International Economics Quiz

Podcast

Play an AI-generated podcast conversation about this lesson

Questions and Answers

Which account in the Balance of Payments includes trade in goods?

Monetary Policy Account

Current Account (correct)

Capital and Financial Account

Financial Integration Account

What was a characteristic of the Bretton Woods system?

Purely floating exchange rates

US-backed fixed but adjustable exchange rates (correct)

Absence of capital flows

Total abandonment of the Gold Standard

What challenge does financial integration pose regarding the trilemma?

It limits trade diversification

It encourages the use of gold reserves

It necessitates independent fiscal policy

It complicates maintaining fixed exchange rates (correct)

Which period saw the Gold Standard operating with open capital flows?

1870-1914 Signup and view all the answers

Why are capital controls seen as difficult to implement today?

Rapidly advancing technology Signup and view all the answers

What is the consequence of a central bank increasing the money supply?

Boost in production and employment Signup and view all the answers

What does the Phillips Curve illustrate?

The trade-off between inflation and unemployment Signup and view all the answers

How does uncertainty in foreign exchange rates affect investment?

It prevents firms from exploiting comparative advantage Signup and view all the answers

What occurs when a central bank raises interest rates?

Unemployment rises and production decreases Signup and view all the answers

Why is an international medium of exchange important?

It simplifies the determination of goods' value across nations Signup and view all the answers

What happens to the value of a Dutch firm's contract if the exchange rate changes unfavorably?

The cost of fulfilling the contract increases in Guilders Signup and view all the answers

What is a potential downside of purchases from domestic firms compared to international transactions?

Loss of gains from trade opportunities Signup and view all the answers

When a central bank decreases the money supply, what is the expected impact?

Suppressed inflation rates Signup and view all the answers

What happens to exports and imports when a currency appreciates?

Exports decrease, imports increase Signup and view all the answers

How does a country experiencing a current account deficit typically respond in currency markets?

Depreciation of its currency Signup and view all the answers

When a deficit country experiences a depreciation in its currency, what occurs with exports and imports?

Exports increase, imports decrease Signup and view all the answers

In a surplus country, what is the effect of an appreciation of its currency on exports?

Exports decrease due to higher prices Signup and view all the answers

What drives the adjustment in a floating exchange rate system?

Exchange rate movements Signup and view all the answers

What is the likely impact of excess demand for a country's currency on its exchange rate?

The exchange rate appreciates Signup and view all the answers

What happens to the relative cost of imports for domestic consumers when a currency depreciates?

Costs of imports increase Signup and view all the answers

What is one effect of excessive demand for British goods on the exchange rate of GBP against the Euro?

Appreciation of GBP Signup and view all the answers

What was a significant consequence of the speculation about the devaluation of the dollar?

Investors purchased large quantities of gold. Signup and view all the answers

Which action did the Federal Reserve take in March 1968 in response to gold purchases?

Sold huge quantities of gold. Signup and view all the answers

What was one of the proposed solutions to 'fix' the problems of the Bretton Woods system?

Constrain the US economy and run trade surpluses. Signup and view all the answers

What led to the closure of the gold window by US President Nixon?

Speculation about the dollar's devaluation and large purchases of gold. Signup and view all the answers

What was one of the major reasons for the failure of the Bretton Woods system regarding currency management?

Maintaining a fixed exchange rate amid increasing capital mobility. Signup and view all the answers

What did the coordinated devaluation of the dollar in December 1971 result in?

A decrease in the dollar's value against foreign currencies. Signup and view all the answers

How did the collapse of the Bretton Woods system affect the trading of gold?

Gold became freely tradeable and prices increased significantly. Signup and view all the answers

What was required to adjust the peg to gold for solving Bretton Woods problems?

Coordination with other nations. Signup and view all the answers

What is likely to happen if a central bank lowers interest rates while maintaining a fixed exchange rate?

The currency may become less valuable internationally. Signup and view all the answers

Which of the following actions could a central bank take to determine demand for its currency while maintaining a fixed exchange rate?

Decrease the money supply to match less demand. Signup and view all the answers

According to the Unholy Trinity, which of the following cannot be maintained simultaneously?

