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Hier wird Wissen Wirklichkeit 1 Macroeconomics II Summersemester 2004 Prof. Dr. Paul Bernd Spahn Dipl.-Volkswirt Jan Werner Case Study presented by Judit.

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Presentation on theme: "Hier wird Wissen Wirklichkeit 1 Macroeconomics II Summersemester 2004 Prof. Dr. Paul Bernd Spahn Dipl.-Volkswirt Jan Werner Case Study presented by Judit."— Presentation transcript:

1 Hier wird Wissen Wirklichkeit 1 Macroeconomics II Summersemester 2004 Prof. Dr. Paul Bernd Spahn Dipl.-Volkswirt Jan Werner Case Study presented by Judit Papp Olga Sedova Alesja Stellwag Yevgeniya Yarmanova The Bretton Woods System and its End

2 Hier wird Wissen Wirklichkeit 2 Contents 1.Historical events preceding the Bretton Woods system 2.Establishing of the Bretton Woods system 3.The Bretton Woods chronology 4.Reasons for collapse 5.Discussion

3 Hier wird Wissen Wirklichkeit 3 1. Historical Events Preceding the BW System 1870-1914: Gold standard Creation of central banking systems as note source and legal tender Currencies backed by gold Liberalized export and import of gold Collapsed with the beginning of the World War I 3 main problems that led to collapse: (1) adjustment (2) liquidity (3) confidence 1919-1939: Interwar period a) Floating exchange rates: 1919-1925 b) Gold exchange standard: 1926-1931 Initiated by Great Britain Return to the pre-war gold price instead of adoption a higher gold conversion rate deflationary effect c) Managed float: 1932-1939

4 Hier wird Wissen Wirklichkeit 4 1. Historical Events Preceding the BW System 1930s: Shared experiences of the Great Depression Deflation and competitive devaluations (beggar-thy- neighbour policies) dropping national income, shrinking demand, mass unemployment, decline in world trade Trade and exchange rate controls Early 1940s: Developing a new monetary system Acknowledged need for a stable international monetary system A small number of states holding political power easier to negotiate Two major powers: Great Britain and the U.S.A. Leadership role of the U.S.

5 Hier wird Wissen Wirklichkeit 5 2. Establishing of the Bretton Woods System In the first three weeks of July 1944, delegates from 45 nations gathered at the United Nations Monetary and Financial Conference in Bretton Woods, New Hampshire. Goal: To establish a postwar international monetary system of convertible currencies, fixed exchange rates and free trade. But! Different preferences 2 rival plans

6 Hier wird Wissen Wirklichkeit 6 2. Establishing of the Bretton Woods System I. The Keynes Plan: (Great Britain) Goals:- world trade expansion - international liquidity - protection of the domestic economy from foreign disturbances Essence: Focus on adjustment of real economy wide fluctuation band Focus on world trade expansion and international liquidity Bancor with nominal value fixed in terms of gold Surplus nations (U.S.A): credit balances earning interest Deficit nations (GB): overdrafts bearing interest to surplus nations Assigned quota determines the limit on resources to obtain, if over quoted penalties: devaluation, capital control

7 Hier wird Wissen Wirklichkeit 7 2. Establishing of the Bretton Woods System II. The White Plan: (U.S.A) Goal: Exchange rate stability Essence: -Focus on purchasing power of currencies deviations from parity only in case of fundamental imbalances -Deficit nations: draw resources by selling their own currency for that of other members -Establishment of stabilizing fond IMF, IBRD Penalties: appropriate domestic policies & exchange controls Compromise between I and II = BW Agreement

8 Hier wird Wissen Wirklichkeit 8 2. Establishing of the Bretton Woods System a) Exchange rate mechanism: Par value system: 35 USD per ounce gold Snake: +/- 1% wide corridor for exchange rate fluctuations Adjustable peg Obligation to convert only for central banks Current account liberalization (capital accounts NOT liberalised) 2 main features: a) Exchange rate mechanism b) Set of institutions to safeguard international monetary stability

