1. © Randall W. Stone, 2002 Oye – III - Money and finance in the 1930s and 1980s

2. © Randall W. Stone, 2002 Flexible exchange rates P fc = $ D Q S Exch. rate Inflation Curr Acct Def D fc Devaluation Imp  Exp  Curr Acct balance

3. © Randall W. Stone, 2002 Fixed exchange rates Exch. rate Inflation Real appreciation D fc Imp  Exp  Curr Acct deficit P fc = $ D (fixed) Q Decline in reserves Reserves Decline

4. © Randall W. Stone, 2002 Norms of the gold standard Deficit countriesSurplus countries Defend parity Deflate - ↑ int. rates - ↓ govt. spending Ship gold Extend credits Hold foreign reserves Don’t sterilize gold inflows Primary Norms: Secondary Norms: Do not privatize:- Exchange controls - Loans - Sliding tariffs Simmons 1994

5. © Randall W. Stone, 2002 International lending in the 1930’s Collapse: Run on the Austrian Schilling, 1931 Run on the German RM 1931 > default, cancellation of reparations Discrimination: UK - Sterling bloc: loans, markets, debts Germany- service British banks - not US banks, bonds US surplus loans German WWI reparations UK, France WWI debts

6. © Randall W. Stone, 2002 Breakdown and reestablishment UK 1931 US 1933 France 1936 Breakdown

7. © Randall W. Stone, 2002 Breakdown and reestablishment Reestablishment Tripartite Agreement 1936, further French devaluation Explanation: interests changed –costs of unilateral cooperation declined –US, UK preferred France’s devaluation to commercial discrimination –reserve holdings liquidated

8. © Randall W. Stone, 2002 Objections Circular –Infer interests from behavior –Explain behavior in terms of interests Was there cooperation, harmony or mutual defection after 1936?

9. © Randall W. Stone, 2002 1982 Debt Crisis--Origins Rapid expansion of sovereign lending in the 1970s Reaganomics –U.S. budget deficit → inflation, strong $ –High U.S. interest rates → strong $ → high ratio of debt service/net exports 1979 oil price shock Overcommited capital in money-center banks; no incentives for regional banks to lend Expectations shift → credit dries up → default Contagion effect

10. © Randall W. Stone, 2002 Managing the 1982 Debt Crisis 1985 Baker plan (private, IBRD, IMF); little private lending forthcoming 1989 Brady plan Conclusion: privatization is necessary Banks Borrowers IMF, IBRD, FED

11. © Randall W. Stone, 2002 Objections Subsequent evidence: Resumption of portfolio investment in 1990s after successful domestic adjustment Theoretical: the debt issue area is fundamentally different from trade –There is a basic commitment problem –Lending will dry up unless the commitment problem is resolved

12. © Randall W. Stone, 2002 Macroeconomic coordination Spillovers are public 1978 Bonn Summit: any effects? –FRG delays a fiscal expansion 1981-1985 Reagan’s non-contingent strategy –Contraction 1981-1982 –Expansion after 1982 1985 Plaza Accord to weaken the dollar –Japan refuses expansionary fiscal policy –Dollar declines because Fed lowers interest rates