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Unless the global financial system is radically reformed – and the necessary reforms are looking increasingly unlikely to occur – it will continue to be conducive to financial crises. Government rhetoric and actions can often influence in desirable ways both the speculative actions that now determine the exchange rate and the effect of exchange rate movements on the domestic economy. Managing the exchange rate should start with Australian support for measures such as the Tobin tax that dampen speculation. In 2008 and 2009, exchange rate changes were helpful in reducing the impact of the global financial crisis on Australia, largely because of a very clear commitment by the Australian government to make preservation of jobs its top priority. In 2009, a rapid rise in the exchange rate was unhelpful. In the short run, little can be done about this, but in the longer run, it is possible to offset the adverse effects.
The use of exchange rates based on Purchasing Power Parities to compare incomes across countries and over time has now become standard practice. But there are reasons to believe that this could lead to excessively inflated incomes for poorer countries and in some cases also inflate the extent of real changes over time. Estimates of gross domestic product growth in the Chinese and Indian economies in recent years provide examples of this.
Research on Africa’s monetary history has tended to focus on the imposition of colonial currencies while neglecting the monetary upheavals which faced the colonial powers after the collapse of the gold standard during World War I. Gardner profiles three crises—in The Gambia, Kenya, and Liberia—resulting from shifting exchange rates between European currencies during the 1920s and 1930s. These three cases illustrate the degree to which colonial policies struggled to keep up with the economic turmoil affecting metropolitan states and bring Africa into the story of global monetary instability during the interwar period, which is often told only from a European perspective.
Shortly after the declaration of independence, the Liberian government established the Liberian dollar as its national currency. According to President Joseph J. Roberts, it was intended to both promote commerce and demonstrate the sovereignty of the Liberian state. The first coins were minted in England, with the financial backing of a British banker and abolitionist, as the Liberian state did not then have the means to fund their minting itself. These token coins were later supplemented with paper money printed in Monrovia. The Liberian dollar was an unbacked paper currency. It was initially valued at par with the US dollar but quickly depreciated as the Liberian government turned to the printing press during repeated fiscal crises in the decades after 1847. This chapter chronicles the Liberian government’s efforts to sustain the value of its currency, the adoption by the turn of the century of British sterling as the primary medium of exchange, followed by the replacement of British currency by the US dollar in 1943. The case of Liberia illustrates that formal monetary sovereignty may have little significance for governments lacking the resources and capacity to sustain the value of their currency, which may force them to adopt others to sustain their trade and public finances.
This chapter begins by noting the key ingredients in Akerlof and Shiller’s bestseller Animal Spirits but goes on to cover a far wider range of macroeconomics issues, including a detailed coverage of Minsky’s “financial instability hypothesis” that prefigures their work. After examining alternative theories of how speculative markets work and discussing herding behavior via both information and decision rule cascades, the chapter considers Keynesian view of animal spirits in relation to liquidity preference, leading to a discussion of Katana’s work on the impact of consumer confidence on discretionary spending. Next comes analysis of saving behavior in relation to innovative mortgage products and the impact of evolving bank lending rules on housing affordability. After considering Minsky’s work, material from earlier chapters is used to provide new perspectives on involuntary unemployment, inflation, exchange rate determination and the importance of non-price factors in the determination of international trade (with a discussion of the limited ways in which exchange rates shape trade). Finally, behavioral analysis of decision-making is applied to the making of macroeconomic policy.
Foundational theories of trade politics emphasize a conflict between consumer welfare and protectionist lobbies. But these theories ignore other powerful lobbies that also shape trade policy. We propose a theory of trade distortion arising from conflict between consumer welfare and importer lobbies. We estimate the key parameter of the model—the government's weight on welfare—using original data from Venezuela, where Hugo Chávez used an exchange-rate subsidy to underwrite hundreds of billions of dollars of imports. Whereas estimates from traditional models would make Chávez look like a welfare maximizer, our results indicate that he implemented distortionary commercial policy to the benefit of special interests. Our analysis underscores the importance of tailoring workhorse models to account for differences in interest group configuration. The politics of trade policy is not reducible to the politics of protectionism.
