lecture 14 International Monetary Relations

Comprehensive vocabulary flashcards covering the core concepts, historical regimes, and policy trade-offs of international monetary relations from Lecture 14.

What economic principle explains why countries gain from international trade by specializing in and exporting what they can produce relatively most efficiently?

Comparative advantage

Why do governments implement trade barriers despite the broad economic gains that trade can deliver?

To cater to domestic political pressures and shield specific domestic industries or interest groups from foreign competition (protectionism).

What are the two primary mechanisms through which economic actors invest capital across national borders?

Foreign direct investment (FDI) and portfolio investment

What painful economic policy response typically follows a sovereign debt default when a government can no longer service its foreign loans?

Austerity measures, which include severe spending cuts and tax increases to restore fiscal balance.

Why is an international monetary system necessary for cross-border trade, services, and capital investment to function?

Because each sovereign country issues its own distinct national currency, requiring a predictable mechanism to buy, sell, and exchange them.

Which currency dominates global payments, accounting for more than $50\%$ of all international transactions?

The United States dollar ($\text{USD}$)

What term denotes the price of one national currency expressed in terms of another national currency?

Exchange rate

In the standard exchange rate quotation notation $\text{Currency A / Currency B} = X$, what does the value $X$ represent?

The amount of $\text{Currency B}$ required to purchase one unit of $\text{Currency A}$.

If the exchange rate is quoted as $\text{CAS/USD} = 0.5$, how is the reciprocal exchange rate ($\text{USD/CAS}$) calculated?

Divide $1$ by $0.5$, which yields $2$ ($\text{USD/CAS} = 2$), meaning $1\text{ USD}$ buys $2\text{ castars}$.

If an item in Gondor costs $200\text{ castars}$ when $\text{CAS/USD} = 0.5$, what is its dollar price if the dollar depreciates so that $\text{CAS/USD} = 2$?

The price increases from $100\text{ dollars}$ ($200 \times 0.5$) to $400\text{ dollars}$ ($200 \times 2$).

What term describes an increase in the market value of a currency relative to other currencies?

Appreciation

What term describes a decrease in the market value of a currency relative to other currencies?

Depreciation

How does domestic currency appreciation affect a nation's import volume and citizens traveling abroad?

Foreign goods and travel become cheaper in terms of the domestic currency, which increases imports and makes foreign travel more affordable.

Why does an appreciating domestic currency create an economic disadvantage for domestic export producers?

It makes domestic products more expensive for foreign buyers to purchase, leading to a decline in export sales.

How does currency depreciation impact the prices and volumes of a nation's imports and exports?

Imports become more expensive and decline, while exports become cheaper for foreign buyers, making domestic products more competitive abroad.

Why do domestic consumers generally favor a strong (appreciated) national currency?

A strong currency maximizes consumer purchasing power, making imported goods and services cheaper to buy.

Why do domestic export-oriented producers generally prefer a weak (depreciated) national currency?

A weak currency makes domestically produced goods cheaper and more competitively priced in foreign markets, expanding overseas sales.

Under normal floating market conditions without government intervention, what fundamental economic forces determine a currency's exchange rate?

The interaction of market supply and market demand for that currency.

What macroeconomic management tool do governments and central banks use to influence unemployment, inflation, and growth?

Monetary policy

What primary lever do central banks adjust to carry out monetary policy?

Benchmark interest rates

How does an increase in interest rates by a central bank generally impact the value of the national currency?

It strengthens (appreciates) the currency because higher returns attract foreign investors, increasing demand for that currency.

How does a reduction in interest rates by a central bank generally impact the value of the national currency?

It weakens (depreciates) the currency because lower returns prompt investors to seek higher yields elsewhere, lowering demand for that currency.

What exchange rate regime is defined by a government commitment to keep its currency at a constant value relative to another currency or a commodity?

A fixed exchange rate regime (pegged regime)

What exchange rate regime permits a currency's market value to fluctuate freely in response to changing supply and demand?

