POSC Part 1

Exchange rate appreciation/depreciation

  • Appreciation occurs when a currency increases in value

  • Depreciation occurs when a currency decreases in value

  • Happen under floating regimes driven by supply and demand

  • Appreciation hurts exports, depreciation helps exports

Exchange rate devaluation/revaluation

  • Devaluation is when governments reduce currency value under fixed regimes. Revaluation is when governments increase currency value

  • Deliberate policy decisions, unlike market-driven appreciation and depreciation

  • Devaluation boosts exports but raises inflation

Fixed (pegged) exchange rate/Flexible (floating) exchange rate

  • Fixed exchange rates peg currency values to another currency or gold

  • Governments intervene in markets to maintain the peg

  • Provides stability for trade and investment

  • Requires sacrificing monetary policy autonomy

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  • Flexible exchange rates let market forces determine currency values

  • Exchange rates fluctuate based on economic conditions and trade

  • Allows monetary policy autonomy for domestic goals

  • Creates volatility for international trade

Balance of payments/Current account/Financial account/Capital account

  • Balance of payments records all economic transactions between a country and the world

  • Current account tracks trade in goods and services

  • Financial account records investment flows

  • Deficits in one account must offset surpluses in another

Balance of payments adjustment under a fixed regime/under a flexible regime

  • Under fixed regimes, deficits force governments to sell reserves and raise rates

  • Under flexible regimes, exchange rates automatically adjust to restore balance

  • Fixed regimes require painful domestic adjustments like deflation

  • Flexible regimes adjust automatically without sacrificing monetary autonomy

Bimetallism

  • Uses gold and silver as legal tender at fixed ratios

  • Governments set official exchange rates between gold and silver coins 

  • Problems arose when market ratios diverged from official ratios

  • Abandoned due to Gresham's Law instability

Gold standard (and price specie flow mechanism)

  • The gold standard fixes currency values to gold with guaranteed convertibility

  • Countries settle payments in gold, linking money supplies to reserves

  • Price-specie flow mechanism corrects imbalances automatically through deflation

  • Provided stability but required painful adjustments

Gold-exchange standard

  • Let countries hold convertible foreign currencies as reserves

  • Britain and the U.S. maintained gold convertibility while others pegged to them

  • Emerged after WWI to address gold shortages

  • Collapsed during the Great Depression

Great Depression

  • Severe global downturn from 1929 to late 1930s

  • Spread worldwide through the gold standard's transmission of deflation

  • Countries abandoned gold and engaged in competitive devaluations

  • Its devastation shaped Bretton Woods design

Bretton Woods System

  • Fixed exchange rates to the dollar convertible to gold at $35/ounce

  • Other currencies pegged to the dollar with occasional adjustments allowed

  • Used capital controls and created the IMF

  • Collapsed in 1971 when Nixon ended dollar-gold convertibility

The International Monetary Fund (IMF roles, quota, conditionality)

  • Provides loans to countries facing payment crises

  • Quotas determine voting power and borrowing capacity

  • Conditionality requires policy reforms like austerity for loans

  • Stabilizes currencies but conditions are controversial

Triffin dilemma

  • Occurs when a country’s currency is used as the global reserve currency

  • To supply the world with liquidity, the country must run trade deficits, but this can eventually weaken confidence in that currency

  • Was a major problem during the Bretton Woods System, when the U.S. dollar served as the global reserve currency

Special drawing rights (SDRs)

  • SDRs are international reserve assets created by the International Monetary Fund in 1969

  • They can be exchanged for major currencies and help provide liquidity to countries facing balance-of-payments problems

Stagflation

  • When high inflation, high unemployment, and slow economic growth occur at the same time

  • Became prominent after the 1973 Oil Crisis and challenged traditional economic theories about inflation and unemployment