Fixed exchange rates, independent monetary policy, and capital mobility. Signup and view all the answers

What is a primary consequence of maintaining fixed exchange rates in a globalized economy?

It imposes significant limitations on the money supply. Signup and view all the answers

What happens to the international value of a currency if the money supply is increased without adjusting interest rates?

The currency may depreciate in value internationally. Signup and view all the answers

What happens to imports and exports in deficit countries under a floating exchange rate system?

Imports go down and exports go up. Signup and view all the answers

What is a key benefit of floating exchange rate systems for governments?

They can pursue domestic policy goals independently. Signup and view all the answers

In the context of fixed exchange rates, what is one method the government uses to maintain the fixed rate?

Using monetary policy to buy/sell other currencies. Signup and view all the answers

What occurs when a country experiences an appreciation of its currency in terms of trade?

Imports become cheaper and exports become more expensive. Signup and view all the answers

How can central banks influence exchange rates regarding money supply?

By printing more of their currency to increase its supply. Signup and view all the answers

What is one way surplus countries adjust under a floating exchange rate system?

Increase their exports while decreasing imports. Signup and view all the answers

What happens to domestic prices when a country increases interest rates under a fixed exchange rate?

Domestic prices in deficit countries tend to rise. Signup and view all the answers

What is a likely consequence of excessive appreciation of a currency?

Trade imbalances due to altered import/export dynamics. Signup and view all the answers

Study Notes

Foundations of Monetary and Exchange Rate Policy

The course covers the foundations of monetary and exchange rate policy.
Block II of the 2024 course is taught by Dr. Toenshoff.

Review Questions (Latin America vs East Asia)

Latin America pursued import substitution industrialization (ISI) while East Asia pursued export-oriented industrialization (EOI).
Latin America had stronger political interests in the manufacturing sector.
East Asia had access to larger export markets.
East Asia had a readily available unskilled workforce.
Latin America had larger local markets.

Review Questions (Comprehensive Sanctions)

Comprehensive sanctions are not inherently less humane than targeted sanctions.
They can be less good than targeted sanctions, due to issues with efficiency, effectiveness, and working through corruption.
They are not necessarily better in democracies.
Sanctions have been used since before 9/11.

The Plan

The plan outlines topics for the course:
- What is Money (and an exchange rate regime) Good For?
- Domestic Monetary Policy
- International Monetary Exchange
- Balance of Payments Adjustment
- The Unholy Trinity

The Function of Money

Money serves three key functions:
- Medium of exchange: Resolves the "double coincidence of wants problem".
- Store of value: Allows individuals to convert perishable goods into more durable goods.
- Unit of account: Provides a standard relationship between various goods in the economy.
Having a currency is a public good. It benefits everyone and is nonrival and nonexcludable, but its creation/maintenance suffers from the collective action problem.
Money responds to the same forces of supply and demand as other goods: Supply up value down, Supply down value up, Demand up value up, Demand down value down.
Domestically, price of money = interest rates
Internationally, price of money = exchange rates

A Note on Terminology

Appreciate = Gain value = Purchase more foreign currency for one unit of domestic currency.
Depreciate = Lose value = Purchase less foreign currency for one unit of domestic currency.

Domestic Monetary Policy

Definition: Adjustment of the money supply to change domestic price levels (inflation) and economic output.
Who is in charge of Monetary Policy in Europe? The European Central Bank (ECB).

How do Central Banks do it?

Interest rates = the price of domestic money.
Money supply → Interest rate → Consumption → Dom. Investment → Production, employment → Price (input costs, wages) → Inflation

Let's see if we got that

As a central bank, increase money supply and decrease interest rates to boost production and employment.
As a central bank, decrease money supply and increase interest rates to fight high inflation.
Employment and domestic production decrease when the central bank raises interest rates to fight inflation.

The Phillips Curve

The Phillips Curve shows a trade-off between inflation and unemployment.

International Monetary Exchange

A common medium of exchange is beneficial for interactions between countries and economies.
Easy determination of the value of goods in different countries makes trade and investment easier.

