial integration (capital mobility)]
    • Classical Gold Standard (1900-1914)
    • Floating Rates (1971-)
    • Bretton Woods (1945-1971)

    Pure Gold Standard in Theory

    • Country A imports more from Country B
    • Gold moves from A to B (re-coined/minted)
    • Less money in A → lower prices
    • More money in B → higher prices
    • Country B imports more from Country A
    • Balance is restored
    • Remember, this is the same story as we saw on Monday: fixed XR, BOP restored as domestic prices adjust

    Reality with Paper Money

    • Gold didn't actually flow (transaction costs and gold in the Atlantic Ocean)
    • Central Banks fix the value of their currency to gold
      • E.g., 1 Pound sterling = 7.322g of gold
    • People could, in theory, exchange their paper money for gold
    • When imbalances arose, Central Banks intervened by adjusting the money supply and interest rates (remember adjustment under fixed exchange rate regimes...)
    • Gold Standard → strict discipline!

    What is "discipline"?

    • Central Bank has to cause deflation in times of deficit to lower prices
    • What do "lower prices in Country A" mean?
      • Supply of money down
      • If you expect prices to fall in the future, you don't buy anything today
      • More expensive to borrow
      • BAD economic crisis!
        • Jobs cut! People don't eat! Kids die!

    Side-Note: Beyond Imbalances, the Gold Standard is Inherently Deflationary

    • World's supply of gold is fixed
    • With economic growth, eventually more goods chase less money → prices fall, growth constrained
    • The gold standard was able to be established and persist pre-WWI partly because of new gold discoveries

    How did the Gold Standard End?

    • Breaks down with WWI
    • Countries re-establish it after the war
    • Exacerbated the Great Depression in the early 1930s (more on that in week 6)
    • Countries abandon it again in response to the crisis
    • Bank of England first because it was running out of gold
    • Chain reaction across the world, rush on gold, other countries abandon the gold standard

    Bretton Woods

    • Agreement on the Post WWII monetary system
    • A monetary system is a public good...
    • Coordinating on a common system allowed for: increased international trade and finance, a way to manage crises so they didn't spread
    • Attempted to solve a global problem: How to keep monetary policy autonomy and a fixed XR?

    What Was "Bretton Woods"?

    • Fixed but adjustable XR:
      • The US had a hard peg to gold ($35 an ounce)
      • Other countries were fixed to the US dollar but could adjust within a band to correct an imbalance
    • Capital Controls
    • Stabilization Funds
    • The IMF

    What Was "Bretton Woods"? (Continued)

    • Fixed but adjustable XR:
      • Not total control, but allowed governments to impose controls when faced with speculative threats
      • Current accounts (no controls)
      • Capital accounts (controls)
    • Stabilization Funds:
      • Provide a fund to help governments avoid controls or devaluation when faced with short-term imbalances
    • The IMF:
      • Created to monitor state behavior (XR rate changes) and manage stabilization fund
      • Loans were conditional on policy actions
      • Made sure governments didn't undermine the system by devaluing for an export advantage

    Why did the Bretton Woods system fail?

    • The institutions didn't work:
      • IMF lacked true authority over XR policy.
      • Governments didn't comply, they did what they wanted
      • Governments didn't like conditionality
      • The stabilization fund wasn't large enough to deal with the new imbalances caused by globalization
      • US Privileged
    • Country holding currency used as reserve (dollar) has an “exorbitant privilege”
    • Monetary policy could run BoP deficits
    • US monetary policy influenced economies of other countries

    US Privileged (Continued)

    • Suppose USA increased its money supply:
      • lower US interest rates, putting downward pressure on the value of the US dollar.
      • if other central banks maintain their fixed exchange rates, need to buy dollar-denominated (foreign) assets, increasing their money supplies

    Why did the Bretton Woods system fail? (Continued)

    • US unwilling/unable to maintain system:
      • Bretton Woods depended on the US to exchange $ for gold.
      • US was spending more money than was entering the country
      • Expansionary Macroeconomic Policy: More spending Vietnam War + social spending, without higher taxes
      • US dollars left the country (high imports + US investors invest more abroad)
      • Increased claims on US gold by foreigners who received dollars.
      • Eventually... dollars > actual gold.
      • If confidence in peg was in question, investors would rush to sell dollars (speculation), heightened by newly dynamic capital markets

    US Balance of Payments

    • [Graph showing US Balance of Payments from 1950-1974]

    Why Speculate?

