International Wealth and Power Exam #3 Concepts

1. The Unholy Trinity – Highlights the trade-offs that governments face when making decisions about fixed exchanged rates, monetary policy, and international capital flows. Governments have three policy goals, each of which is desirable in its own right: (1) maintaining a fixed exchange rate; (2) having the ability to use monetary policy to manage the domestic economy, which we refer to as monetary policy autonomy; and (3) allowing financial capital to flow freely into and out of the domestic financial system or capital mobility for short.  The unholy trinity states that any government can achieve only two of these three goals simultaneously.

2. European Monetary System (EMS) – Founded by the European Community government in 1979, the EMS was a fixed-but-adjustable exchange-rate system in which governments established a central parity against a basket of European Union (EU) currencies called the European Currency Unit (ECU). Central parities against the ECU were then used to create bilateral exchange rates between all EU currencies. EU governments were required to maintain their currency’s bilateral exchange rate within 2.25 percent of its central bilateral rate. In January 1999, monetary union replaced the EMS.

3. Exchange-rate misalignments – Large and persistent gaps between the “correct” or equilibrium exchange rate and the actual (or market-determined) exchange rate.

4. Plaza Accord – A pact reached in September 1985 under which the Group of five agreed to reduce the value of the dollar against the Japanese yen and the German mark by 10 to 12 percent. This agreement is the most recent episode of a concerted attempt by the Group of five to manage exchange rates.

5. Tobin Tax – A small tax on foreign exchange market transactions that is high enough to discourage short-term capital flows, but not high enough to discourage long-term capital flows or international trade. By discouraging short-term capital flows, countries gain a degree of macroeconomics  policy autonomy.

 
6. The Keynesian Revolution
7. Electoral Model of Monetary and Exchange-rate Politics
8. Partisan Model of Monetary and Exchange-rate Politics
9. Sectoral Model of Monetary and exchange-rate Politics

10. The Phillips Curve – Curve that posits a trade-off between inflation and unemployment: Government can reduce unemployment only by causing higher inflation and can reduce inflation only by causing higher unemployment. Named after British economist A. W. Phillips, who was the first to pose such a relationship in 1958. The trade-off between inflation and unemployment is now seen to hold only in the short run.

11. Natural Rate of unemployment in the US and EU – The economy’s long-run equilibrium rate of unemployment, or the rate of unemployment to which the economy will return after a recession or boom. The natural rate of unemployment is never zero and can in fact be substantially above zero.  The natural rate  of employment in the US and EU is…

12. Central Bank Independence – The degree to which a country’s central bank can set monetary policy free from interference by the government. Typically considered to be a function of three things: the degree to which the central bank is free to decide what economic objective to pursue, the degree to which the central bank is free to decide how to set monetary policy in pursuit of this objective, and the degree to which central bank decision can be reversed by other branches of government. Contemporary economic theory argues that independent central banks are better able to deliver low inflation than are central banks controlled by the government.

13. Price Stability – Now commonly considered by governments to be the appropriate for monetary policy, it connotes a low and stable rate of inflation –about 1-2 percent per year.

 
14. Accelerationist Principle – A central component of monetarist theories and first stated by Milton Friedman in the 1960s, it claims that a government can keep unemployment below the natural rate of unemployment only if it is willing to accept a continually increasing rate of inflation. That is, the principle claims that there is no long-run Phillips Curve trade off between inflation and unemployment. Such a trade-off exists only in the short-run. This principle became widely accepted by governments and central bankers in the advanced industrialized countries during the 1980s, leading to the demise of the Keynesian strategies of macroeconomics managements.

15. Time-Consistency Problem – Situations in which the best course of action in the present is not the best course of action in the future.

16. Foreign Capital and Economic Development

17. Petrodollars – the revenue dollars earned by Organization of Petroleum Exporting Countries (OPEC) governments in the wake of the 1973 oil price rise. These funds were channeled by commercial banks to some developing country governments to finance their current account deficits in a process that came to be called petrodollar recycling.

18. Liquidity Problem – Situation that arises in financial markets in which a financial institution or other actor is solvent (assets are greater than liabilities) but cannot readily trade its assets for the cash required to settle a liability.

19. The London Club – A private association established and run by the large commercial banks engaged in international lending. Developing countries’ governments that want to reschedule their commercial bank debt must work out the terms of a rescheduling agreement with the London Club.

20. The Brady Plan – Proposed in 1989 by Secretary of the U.S. Treasury Nicholas J. Brady, his plan attempted to bring the developing-country debt crisis to a close. It encouraged commercial banks to negotiate debt reduction agreements with debtor governments. To make the proposal attractive to commercial banks, the advanced industrialized countries and the multilateral financial institutions advanced $30 billion with which to guarantee the principal of the Brady bonds, as the new debt instruments came to be called.

21. The Asian Financial Crisis – Four hardest hit countries that the Asian Crisis originated from are: Thailand, Indonesia, South Korea, and Malaysia. (need to add more)

22. Moral Hazard – A consideration that arises when banks believe that government will bail them out if they suffer large losses on the loans they have made. If banks believe that the government will cover their losses, they have little incentives to carefully evaluate the risks that are associated with the loans they make. If the loans are repaid, banks earn money. If the loans are not repaid, the government –and hence society’s taxpayers –picks up the tab. In such an environment, banks have an incentive to make riskier loans than they would make in the absence of a guarantee from the government, thereby raising the likelihood of a crisis.

23. Crisis in Argentina – In 2001:

Exchange Rate: Fixed to the U.S. Dollar

Financing problem: Large government short-term debt

Trigger: Speculative attacks against this peg emerged in 2000 and continued sporadically into 2001. The government introduced some exchange-rate flexibility in mid-2001, generating new speculative attacks. The government floated the peso in January 2002 and defaulted on its foreign debt.

IMF Support: Argentina secured a total of $40 billion in credits from the IMF and the advanced industrialized countries.

Fallout: Argentina’s economy collapsed into deep depression. 

24. Hot Money – Financial capital held in short-term instruments that can be quickly liquidated at the first sign of financial trouble. Seen by many to be a source of volatility and instability in contemporary capital markets.

25. Paris Club – An informal group composed of nineteen permanent members, all of which are governments that hold large claims on other governments. Its primary role is to negotiate the rescheduling of these debts.