Modern Exchange-rate Regimes, Stabilisation Programmes and Co-ordination of Macroeconomic Policies

Recent Experiences of Selected Developing Latin American Economies

Maria Luiza Falcão Silva

• Publisher: Routledge
• Year: 2018
• ISBN:
  9780429837197
• Edition: 1
• Topic: Economics
• Subtopic: Macroeconomics
• Index: Economics

Published in 1999, this work analyzes the phenomenon of macroeconomic adjustment, with special emphasis on selected Latin American countries facing stabilization programmes. It provides a historical description of the origins, functioning and collapse of exchange-rate regimes from the international classical gold standard period to modern arrangements. The author supports the argument that systemic asymmetries in the worldwide adjustment mechanism are inherent in the international monetary system. The recent theoretical literature dealing with the rules vs discretion debate and its interaction with the credibility issue is reviewed. This topic is intrinsically related to the dispute over the appropriate role of exchange-rate anchors in disinflation programmes. Against a background of academic dispute between advocates of exchange-rate prescriptions and monetary conceptions, the contrasting views of different theorists regarding the choice of exchange rate regimes are presented and assessed. Finally, a comparative analysis of recent experiments in Argentina, Brazil, Chile and Mexico with exchange-rate based disinflation stabilization programmes is undertaken. The problems that have arisen while establishing new institutional arrangements, such as new currency or a policy rule for monetary base creation, are examined.

1 Origins and Functioning of Modern Exchange-Rate Regimes

The Gold-Standard Period

A country is said to adopt a gold-standard arrangement when it establishes an official and fix price or ‘mint parity’ for gold in terms of its domestic currency, and stands ready to exchange gold for domestic money at the official par value. From about 1880 until the beginning of World War I, the so-called classical gold standard prevailed on a global scale. “During and between the two world wars, the international monetary system evolved through a sequence of short-lived arrangements as stability proved elusive” (Isard, 1995, p.36). Between 1918 and 1925, the international monetary system experienced a short period during which the exchange rates among the major currencies were allowed to float. Nevertheless, the gold-standard regime was restored from 1925 to 1931 in a number of countries, and the establishment of a gold-exchange standard evolved elsewhere. After Britain’s suspension of gold convertibility in September 1931, the gold standard collapsed, and what emerged was an uncoordinated hybrid regime that lasted until 1936, with the Tripartite Monetary Agreement between Britain, France, and the United States leading to a regime in which the management of exchange rates became co-ordinated.¹

According to Argy’s (1994) understanding, three institutional arrangements operated during the gold-standard era:²

i. The specie-standard regime, where money was made up only of gold coins with a fixed gold content. The national mint would always supply gold by melting down gold coins or coin gold supplied to it by the public. There was an adherence to the fixed price of specie, which characterised all convertible metallic regimes. Adjustment in this case was automatic.

ii. The simplest gold bullion standard, where money was made up of notes only, which were not themselves backed 100 percent by gold. In this case, the outcomes and the method of adjustment were effectively the same. Partial backing, may weaken the corrective mechanism of the gold standard and threaten the reserve position. The smaller this backing the greater the danger that the corrective mechanism might not work before reserves are severely depleted.

iii. Finally, the case where the system in force was a gold standard in which one country’s currency (the reserve currency) was held as ‘reserves’ by the rest of the world while the reserve currency itself was backed by gold. In this case Argy (1994) shows that there might be no automatic adjustment. There would also be an asymmetry in that the full burden of the adjustment would now fall on the rest of the world. The automaticity of a gold-standard regime in this case was further weakened.

The gold standard, however, has become, in the late-twentieth century, a controversial issue following proposals for its readoption, and the experiences undertaken by several developing countries, pegging their currencies to specific foreign currencies at fixed exchange-rate parities. These recent experiments closely resemble the gold standard , with fiat-foreign money being used instead of gold, to back domestic money creation. In this sense, it is appropriate to treat the gold-standard regime as a modern exchange-rate regime. Further, it is fundamental to understand how the system actually worked to generate better insights about the future of developing countries adopting, recently, similar regimes.