    • [Diagram showing the speculative behavior between two countries]

    Why did the Bretton Woods system fail? (Continued)

    • To "fix" the problem:
      • The US would have to constrain US economy, run trade-surpluses, change foreign policy
      • Adjust the peg to gold (requires coordination, can't be done unilaterally)
      • Expand economic activity in the rest of the world (many states unwilling to experience inflation).
      • None of these options was politically popular

    The End of BW

    • First, speculation about devaluation of the dollar caused large purchase of gold by investors
      • Federal Reserve sold huge quantities of gold in March 1968
      • US President Nixon "closes the gold window" on August 15 1971 = no more gold-US dollar exchange
    • Second, speculation about devaluation of dollar caused investors to purchase large quantities of foreign currency assets
      • Coordinated devaluation of the dollar against foreign currencies of about 8% occurred in December 1971
      • Speculation about another devaluation occurred: European central banks sold huge quantities of European currencies in February 1973
      • Japan and Europe stopped selling their currencies and purchasing of dollars in March 1973, allowing the value of the dollar to fall
    • End of BW monetary system

    (Gold Finger Wins After All)

    • Before collapse of BW, imports and exports of gold had to be limited through capital controls for Fixed XR & Domestic Monetary Policies
    • As soon as BW system collapses, gold became freely tradeable, and prices shot up.
      • [Graph showing the rise in gold price after the collapse of Bretton Woods]

    Core Take Aways Bretton Woods

    • Fixed exchange rate hard to maintain with increasing capital mobility + democratic demands for domestic monetary policy
    • Gold standard had been backed by the British, BW had been backed by the US (remember hegemonic stability theory from trade lectures...)
    • While it would've been nice to have XR stability, The US was no longer in a position/willing to enforce cooperation
      • US acted in self-interested way
      • As did other countries

    POST BW

    • Post BW most major economies floated their currency
    • Europe tried to organize a regional monetary cooperation around German policy, eventually adopt a monetary union (the EURO)
      • More on this next week
    • Other countries floated or pegged to the $US/European currencies
    • Dollar remains world's reserve currency
    • Despite floating XR, global imbalances still pose a threat to the global economy...
    • Uncoordinated macroeconomic policy still has the potential for large problems...

    Summary: Increasing Democracy & Capital Mobility

    • [Graph showing the relationship between the degree of global capital mobility and fixed/floating exchange rates, and the increasing levels of democracy & labor unions]

    10 Minute Break

    Central Banks

    Central Banks: The Problem

    • We just argued that democracy → demand for monetary policy autonomy.
    • With the fall of BW and floating exchange rates, Central banks were free to use monetary policy domestically
    • Yet, monetary manipulation can lead to runaway inflation, this drags on growth and investment in the long run despite short-run benefits

    Upward spiral of inflation

    • Keynes had assumed a stable relationship between unemployment and inflation
    • "Stagflation" in 1970s showed that that assumption could be wrong
      • [Diagram showing the long-run and short-run Phillips Curve]

    The Problem: Time Inconsistency

    • In the long-run, governments want price stability, but in the short-run, boosting employment is tempting
    • How can we avoid this problem?
      • Adopt a fixed exchange rate? Ties your hands to stop using expansionary monetary policy
      • This is the choice many developing countries make
      • Democracies don't do well with fixed XR and free capital flows
      • Domestic price instability...
      • Inability to deal with real crises

    The Solution

    • Governments might adopt an INDEPENDENT CENTRAL BANK
      • Appointed for long terms
      • Don't face electoral pressures
      • Or are distanced from them

