Unit 4: International Macroeconomic Policy
In the previous unit, we saw how a country can use monetary, fiscal, and exchange rate policy to change the levels of employment and production within its borders. The inherent independence of open national economies has sometimes made it more difficult for governments to achieve such policy goals as low unemployment and stable prices. The channels of independence depend, in turn, on the monetary and exchange rate arrangements that are adopted by countries and are collectively known as the international monetary system.
In this unit, we will examine how the international monetary system influences macroeconomic policy-making and performance. We will also apply models of fixed and floating exchange rates to examine the recent performance of floating rates and to compare the macroeconomic policy problems of different exchange rate regimes. Then, we will study the role that international trade plays in both developing countries and economies transitioning from a central planning system to a market-based one.
Completing this unit should take you approximately 19 hours.
Upon successful completion of this unit, you will be able to:
- discuss the structure and effectiveness of the international gold standard;
- define the Bretton Woods system, its goals, and reasons for its collapse;
- define the International Monetary Fund;
- list arguments for and against flexible exchange rates;
- define the Plaza accord and the Louvre accord as well as the main purposes of each;
- explain how fiscal and monetary policies in large countries can affect other countries' economies;
- explain the history, structure, and purpose of the European Monetary System;
- explain the theory of optimal currency areas;
- list several motivations for trading assets in international capital markets;
- identify the major participants in international capital markets;
- define offshore banking and offshore currency trading;
- describe the types of U.S. bank regulation;
- explain how international bank regulation and U.S. bank regulation differ;
- list the characteristics of poor countries;
- discuss the level of developing country debt, and how this has evolved since 1973;
- explain how debt crises come about;
- define "original sin” in the context of international borrowing;
- define currency boards and the policy of "dollarization"; and
- explain the trade-offs inherent in deciding the relative importance of exchange rate stability, financial capital mobility, and monetary policy autonomy.
4.1: The International Monetary System, 1870–1973
In this subunit, we will learn how the goals of internal and external balance motivate economic policy makers in open economies. We will also discuss the structure of the international gold standard that linked countries' exchange rates and policies prior to World War I, and the role of the Great Depression of the 1930s in ending efforts to restore the pre-1914 world monetary order. Then, we will discuss how the post-World War II Bretton Woods system of globally fixed exchange rates was designed to combine exchange rate stability with limited autonomy of national macroeconomic policies, list and assess the policy options available for attaining internal and external balance under the Bretton Woods arrangements, and explain the factors that led to the final collapse of the Bretton Woods system in 1973 (and the subsequent shift to the current system of floating exchange rates).
4.2: Macroeconomic Policy and Coordination under Floating Exchange Rates
In this subunit, we will examine the reasons why many economists favor an international financial system based on floating dollar exchange rates and the counterarguments they face. We will also discuss how commodity-price and policy disturbances raised inflation and unemployment in the early years of floating exchange rates (1973–1980), summarize how the monetary and fiscal policies of a large country such as the United States are transmitted abroad, and describe the effects of the disinflationary and fiscal policies followed by the United States in the 1980s and the role of international policy coordination. Then, we will discuss how the world economy has performed in recent years and consider the lessons the post-1973 experience holds in terms of reforming the international monetary system.
Read these slides and take notes.
4.3: Optimum Currency Areas and the European Experience
In this subunit, we will discuss why Europeans have long sought to stabilize their mutual exchange rates while floating against the US dollar. We will also learn how the European Union, through the Maastricht Treaty of 1991, placed itself on the road to having a single currency (the euro) issued and managed by a European System of Central Banks (ESCB). We will then detail the structure of the ESCB and the European Union's restrictions on member states' fiscal policies, articulate the main lessons of the theory of optimum currency areas, and recount how the 19 countries using the euro have fared so far in their currency union.
4.4: The Global Capital Market: Performance and Policy Problems
In this subunit, we will discuss the economic function of international portfolio diversification, explain factors leading to the explosive recent growth of international financial markets, and analyze problems in the regulation and supervision of international banks and nonbank financial institutions. We will also describe some different methods that have been used to measure the degree of international financial integration and evaluate the performance of the international capital market in linking the economies of the industrial countries.
4.5: Developing Countries: Growth, Crisis, and Reform
In this subunit, we will describe the persistently unequal world distribution of income and evidence that has been gathered in order to define its causes. We will also summarize the major economic features of developing countries and explain the position of developing countries in the world capital market before examining the problem of default by developing borrowers. Then, we will recount the recent history of developing country currency and financial crises and discuss measures that have been proposed in order to enhance poorer countries' gains from participation in the world capital market.
