International Economics and Bretton Woods

The International Labour Organization (ILO) was founded after World War I by the victorious Allies.

The ILO is composed of representatives from governments, employers, and workers.

The ILO promotes decent work conditions and aims to improve working conditions worldwide.

The return of the British pound to the gold standard at pre-war parity led to deflationary consequences.

The 1929 Wall Street Crash had global repercussions, contributing to the Great Depression.

The US' tendency to work outside the League of Nations led to collaborative efforts between central banks, especially the Bank for International Settlements (BIS).

The Bretton Woods Agreement aimed to establish a postwar international economic system by creating institutions like the IMF and World Bank, and a fixed exchange rate system.

The Bretton Woods Agreement encouraged open economic systems, promoting international trade and financial flows for reconstruction.

An international reserve asset created by the IMF to provide non-USD-dominated liquidity to member countries.

The SDR is not a currency but a basket of five major currencies: US Dollar, Euro, Chinese Yuan, Japanese Yen, and British Pound.

Countries with larger IMF quotas receive more SDRs.

SDRs help countries increase their foreign exchange reserves, making it easier to meet external financial needs.

SDRs provide liquidity, especially during economic crises, by offering an alternative source of funding.

SDRs are not affected by exchange rate fluctuations, providing stability for countries managing their reserves.

The IMF periodically distributes SDRs to member countries to address global liquidity needs and support economic recovery.

The most recent SDR allocation was designed to help countries cope with the economic impact of the COVID-19 pandemic.

In a fixed exchange rate regime, domestic interest rates (i) might differ from international interest rates (i*) in the short run to finance balance of payments (BP) deficits.

In the long run, a country's output (Y) and inflation rate (pi) might need to adjust to international levels (Y* and pi*) for a stable balance of payments in a fixed exchange rate system.

Domestic monetary and fiscal policies are essential for managing the external balance in a fixed exchange rate system.

An increase in domestic output (Y) and interest rates (i) leads to higher imports, decreasing the current account (CA) balance.

Higher interest rates attract foreign capital, boosting the financial account (F), potentially offsetting a CA deficit.

Short-term policy adjustments can lead to a CA deficit and increased external debt.

Long-term external adjustment requires measures to address unsustainable external debt, often through expenditure-switching or -reducing policies.

Expenditure-switching policies, like exchange rate depreciation or protectionism, aim to replace imports with domestic production.

Countries choosing to fix their currency's value to a foreign currency, essentially adopting the monetary policy of that other country. This can be seen as 'importing' the external monetary policy.

Speculative attacks can destabilize a fixed exchange rate system, leading to an unexpected and rapid depreciation of the currency, which then becomes self-fulfilling. The credibility of the central bank and a country's economic vulnerabilities are important factors in determining the susceptibility to such attacks.

The use of monetary policy to achieve domestic objectives may be compromised when a country maintains a fixed exchange rate system. The central bank's ability to control interest rates and money supply may be limited to ensure the fixed exchange rate.

Significant fluctuations in exchange rates causing uncertainty and disruption in the real economy, leading to decisions based on short-term fluctuations rather than intrinsic long-term values. This uncertainty can be costly, requiring businesses and individuals to hedge against risk.

Intermediate exchange rate regimes, like crawling pegs, offer a middle ground between fully fixed and completely flexible exchange rates. They allow some degree of control over domestic monetary policy while providing a degree of exchange rate stability. Examples include soft pegs, currency boards, and dollarization/euroization.

The value of an exchange rate that would allow you to buy the same amount of goods in different countries, as if comparing the price of a Big Mac worldwide.

The fundamental value of an exchange rate is determined by the PPP. Exchange rate fluctuations often reflect differences in inflation rates between countries.

The amount of return you get from holding a currency, considering both interest rates and potential appreciation or depreciation of the currency.

In the short-run, exchange rates are volatile due to changing expectations about the future, which immediately impact the equilibrium exchange rate.

In the long run, the money supply, price levels, and nominal exchange rates tend to move proportionally. For example, a 50% increase in the money supply leads to a 50% increase in prices and a 50% increase in the price of foreign currency.

For short-run equilibrium, the overall returns of two currencies must be equal. This means the interest rate on one currency is equal to the interest rate on the other currency plus the expected appreciation of the first currency against the second.

The idea that exchange rates have a forward-looking nature, meaning they are influenced by expectations about future economic conditions and events.

Exchange rates can fluctuate in the medium run, experiencing periods of overvaluation and undervaluation of currencies. These fluctuations are often driven by factors beyond simple PPP.

Countries like Greece, Portugal, and Italy borrowed heavily to finance their spending programs, leading to unsustainable levels of debt.

The idea that a strong monetary union requires a parallel fiscal union to control excessive borrowing and spending by member countries.

The Maastricht Treaty required EU member states to meet specific economic criteria before joining the Eurozone, including low inflation, stable exchange rates, and controlled government debt.

EU countries were required to keep their budget deficit below 3% of GDP and their public debt below or approaching 60% of GDP.

The 1992 European exchange rate crisis, triggered by speculative attacks on weak currencies, exposed the vulnerabilities of fixed exchange rate systems and highlighted the need for more flexible economic policies.

The UK's decision to withdraw from the European Exchange Rate Mechanism (ERM) in 1992 due to market pressures and a speculative attack on the British pound.

The sudden selling of untrustworthy assets by previously inactive speculators, often leading to market instability and currency fluctuations.

The principle that a country cannot simultaneously maintain a fixed exchange rate, free capital movement, and an independent monetary policy without facing economic instability.