The Classical Gold- Standard Regime: 1880-1914

Origins and Functioning As Guttmann puts it:

Economists have long recognised that trade plays a crucial role in the economic development of societies. During the seventeenth century and the first half of the eighteenth century it was widely believed that national welfare of a country depended on its ability to increase its gold and silver reserves by running persisting trade surpluses. This early theory, known as mercantilism, regarded exports as the principal source of wealth. By favouring policies to protect a nation’s balance of trade, which included import restrictions as well as the direct use of military force as an instrument of external economic relations, the mercantilists in effect provided an ideological cover for colonialism. Conquest of foreign lands opened up markets in which the manufacturers of the colonial power could undersell local artisans and at the same time secure cheap access to valuable raw materials. [Guttman, 1994, pp.324-325]

From the second half of the eighteenth century on, mercantilism came under attack by the classical political economists. As is well known David Hume (1752), Adam Smith (1776) and David Ricardo (1817) built a strong case favouring free trade.³ It has been argued that the specie-flow adjustment mechanism described by Hume, when demonstrating that it would be virtually impossible for any country to accumulate gold for a long period of time, turned into the standard justification for the use of gold as world money.⁴

Under the gold-standard regime exchange rates were permanently fixed. This system has been associated with three basic rules. As Argy (1994) defines: the first rule relates to the fact that in each participating country the price of the domestic currency - the exchange rate - must be fixed in terms of gold. The second rule is that there must be a free import and export of gold. The third rule is an adjustment rule: a surplus country, which has a liquid gold entrance, should allow its volume of money to increase while a deficit country, which is losing gold should allow its volume of money to fall.

Of course the action of the first two rules simultaneously ensure that between participating countries the exchange rates are fixed and any deviation from the fixed rate should be rapidly eliminated by arbitrage operations. In fact, when countries define their currencies in terms of a fixed weight of gold it is equivalent to determining a fixed price for each currency.

The third rule implies an automatic mechanism of adjustment in each participating country’s balance of payments such that any balance of payment disequilibrium would be corrected through one of the following potential mechanisms by which changes in the money supply affect the balance- of-payments results:

i. Through variations in the interest rate which induce corrective movements of capital. Surplus countries would lower their interest rate while the deficit countries would raise their interest rate such that capital would flow from the former to the latter.

ii. Through the functioning of the goods market when exposed to situations of deflation or inflation as consequences of alterations of their money supplies leading to relative changes in prices and/or real output that correct the imbalances. The adjustment through prices is associated with the classic price-specie-flow mechanism while the adjustment through output is associated with later Keynesian thinking.

The precise operation of these three rules varied depending on the institutional arrangement that was under operation in different periods of the gold-standard era. Considered by some analysts as a primitive monetary system (Argy, 1994) and by others as the most admirable monetary regime (McKinnon, 1988a), the global economy experienced the classical gold-standard era between 1880 and 1914.

Nevertheless, the gold standard had no precise date of origin. It emerged, gradually, in the latter part of the nineteenth century, although by 1819-21 Britain was already on a full-fledged gold standard. However, it was not until about 1880 that it reached its heyday, when most of the industrial world joined Britain in meeting the conditions of the gold standard. This regime was to endure until the out break of the First World War. The developing countries followed them but in a different path as will be analysed later.

Indeed, gold had come to play a dominant role in Great Britain much earlier, and by the end of the 1700s the country was de facto on a gold standard.⁵ The Peel Act of 1819 made that evolution official. The British used their hegemonic position to implement a new international economic order: the pound sterling was put on a gold standard and protectionism was abandoned when Parliament repealed the Corn Law, which had imposed prohibitive tariffs on imported grains thirty years earlier.⁶

Of course Britain used its dominant position on the global economy to impose ‘free trade’ policy on other nations so that it could assure access to cheaper imports and allow its industries to exploit their competitive advantages in the world market. In these years all Imperial territories were as firmly committed to free trade as was their mother country. Britain, however, managed to preserve in trade with her Empire a position of total supremacy, where she maintained a virtual export monopoly.