A floating exchange rate regime

What is the primary economic benefit of adopting a fixed exchange rate regime?

It provides exchange rate stability and predictability, eliminating currency risk for international trade and investment.

What major economic capability must a sovereign government surrender when adopting a fixed exchange rate?

Independent monetary policy autonomy, because interest rates must be adjusted to defend the exchange rate peg rather than manage domestic economic conditions.

What is the principal advantage for a government operating under a floating exchange rate regime?

Full monetary policy freedom to adjust interest rates in response to domestic economic challenges, such as high unemployment or inflation.

What is the primary drawback of operating under a floating exchange rate regime?

Exchange rate volatility and uncertainty, which increase risk for cross-border trade and foreign investment.

Which domestic economic actors are most likely to advocate for a fixed exchange rate regime, and why?

Actors engaged in cross-border economic activities (such as international investors, importers, exporters, and multinational corporations), because price stability eliminates currency risk.

Which domestic economic actors are most likely to advocate for a floating exchange rate regime, and why?

Actors focused purely on domestic economic activities, because they benefit when the government can freely use monetary policy to stimulate the domestic economy.

What term describes a formal or informal arrangement widely accepted among sovereign states to govern relations among currencies?

An international monetary regime

What are the two principal structural features that define any international monetary regime?

1. Clarifying whether currency values are expected to be fixed, floating, or a hybrid.
2. Establishing whether there exists a common benchmark or commodity base to which currencies are compared.

Which international monetary regime governed global commerce from the 1870s to 1914 by directly pegging currencies to a precious metal?

The gold standard

Under the Bretton Woods system (1945–1973), how were the U.S. dollar and other national currencies pegged?

The U.S. dollar was pegged directly to gold at $35\text{ dollars}$ an ounce, while other member currencies were pegged to the U.S. dollar.

How did the Bretton Woods monetary system incorporate flexibility that the classical gold standard lacked?

It functioned as an adjustable peg system, allowing member states to make negotiated currency revaluations or devaluations in cases of fundamental economic disequilibrium.

What exchange rate arrangement characterizes relations among the world's major reserve currencies (such as the USD, EUR, JPY, and GBP) today?

A system of floating exchange rates

What regional monetary integration arrangement was adopted in 2002 to create a shared currency among European Union member states?

The Eurozone (adoption of the euro)

Which European Union member country holds a formal treaty opt-out exempting it from the obligation to adopt the euro?

Denmark

What key institutional distinction separates the Eurozone from the Schengen Area in European governance?

The Eurozone unifies monetary policy and legal tender, whereas the Schengen Area eliminates passport checks and internal border controls to facilitate free human mobility.

What event occurs when market actors doubt a government's ability or willingness to maintain its exchange rate peg, triggering massive capital flight?

A currency crisis (balance of payments crisis)

Why does a speculative run on a pegged currency force a central bank to abandon its peg?

The central bank must spend its limited foreign currency reserves to purchase its own currency to maintain the peg; once reserves are depleted, the currency collapses and is forced to devalue.

Why does a steep currency collapse during a crisis frequently precipitate a severe domestic recession?

It drastically escalates the real burden of foreign-currency-denominated debt, destabilizes the domestic banking system, causes corporate bankruptcies, and forces austerity.

What are two prominent examples of currency crises that occurred in emerging markets during the 1990s?

The 1994 Mexican Peso Crisis and the 1997 East Asian Financial Crisis

What digital asset category, initiated with Bitcoin in 2009, operates across decentralized networks without being issued or backed by a central sovereign authority?

Cryptocurrency

What primary economic vulnerabilities and institutional conflicts emerged when countries like El Salvador and the Central African Republic experimented with Bitcoin as legal tender?

Severe price volatility, limited domestic adoption and technical readiness, and political conflict with international lending institutions like the International Monetary Fund (IMF).