    Central banks as commitment mechanisms

    • Political independence provides the mechanism to maintain monetary policy autonomy but not tempt politicians (too much) to abuse it.
    • Central banks differ in their independence
      • Freedom to choose economic objectives to pursue
        • Inflation and/or employment
      • Freedom to set monetary policy to pursue that objective
      • Whether the policy can be reversed by politicians in government

    CBI World Average

    • [Graph showing CBI World Average by different datasets/studies]

    European Central Bank

    • Mandate for price stability primarily
    • Each country appoints a governing member
    • An executive council sets decisions
    • Appointed to non-renewable 8-year terms
    • Appointed by "common accord" of member governments
    • Can't be removed by politicians
      • [photograph of ECB President Lagarde]

    The US Federal Reserve

    • President appoints a Fed Chair every four years (in non-presidential election years)
    • Confirmed by the Senate
    • Can't be removed
    • Must "report" to Congress bi-yearly
    • Now has a dual mandate to pursue low unemployment and stable prices and interest rates
    • This set-up allows it to act in times of crisis but avoid political time inconsistency problems
    • [Political context involving headlines on Trump and Fed Chairman Powell]

    Other Examples

    • Swiss National Bank
      • No provision whatsoever for the government to influence monetary policy
      • Highly independent
    • Reserve Bank of Australia
      • Highly subordinate
      • Secretary of Treasury has final authority on monetary policy decisions and interest rate changes
    • Reserve Bank of India
      • Government appoints governor and board of directors to 4-year terms
      • Not constitutionally independent, government can overrule
      • Faces political pressure

    Other Examples (Continued)

    • Central Bank of the Republic of Turkey:
      • Highly subordinate
      • Erdogan – “enemy of interest rates” – has fired three central bank chiefs -[Graph showing the trend of the Turkish Lira]

    Central banks as commitment mechanisms (Continued)

    • Does Central Bank Independence Work?
    • Provides greater certainty over monetary policy
    • This Should lead to decreased inflation and greater growth?
    • Does it?

    Inflation & CBI in Developing Countries 1980-2013

    • [Graph showing the relationship between Inflation & CBI for developing countries]

    Central Bank Independence and Economic Growth, 1969-1995

    • [Graph showing the relationship between Central Bank Independence & Economic Growth]

    Crypto = Future of Currencies?

    • [Diagram of meme showing crypto coins]

    What is Cryptocurrency?

    • Decentralized currencies based on the 'blockchain'
    • (Typically) not backed by Central Banks
    • Some (e.g. Bitcoin) supposed to be finite in number – meant to combat inflation

    Crypto = The future of money?

    • Medium of exchange:
      • Transactions are VERY computationally expensive – Not clear that blockchains can handle enough transactions & huge energy demands
    • Store of Value and Unit of Exchange = shouldn't be too volatile
      • [Graph showing Bitcoin price volatility]

    Crypto = The future of money? (Continued)

    • Fixed supply of money is not a good thing:
      • Fixed money supply = lower growth and/or deflation
      • See: Gold standard
    • People's willingness to use a currency to save and invest depends on TRUST

    Conclusion: To the Moon?

    • Crypto is one speculative asset you can bet on to make (or lose) money
    • Under Trump, crypto will likely be deregulated and become a more common asset in mainstream banks' portfolios
      • HOWEVER
        • Not ideal as your MAIN investment for retirement
        • Cannot fulfill the function of a government-backed currency

    Example Short Answers Qs

    • Question 2 (out of a choice of 3 questions, 300-500 words)
      • The Doha Round at the WTO has been stalled for the past two decades
      • a) Outline the main objectives of the Doha Round
      • b) Name and explain two reasons why the negotiations have stalled
      • c) Countries have turned to RTAs since the failure of the Doha Round. Give one reason why you think that RTAs are better or worse for developing countries than an agreement at the WTO level -[Answer to the questions]

    Next up: Societal Interests in Monetary Policy & EMU

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    Description

    Test your knowledge on the Bretton Woods agreement and its impact on international trade and monetary policy. This quiz covers the characteristics, roles, and consequences of the Bretton Woods system, including the U.S. dollar's function as a reserve currency and the implications of capital controls.

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