Outline for 10/31: International Money II
The Impossible Trinity
The Bretton Woods Institutions
Collapse of the Bretton Woods System
Monetary Diversity in the Post-Bretton Woods Era
The International Monetary Fund

The Impossible Trinity
3 Desirable Monetary Conditions
1. International Capital Mobility (ICM)
2. Fixed Exchange Rates (FER)
3. Domestic Monetary Policy Autonomy (MPA)
But countries can have only 2 of these 3 conditions at any one time.
ICM
∆e = i – i* e is the exchange rate i is the domestic interest rate i* is the external interest rate
FER MPA

The Bretton Woods System
Background: Economic Problems in the 1930s
Great Depression: 25% unemployment in the United States, 44% in Germany
Collapse of international trade: Smoot-Hawley tariffs
Rise of fascism in Europe
WWII
Bretton Woods Conference in July 1944
Led by the United States, attended by delegates from 44 countries
Goal was to create a set of institutions to avoid a repeat of the 1930s
What institutions were created?

1. GATT
2. Fixed exchange rate system
The Bretton Woods Institutions
US dollar fixed to gold
Other national currencies fixed to the US dollar
3. International Monetary Fund (IMF)
– short-term loans to increase foreign exchange reserves
4. Capital Controls (restrictions on flows of speculative capital, but not on capital flows related to trade)
5. International Bank for Reconstruction and Development (IBRD or World Bank)
– longer-term loans for development projects

Where does the Bretton Woods System fit on this triangle?
International Capital Mobility
Fixed Exchange Rates Domestic
Monetary
Policy Autonomy
Was this system sustainable?

Collapse of the Bretton Woods System
Nixon ended US dollar convertibility to gold in 1971
Other countries stopped fixing to the US dollar thereafter
Why?
1. Capital controls ineffective
2. Dollar overhang
S
US$ gold time
Certain Bretton Woods institutions still remain – GATT(WTO), IMF, World Bank

The Post-Bretton Woods Era
International Capital Mobility
Western Europe
Snake
EMS
EMU
United States
Fixed Exchange Rates Domestic Monetary
Bretton Woods Policy Autonomy

Why did (much of)Western Europe choose Fixed Exchange Rates,
While the United States chose Domestic Monetary Autonomy?
Internationally-oriented producers vs. Domestically-oriented producers
Which group benefits most from fixed exchange rates?
Which group benefits most from domestic monetary autonomy?
Western Europe and United States
Which country (set of countries) has a bigger share of internationally-oriented producers?
Which country (set of countries) has a bigger share of domestically-oriented producers?

The International Monetary Fund
Each member-countries pays a quota based on GDP
Quotas stored in special IMF currency – Special Drawing Rights (SDRs)
Member-countries borrow from combined quotas
During Bretton Woods, countries could borrow to increase their foreign exchange reserves
In the post-Bretton Woods era – countries can borrow for other reasons
IMF loans require approval from Board of Executive Directors (weighted voting)
IMF loans come in slices (tranches) with associated conditions
Why conditions?
Why slices?