It had become a question of vital importance for her to be able to retain that position, since she had become dependent on the rest of the world for raw materials and agricultural products and could not offset these purchases against comparable sales of manufactured goods. As a source of food, the Empire was inadequate as is shown by Britain’s trade deficit with the United States, Argentina and Europe. [De Cecco, 1974, p.28]

But De Cecco (1974) also argues that as a source of raw materials the Empire was not unimportant although it could not provide Britain with all that she needed. However, the

Imperial territories realised a large enough export surplus with the rest of the world to be put at the mother country’s disposal. Britain’s retreat into Imperial markets, and her staunch defence of the privileges she enjoyed there, is one of the principal keys to an understanding of world economic history in the 25 years of our period. [De Cecco, 1974, p. 29]

Britain managed to preserve a monopoly in the Empire apparently through a system of non-tariff protection, which was not too difficult to impose since in the Empire proper foreign trade was for the most part in the hands of the colonial authorities. This seems to have been particularly true in India.⁷

Britain’s international transactions had undergone a profound transformation during the 35 years of the gold-standard era. By 1850 Britain had achieved absolute supremacy in the production and world trade of manufactures, particularly of those commodities produced in factories organised on capitalists lines. These years had also seen the triumph of free trade, a policy that was not only convenient for Britain, but also for those countries who wanted to import British-made machinery and know-how to increase their rate of industrialisation.

The period between 1870 and 1914, however, witnessed what has been called the ‘Second Industrial Revolution’ which was by contrast not al all a British monopoly.⁸ In 1899, Britain’s share of world manufacturing production was 20.8 percent while her share of world exports of manufactured goods was 38.3 percent. In 1913 these figures had decreased to 15.8 percent and 31.8 percent, respectively. Germany’s quota had increased, in the same period, from 15.1 percent to 18.4 percent, and from 20.4 percent to 25.9 percent.⁹

Although Britain had lost the leadership as far as world manufacturing production is concerned it still maintained her top position as the largest individual share of world exports of manufactures. But this privilege turned hard to be preserved. Different from the ‘First Industrial Revolution’ based on small units, owned and run by individual entrepreneur families, the ‘Second Industrial Revolution’ was based on the development of new technology and heavy industry, and increasing returns to scale had strongly begun to be present in production. The machine-based technology resulted in rapid economic obsolescence of vast stocks of perfectly good equipment and ample financial resources were required to enter into or remain in, industrial production. Labour productivity grew from 1890 to 1907 at an annual rate of 2 percent in the United States, but only of 0.1 percent in Britain. Britain demonstrated, according to De Cecco’s (1974) analysis, drawing on figures calculated by Maizels (1963), a decreasing ability to compete with German industry in her own home market: German exports of manufactured goods to Britain actually increased by more than 70 percent between 1899 and 1913, at 1913 prices when, in the same period, British exports of manufactured goods to Germany remained stationary, whereas total manufacturing exports to Germany rose 39 percent and the United States exports of manufactured goods to Germany increased 140 percent. There is also some evidence on De Cecco (1974) study supporting the idea that the British decline was also evident in European markets as well. In Latin American markets, however, Britain maintained her supremacy until the end of the period.

The evidence presented above suggests that the comparative advantage in building up new industrial sectors - steel, chemicals, electricity and electrical products - began to shift away from Great Britain towards Germany and the United States.¹⁰

The transformation in world production, with strong implications upon the growth of world trade, sharply increased the demand for gold, and in the middle of the nineteenth century the metal was in short supply.

The scarcity disrupted economic activity and prompted a search for new supplies. In 1848, just when most of Europe was swept by a major wave of social unrest, California’s gold rush began. New sources of gold were also found in Alaska and Australia during the 1850s, followed by the discovery of the largest gold deposits ever in South Africa in 1866. After building up a gold-mining industry in this colony within a few years, Great Britain had assured itself of a steady supply of the money-commodity. [Guttmann, 1994, p.359]

Great Britain’s control over much of the world’s gold reserves made it easier

to cement its position as the world’s principal creditor nation, spending on average about 40 percent (and in some years more than half) of its total investment abroad. Because of this incredible propensity for capital exports, unmatched in history, sterling increasingly became used as an international transaction currency. Foreign cou...

Table of contents

• Cover
• Half Title
• Title Page
• Copyright Page
• Table of Contents
• Acknowledgements
• List of Figures
• List of Tables
• Preface
• Introduction
• 1 Origins and Functioning of Modern Exchange-Rate Regimes
• 2 Systemic Asymmetries Inherent in the International Monetary Systems
• 3 Monetary vs. Exchange-Rate Targeting
• 4 Exchange-Rate Regimes
• 5 The Dilemma of Selected Latin American Countries Facing Stabilisation Programmes
• 6 The International Financial System
• Concluding Remarks
• Bibliography