9 Hier wird Wissen Wirklichkeit 9 2. Establishing of the Bretton Woods System b) Bretton Woods institutions: IMF Major functions: 1. Regulatory (administering the rules governing currency values and convertibility) 2. Financial (supplying supplementary liquidity) 3. Consultative (providing a forum for cooperation among governments) IBRD - Fighting poverty - Improving living standards in the developing countries ITO GATT WTO H. D. White & J. M. Keynes, 1946

10 Hier wird Wissen Wirklichkeit 10 2. Establishing of the Bretton Woods System Classical gold standardFloating exchange rates vs. Exchange rate stability Long-run price stability Loss of national monetary authority Monetary sovereignty Insulation from foreign shocks Destabilization and free rider problems Lack of disciplining effects of fixed exchange rate regimes Excursus(1): The Bretton Woods System – an attempt to combine the advantages of both systems Question: Is it theoretically possible?

11 Hier wird Wissen Wirklichkeit 11 2. Establishing of the Bretton Woods System Excursus(2): The Inconsistent Trinity: Only 2 of 3 following objectives can be achieved simultaneously Fixed exchange rates Free capital mobility Democratic policies aimed toward full employment YES NO= Gold Standard YES NO YES= Bretton Woods NO YES = 1971- today

12 Hier wird Wissen Wirklichkeit 12 3. The Bretton Woods Chronology 1.The Period of dollar shortage" (1945-1958): The U.S. serves as a stabilizing force -The U.S. trade surplus and global liquidity – the dollar "gap -Accommodating role of the U.S. foreign aid programs (i.e. Marshall Plan), and overseas military expenditures (e.g. the Korean War) -Foreign aid and macroeconomic discipline at home supports world economy

13 Hier wird Wissen Wirklichkeit 13 3. The Bretton Woods Chronology 2. The Period of dollar glut" (1958-1971): The U.S. serves as a destabilizing force -Expansionary domestic (Great Society) and foreign (Vietnam) policies are financed by inflation -Key Status of the dollar meant that the U.S. could export inflation and avoid macroeconomic adjustment -Confidence crisis: doubtful convertibility of the dollar into gold runs on the gold -"Nixon shocks" of 1971 March 16, 1973 - COLLAPSE - Switch to flexible exchange rates - End of the official gold price - Gold-peg abolished at peace time It was clear that it as NOT a temporary break

14 Hier wird Wissen Wirklichkeit 14 4. Reasons for Collapse 1.The Triffin Dilemma: Relies on the U.S. deficits to avert world liquidity shortage -After 1958, the U.S. dollar overhang was growing larger than its gold stock erosion of Americas net reserve position -To forestall speculation U.S. deficits have to go down liquidity problem -To forestall liquidity problem U.S. deficits have to grow Confidence problem

15 Hier wird Wissen Wirklichkeit 15 4. Reasons for Collapse Attempts to save BW: a)Mid-1960: SDR b) 1961-67: Gold Pool: U.S.A:50.00% GB, F, I:9.26% (each) D:11.12% CH, B, NL:3.70% (each) c) Split market for gold March 1968: Official price: 35 USD / ounce gold Private investors: gold price flexible 2. Rigidity of Exchange Rates -Fears of potential world liquidity shortage -Irresistible incentives for speculative currency shifts -Global confidence problem 3. Growing concerns in Europe and Japan about Americas use of its privilege of liability financing (Exorbitant Privilege – C. de Gaule)

16 Hier wird Wissen Wirklichkeit 16 4. Reasons for Collapse 4. Inflation -BW assumption of a stabile economic policy in the U.S. -After 1965 – the U.S. behaviour became increasingly destabilizing Inflation Members had to buy the growing surfeit of dollar to defend their pegged rates Accelerating inflation everywhere Evident incapability of coping with widening of payments imbalances & worsening of confidence problem (speculators)

17 Hier wird Wissen Wirklichkeit 17 *Ex-Secretary of the State under the U.S. President Roland Reagan **President of the John M. Olin Foundation, ex-secretary of the Treasury under President R. Nixon and G. Ford Wall Street Journal, 3rd February 1998: The IMF is ineffective, unnecessary, and obsolete. George Schulz* & William Simon** Thank you for your attention! 5. Discussion

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