Think about Europe w/o the Euro

With different and floating currencies, a Dutch firm might experience an exchange rate change impacting their profitability.

International Monetary Exchange (Continued)

For most of modern history, gold and silver-backed paper currencies served as the common medium of exchange between economies.
Each country's currency had a fixed amount of gold or silver (specie). This made it easier to determine relative values.
Today, most states have a floating currency system. The value of the currency is determined by market forces. USD serves as the primary unit of account and store of value.

International Monetary Exchange (Exchange Rate Regimes)

Exchange rate regime: Set of rules governing how much national currencies can appreciate and depreciate in the foreign exchange market.

Exchange Rate Regimes

Fixed: Governments buy/sell currencies to maintain a fixed price.
Floating: Governments do not intervene in the exchange rate.
Fixed-but-Adjustable: Governments intervene under specific circumstances.
Managed Float: Governments intervene, but there are no clear rules.

Balance of Payments

Definition: The difference between the money entering and leaving a country.
Current Account: Imports, exports, services, interests, fees, profit, remittances, and foreign aid.
Capital & Financial Accounts: Direct investment, portfolio investment, loans, and other investments. (financial flows). The current and capital/financial accounts are a mirror image of each other.

Balance of Payments (Floating XR)

Floating XR regimes: BoP adjustment through exchange rate movements.
Fixed XR regimes: BoP adjustment through changes in domestic prices.

Current Account ➡ Exchange Rate

Exports increase demand for home currency; thus, more demand.
Imports increase supply of home currency; thus, more supply.

Exchange Rate ➡ Current Account

Currency appreciation leads to less export demand; more imports.
Currency depreciation leads to more export demand; less imports.

Balance of Payments, Floating XR

Deficits see depreciation in currency (global markets)
Surplus countries see appreciation in currency (excess demand for the currency)

BoP Adjustment, Floating XR

Adjustments occur through exchange rate movements in a floating system.

Balance of Payments, Floating XR (Continued)

Balance is restored as exchange rates adjust for deficits and surpluses.
Domestic prices of goods & services remain rather stable.
Governments are free to use monetary policy to target employment or control inflation.

Balance of Payments, Fixed XR

Adjustment occurs through price changes, rather than exchange rate movements.
Deficit countries have reduced money supply/increased interest rates
Surplus countries have increased money supply/reduced interest rates
Government can manipulate their currency’s exchange rate through buying/selling it on the exchange market, adjusting interest rates, or imposing capital controls.

Changes in Money Supply ➡ Exchange Rates

Central banks, e.g. ECB, can manipulate money supply to influence exchange rates.
If increasing money supply, print more Euros, exchange them for US dollars.
If decreasing money supply, sell Euros for US dollars; fewer euros.

1) Adjustment in reserves

XR between Pound and Euro was fixed; excessive demand for GBP → upward pressure on GBP → Bank of England buys Euros, using GBP → Supply increase → prices of British goods increase → British exports decrease, British imports increase → Pressure on XR relieved.

Changes in Interest Rates ➡ Exchange Rates

Domestic investors borrow money, using home currency for capital investments.
International investors take money from home, exchange for foreign currency, to invest in foreign market.
Higher interest rates cause increased demand for domestic currency; thus, pressure to increase XR, and vice versa.

2) Changes in Interest Rates

Excessive demand for British pounds in EZ; upward pressure on GBP → Bank of England lowers interest rates → More domestic consumption and investment → Less demand for foreign investors → Pressure on XR relieved

3) Capital Controls

Excessive demand in EZ for GBP → Bank limits EZ purchase of Sterling → Market exchange rate remains fixed → upward pressure on GBP vis-à-vis Euro is restricted

Balance of Payments, Fixed XR & No Capital Controls

Adjustment happens through changes in price, rather than exchange rates.
Deficit countries see a decline in money supply, increased interest rate, and decreasing domestic good prices
Surplus countries see an increase in money supply and reduced interest rates; thus, increasing domestic good prices.