With the future of liberal internationalism in question, how will China's growing power and influence reshape world politics? We argue that views of the Liberal International Order (LIO) as integrative and resilient have been too optimistic for two reasons. First, China's ability to profit from within the system has shaken the domestic consensus in the United States on preserving the existing LIO. Second, features of Chinese Communist Party rule chafe against many of the fundamental principles of the LIO, but could coexist with a return to Westphalian principles and markets that are embedded in domestic systems of control. How, then, do authoritarian states like China pick and choose how to engage with key institutions and norms within the LIO? We propose a framework that highlights two domestic variables—centrality and heterogeneity—and their implications for China's international behavior. We illustrate the framework with examples from China's approach to climate change, trade and exchange rates, Internet governance, territorial sovereignty, arms control, and humanitarian intervention. Finally, we conclude by considering what alternative versions of international order might emerge as China's influence grows.
This chapter is devoted to price formation and price trends in commodities. The chapter first discusses factors determining price levels, both in the short and long run. It thereafter turns to the blurred nature and instability of the short-run supply curve. The third focus is on price fluctuations in commodities, both the short-run instability as well as the long-run price trends. Fourth, alternative trading arrangements and their implications for price formation are explored. The final sections of the chapter discuss actual price quotations and the implications of exchange rates on commodity prices.
After 1985, the UK first assigned a ‘greater importance‘ to exchange rate objectives, without specifying any rule; then followed between early 1987 and March 1988, an unannounced policy of linking the pound to the deutschemark at the rate of 3 DM/£ was pursued. That policy, undertaken without the knowledge of the Prime Minister, eventually led to a sharp political conflict between Thatcher and Lawson. Subsequently, the exchange target was abandoned. All three phases of the new exchange rate regime were conceptually incoherent, and the lack of monetary control in the second half of the 1980s eventually produced not only rapid growth (that looked like a policy success and was termed the ‘Lawson boom‘) but also a new upsurge of inflation that increasingly concerned the Bank. Eddie George emerged not only as a key architect of Bank strategy but also as a favoured interlocutor of Margaret Thatcher. A background to the policy debates was the increased attraction, to the Treasury and to some figures in the Bank, of the European Monetary System as a way of securing the deutschemark as an anchor, and international coordination on exchange rates became more central to monetary policy management; Thatcher and George were critical of that vision.
This chapter provides an introduction to exchange rates, including the nominal and real exchange rate. It describes and assesses the purchasing power parity model of exchange rate determination. It considers the role of hedging and foreign exchange derivatives. Appendices look at price levels and the PPP model and develop the monetary approach to exchange rate determination.
This chapter provides an introduction to flexible exchange rates. It presents both a simple supply and demand model of exchange rate determination and the assets-based approach of the interest rate parity condition. It considers the role of interest rates and expectations in exchange rate determination. An appendix analyzes monetary policies and the nominal exchange rate.
This chapter provides an introduction to fixed exchange rates. It first considers a range of possible exchange rate regimes. It presents a simple supply and demand model of exchange rate determination and the assets-based approach of the interest rate parity condition, both applied to a fixed exchange rate regime. It considers the role of interest rates and expectations under fixed exchange rates. It briefly considers the impossible trinity and currency boards. An appendix analyzes monetary policies under fixed exchange rate regimes.
Since Meese and Rogoff (1983) results showed that no model could outperform a random walk in predicting exchange rates. Many papers have tried to find a forecasting methodology that could beat the random walk, at least for certain forecasting periods. This Element compares the Purchasing Power Parity, the Uncovered Interest Rate, the Sticky Price, the Bayesian Model Averaging, and the Bayesian Vector Autoregression models to the random walk benchmark in forecasting exchange rates between most South American currencies and the US Dollar, and between the Paraguayan Guarani and the Brazilian Real and the Argentinian Peso. Forecasts are evaluated under the criteria of Root Mean Square Error, Direction of Change, and the Diebold-Mariano statistic. The results indicate that the two Bayesian models have greater forecasting power and that there is little evidence in favor of using the other three fundamentals models, except Purchasing Power Parity at longer forecasting horizons.
Based on a thorough analysis of the BIS Annual Reports from the early 1970s to the late 2010s, this chapter traces the evolution of the BIS’s thinking on the international monetary and financial system. It demonstrates how – as a result of the growth of the Eurocurrency markets in the 1970s and of the sovereign debt crisis of the 1980s – the BIS’s traditional focus on exchange rates and their potential impact on monetary stability gradually shifted to global capital flows and to the risks posed by an increasingly complex and interconnected banking system. The 1995 Mexico crisis and 1997–8 Asian crisis reinforced this shift and led to an overriding concern with the procyclicality of the financial system as a potential threat to financial stability. While recognising that the focus of the BIS on a macro-financial stability framework has contributed a lot to advancing the work of the Basel-based committees and standard-setting bodies, the chapter also concludes that not much progress has been made in coordinating monetary policies or in addressing the fundamental problem of excessive elasticity of the financial system.
