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1、Chapter 20The International Financial System 2005 Pearson Education Canada Inc.Exchange Market InterventionUnsterilized:Bank sells$1 billion of$,buys$1 billion of foreign assetsBank of CanadaAssets LiabilitiesForeign assets+$1 bCurrency or reserves+$1 b(international reserves)(monetary base)Results:
2、1.International reserves,+$1 billion2.Monetary base,+$1 billion3.Then analysis in Fig 1,Et 2 2005 Pearson Education Canada Inc.Exchange Market InterventionSterilized:To reduce MB back to old level,Bank of Canada sells$1 billion of government bondsBank of CanadaAssets LiabilitiesForeign assets+$1 bCu
3、rrency or reserves$0 b(international reserves)(monetary base)Government bonds$1 bResults1.International reserves,+$1 billion2.Monetary base unchanged3.Et unchanged:no shift in RD and RF3 2005 Pearson Education Canada Inc.Exchange Rate Intervention,Sell$1.Sell$,buy F:MB,Ms 2.Ms,P,Eet+1,expected appre
4、ciation of F,RF shifts right in Fig.13.Ms,iD,RD shifts left,go to point 2 and Et 4.In long run,iD returns to old level,RD shifts back,go to point 3:Exchange rate overshooting4 2005 Pearson Education Canada Inc.The Gold StandardCurrency convertible into gold at fixed valueExample of how it worked:Can
5、ada:$20 converted into 1 ounceU.K.:4 converted into 1 ouncePar value of 1=$5.00If to$5.25,importer of 100 of tweed has two alternatives:1.Pay$5252.Buy$500 gold(500/20=25 ounces),ship to U.K.,convert into 100(=25 4)and buy tweed5 2005 Pearson Education Canada Inc.The Gold StandardIf shipping cheap,do
6、 alternative 21.Gold flows to U.K.2.MB in U.K,MB in Canada3.Price level U.K.,Canada4.depreciates back to parTwo Problems:1.Country on gold standard loses control of Ms2.World inflation determined by gold production6 2005 Pearson Education Canada Inc.Fixed Exchange Rate SystemsBretton Woods1.Fixed ex
7、change rates2.Other central banks keep exchange rates fixed to$:$is reserve currency3.$convertible into gold for central banks only($35 per ounce)4.International Monetary Fund(IMF)sets rules and provides loans to deficit countries5.World Bank makes loans to developing countriesEuropean Monetary Syst
8、em1.Value of currency not allowed outside“snake”2.New currency unit:ECU3.Exchange Rate Mechanism(ERM)Key weakness of fixed rate systemAsymmetry:pressure on deficit countries losing international reserves to M,but no pressure on surplus countries to M7 2005 Pearson Education Canada Inc.Intervention i
9、n a Fixed Exchange Rate System8 2005 Pearson Education Canada Inc.Analysis of Figure 2:Intervention in a Fixed Exchange Rate SystemSince Eet+1=Epar with fixed exchange rate,RF doesnt shiftOvervalued exchange rate(panel a)1.Central bank sells international reserves to buy domestic currency2.MB,Ms,iD,
10、RD to right to get to point 23.If dont do this,have to devalueUndervalued exchange rate(panel b)1.Central bank sells domestic currency and buys international reserves2.MB,Ms,iD,RD to left to get to point 23.If dont do this,have to revalue9 2005 Pearson Education Canada Inc.Exchange Rate Crisis1.At E
11、par,R2F right of RD because Bundesbank tight money keeps German interest rates high2.Bank of England could buy,iD,RD shifts right3.When speculators expect devaluation,Eet+1,RF shifts right4.Requires much bigger intervention by UK5.When UK pulls out of ERM,10%,big losses to central bank10 2005 Pearso
12、n Education Canada Inc.International Financial ArchitectureCapital Controls1.Controls on outflows unlikely to work2.Controls on inflows may prevent lending boom and financial crisis,but cause distortionsRole of IMF1.There is a need for international lender of last resort(ILLR)and IMF has played this
13、 role2.ILLR creates moral hazard problem3.IMF needs to limit moral hazard Lend only to countries with good bank supervision4.Need to do ILLR role fast and infrequently11 2005 Pearson Education Canada Inc.Monetary Policy:International Considerations1.Direct effects of FX marketWhen intervene,MB changes2.Balance of payments considerationsWhen B of P is in deficit need Ms 3.Exchange rate considerationsWhen want lower E,need Ms 12 2005 Pearson Education Canada Inc.