The Unholy Trinity/Trilemma

States face a dilemma when choosing exchange rates relating to policy control.
There are three possible outcomes of the trilemma: fixed exchange rate, monetary policy autonomy, and free capital flow.
Under no conditions can these three outcomes be obtained simultaneously.

The Unholy Trinity/Trilemma (continued)

If free capital + MP autonomy + fixed XR, any effort to adjust interest rates/money supply to stimulate activity will change international demand and supply of the currency.

Monetary Policy to Boost Domestic Economy

Central bank lowers interest rates/increases money supply to boost employment and output domestically.
Higher money supply makes the currency less valuable internationally.
Lower rates make investment less valuable.
Interest rate, money supply adjustment to maintain fixed exchange rates; but doing so makes investment elsewhere more attractive
This negates policy objectives

The Unholy Trinity/Trilemma (Illustrative diagram)

Shows the relationship, tradeoff, between Fixed exchange rates, Independent monetary policy, and Financial integration (capital mobility)

Core Take Aways Bretton Woods

Fixed exchange rates are hard to maintain with capital mobility and democratic pressure.
The US, backed the Bretton Woods, but had an inability to ensure long-term cooperation.

POST BW

Most major economies floated their currency following BW; Europe tried to organize regional monetary cooperation around German policy.
Most countries pegged to US/European currencies; despite floating XR, global imbalances.

Summary: Increasing Democracy & Capital Mobility

There is a graph showing the relationship between fixed/floating exchange rates and capital mobility. Data related to the time periods: Post WW I and post WW II respectively.

Central Banks

Democracy demands monetary policy autonomy.
Monetary policy manipulation can lead to runaway inflation—this drags on long-run growth/investment

Central Banks: The Problem

Democracy leads to the demand for monetary policy autonomy.
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 assumed a stable relationship between unemployment and inflation.
Stagflation in the 1970s showed this assumption was incorrect.

Upward spiral of inflation (Illustrative diagram)

A graph demonstrating long-run Phillip’s Curve and the short-run Phillip’s Curve

The Problem: Time Inconsistency

Governments want price stability long term, and employment in the short term.
Adopting a fixed exchange rate ties your hands from using expansionary monetary policy; to avoid this problem, use an independent central bank

The Solution

Governments might adopt an independent central bank.

Central banks as commitment mechanisms

Political independence to maintain monetary policy without undue political pressure
Central Banks differ in their independence
Freedom to choose economic objectives (inflation & employment).
Freedom to set monetary policy.
Reversibility of the policy decisions.

Other Examples:

Swiss National Bank: Highly independent
Reserve Bank of Australia: Highly subordinate.
Reserve Bank of India: Not constitutionally independent
Central Bank of Republic of Turkey: Highly subordinate

Central banks as commitment mechanisms (Does Central Bank Independence Work?)

Central bank independence provides certainty over monetary policy.
Is this associated with decreased inflation and growth?

Inflation & CBI in Developing Countries 1980-2013 (Illustrative graph)

Data on inflation and CBI average across a sample of developing countries

Crypto = Future of Currencies?

Fixed money supply is not a good thing as it results in either reduced growth (e.g., deflation) or reduced price stability.
People’s willingness to use crypto depends on trust.

Conclusion: To the Moon?

Crypto is a speculative asset subject to regulation.
Crypto is not an ideal investment for retirement.

Example Short Answers Qs

Outline the objectives of the Doha Round (focus on economic development relating to intellectual property and environmental protections).
Reasons for the stalling of Doha negotiations: unwillingness of developed/industrialized countries to liberalize agriculture and difficulties with procedural hurdles.
Countries turned to RTAs due to Doha negotiations’ failure; RTAs might be better for developing countries as it’s an agreement amongst a smaller number of participants rather than the whole world. They are less complex than WTO agreements.

Next up: Societal Interests in Monetary Policy & EMU

Topics for the subject.

Studying That Suits You

Use AI to generate personalized quizzes and flashcards to suit your learning preferences.

Description

Test your knowledge on key concepts in international economics, including the Balance of Payments, the Bretton Woods system, and the implications of monetary policy. This quiz covers essential theories and real-world applications, including exchange rates and capital controls. Perfect for students studying economics or related fields.