In this article, we analyze the impact of varying exchange rates on French wine exports using a dynamic Armington panel model for the time period from 2000 to 2011. Our results suggest that French wines have become less competitive during the 2000s. This is due to two factors: rising domestic wine prices relative to foreign competitors and the appreciation of the euro against the USD and the GBP. Chinese demand appears to be a key driver of French wine exports. In addition, we find some compositional effects in Bordeaux wine exports. In response to the appreciation of the euro, the share of high-priced wines has increased, suggesting some degree of quality sorting in response to exchange-rate changes. (JEL Classification: F14, F31, Q17)
We study the exchange rate effects of monetary policy in a balanced macroeconometric two-country model for the United States and United Kingdom. In contrast to the empirical literature, which consistently treats the domestic and foreign countries unequally in the modeling process, we consider full model feedback, allowing for a thorough analysis of the system dynamics. The problem of model dimensionality is tackled by invoking the approach by Aoki (1981). Assuming country symmetry in the long run allows to decouple the two-country macrodynamics of country averages and differences such that the cointegration analysis can be applied to smaller systems. Second, the econometric modeling is general-to-specific, a graph-theoretic approach for the contemporaneous effects combined with automatic general-to-specific model selection. We find delayed overshooting of the exchange rate in the case of a Bank of England monetary shock but instantaneous response to a Fed shock. Altogether the response is more pronounced in the former case.
Real exchange rate movements are robustly related to the rise and fall of trade protectionism. I demonstrate this by presenting a theoretical model that incorporates the real exchange rate into a standard factor proportions model of trade policy preferences. The model demonstrates why some firms' trade policy preferences, and thus total demands for protectionism, change in response to real exchange rate movements. I evaluate the model with data on antidumping investigations in six industrialized countries between the late 1970s and 2004. The exercise suggests that the real exchange rate hypothesis offers a more compelling explanation for protectionist waves than the business cycle hypothesis.
The globalization of production and finance is responsible for much of the variation in political contestation over exchange rates since the end of Bretton Woods. On the one hand, globalization increases the salience of the policy decisions that affect exchange rates, as more firms and their workers engage more in international trade and compete more against imports. On the other hand, globalization offers firms a myriad of opportunities to manage their exchange rate risk, through operational and financial hedging. But hedging is available to only certain types of economic actors and in certain situations of exchange rate risk. In this way, globalization has redrawn traditional political cleavages on exchange rates. This argument is tested with an original survey of US firms, labor unions, and trade associations on their preferences and political activity on exchange rate policy.
While it is generally accepted that change in the real value of the dollar is an important determinant of exports, it has not been rigorously demonstrated that this relationship, derivable from theory, holds empirically for agricultural exports and the components of agricultural exports. Starting with a dynamic maximizing framework, this paper estimates the real trade-weighted exchange rate and trade partner income effects on U. S. agricultural exports. For the period 1970–2006, a one percent annual increase in trade partners’ income is found to increase total agricultural exports by about 0. 75 percent, while a one percent appreciation of the dollar relative to trade partner trade-weighted currencies decreases total agricultural exports by about 0. 5 percent. While these effects carry over to 12 commodity subcategories, they are conditioned by differences between bulk and high value commodities, and differences in the export demand from high compared to low income countries. We use a directed acyclic graphs (DAG) technique to identify the inverted fork causal relationships from vector autoregression (VAR) models. We also find that there is an asymmetric exchange rate effect so that the negative effect of exchange rate appreciation on exports sometimes dominates the positive effect of foreign income growth.
In 1922, British colonial Gambia demonetized the French 5-franc coin, which had been legal tender at a fixed rate in the colony since 1843. Until World War I, this rate was close to the international rate under the gold standard. When the franc began to depreciate in 1918, however, a gap emerged between the Gambian rate and the international rate, prompting a rapid influx of the coins. The demonetization cost the colonial administration over a year's revenue, affecting the later development of the colony. The 1920s have long been a fruitful period for the study of monetary history owing to the instability of exchange rates during and after the war. This article extends the study of this period to examine the impact of these changes on dependent colonies in West Africa, highlighting the importance of local compromises and particularities in colonial monetary systems.