Key Words exchange rates, currency policy, monetary policy, international capital mobility, monetary regimes n Abstract The structure of international monetary relations has gained increasing prominence over the past two decades. Both national exchange rate policy and the character of the international monetary system require explanation. At the national level, the choice of exchange rate regime and the desired level of the exchange rate involve distributionally relevant tradeoffs.
Interest group and partisan pressures, the structure of political institutions, and the electoral incentives of politicians therefore nfluence exchange rate regime and level decisions. At the international level, the character of the international monetary system depends on strategic interaction among governments, driven by their national concerns and constrained by the international environment. A global or regional fixed-rate currency regime, in particular, requires at least coordination and often explicit cooperation among national governments.
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INTRODUCTION The study of international monetary relations was long the domain of economists and a few lonely political scientists. It was routinely argued that, unlike international rade, debt, or foreign investment, exchange rates and related external monetary policies were too technical, and too remote from the concerns of either the mass public or special interests, to warrant direct attention from political economists (Gowa 1988).
This was never really accurate, as demonstrated historically by the turbulent politics of the gold standard and more recently by the attention paid to currency policy in small, open economies such as those of Northern Europe and the developing world. But the tedious predictability of currency values under the BrettonWoods system lulled most scholars into inattention (exceptions include Cooper 1968, Kindleberger 1970, Strange 1971 , Cohen 1977, Odell 1982, and Gowa 1983).
The collapse of BrettonWoods increased the interest of political scientists in the issue, and in the 1980s, international monetary affairs took so prominent a place in domestic and international politics as to warrant widespread scholarly attention. The 50% real appreciation of the US dollar and the domestic and international firestorm of concern it prompted, dramatic currency collapses in many heavily indebted developing countries, and the controversial attempts to fix European exchange rates ll drew researchers toward the topic.
Since 1990, international monetary relations have become extremely prominent in practice, and the study of their political economy has accordingly increased in importance. Exchange rate policies have been at the center of what are arguably the two most striking recent developments in the international economy: the creation of a single European currency and the waves of currency crises that swept through Asia, Latin America, and Russia between 1994 and 1999.
Although most research on the political economy of international monetary relations pproaches, analytical arguments, and empirical conclusions. We summarize this work without attempting to cover exhaustively a complex and rapidly growing literature. In this section, we outline the analytical problem, delineating the range of outcomes in need of explanation. The next section focuses on one set of things to be explained, the policy choices of national governments, surveying work on the domestic political economy of exchange rate choice.
The third section looks at the second set of things to be explained, the rise and evolution of regional and global exchange rate institutions. Two interrelated sets of international monetary phenomena require explanation. The first is national: the policy of particular governments towards their exchange rates. The second is global: the character of the international monetary system. These two interact in important ways. National policy choices, especially of large countries, have a powerful impact on the nature of the international monetary system.
The United Kingdom and the United States were essentially the creators of the classical gold standard and the BrettonWoods monetary order, respectively, and their decisions to ithdraw from these systems effectively ended them. By the same token, the global monetary regime exercises a powerful influence on national policy choice. A small country, such as Belgium or Costa Rica, is much more likely to fix its exchange rate??” to gold before 1914, to the dollar or some other currency since 1945??”when most of its neighbors have done so.
The national and the international interact in complex ways, but for ease of analysis it is useful to look at separate dependent variables: the national policy choices of governments and the character of the international monetary system. National Exchange Rate Policy Each national government must decide whether to fix its currency??”to the dollar, to another national currency, or to gold (in earlier periods)??”or to allow it to float. If it chooses to let its currency float, it must decide whether it intends to let currency markets freely set the currency’s value or whether it intends to target a particular range of exchange rates.
If the latter, the government needs to determine the desired level of the currency’s value??”whether, generally speaking, it prefers the exchange rate to be “strong” (relatively appreciated) or “weak” (relatively depreciated). In specific instances, governments may be faced with more immediate choices, such as whether to defend or devalue a currency under attack. There are, roughly speaking, two kinds of national decisions to be made. One concerns the regime under which the currency is managed (fixed or floating, for example), and the other concerns the level of the currency (strong or weak).
These choices have significant economic and political implications, and there is no reigning economic argument as to the optimal national exchange rate policy. In this, international monetary policy differs from trade policy. There are powerful economic arguments for the welfare superiority of free trade, and free trade can usefully be considered a baseline from which national policies deviate, with the “distance” from free trade a measure worth explaining. In currency policy, there is no clear economic- efficiency argument for or against any particular level of the real exchange rate.
A strong (appreciated) currency is one that is valuable relative to others; this gives subjects national producers of tradable products (goods and services that enter into international trade) to more foreign competition, for the strong currency makes oreign products relatively cheaper. Although politicians certainly care about these effects??”weighing the positive effects of increased mass incomes versus the negative effects of increased foreign competition??”there is no purely economic reason to opt for one or the other.
There is a reigning economic approach to currency unions (and, somewhat by extension, to fixed exchange rates), drawn from the literature on optimal currency areas. But this literature is by no means conclusive, so even here there are few purely economic factors that could explain national government policy. This means that national exchange rate policy must be made with an eye toward its political implications, since the tradeoffs governments must weigh are largely among values given different importance by different sociopolitical actors.
Governments must evaluate the relative importance of the purchasing power of consumers, the competitiveness of producers of tradable products, and the stability of nominal macroeconomic variables. Below we survey the political considerations that affect policy, but first we describe the international level of analysis in international monetary affairs. InternationalMonetary Systems There are effectively two ideal types of international monetary regime, with actual systems tending toward one or the other.
One is a fixed-rate system, in which national currencies are tied to each other at a publicly announced (often legally established) parity. Some fixed-rate systems involve a common link to a commodity such as gold or silver; others use a peg to a national currency such as the US dollar. The other ideal-typical monetary regime is is a free-floating system, in which national currency values vary according to market conditions and national macroeconomic policies. There are many potential gradations between these extremes. In the past 1 50 years, the world has experienced three broadly defined international monetary orders.
For about 50 years before World War l, and again in substantially modified form in the 1920s, most of the world’s major nations were on the classical gold standard, a quintessential fixed-rate system. Under the gold standard, national governments announced a fixed gold value for their currencies and committed themselves to exchange gold for currency at this rate. From the late 1940s until the early 1970s, the capitalist world was organized into the BrettonWoods monetaryorder, a modified fixed-ratesystem. Under BrettonWoods, national currencies were fixed to the US dollar and the US dollar was fixed to gold.
However, national governments could and did change their exchange rates in unusual circumstances, so that currencies were not as firmly fixed as under the classical gold standard. From 1973 until the present, and briefly in the 1930s, the reigning order has been one in which the largest countries had more or less freely floating national currencies with no nominal anchor, whereas smaller countries tended either to fix against one of the major currencies or to allow their currencies to float with varying degrees of overnment management.
Monetary regimes can be regional as well as global. Within the international free-for- all that has prevailed since 1973, a number of regional fixed-rate systems have currencies of relatively small countries to the currency of a larger nation; for instance, the CFA (African Financial Community) franc zone ties the currencies of 12 African countries to each other and to the French franc (and now to the euro). Several countries in Latin America and the Caribbean have similarly tied their currencies to the US dollar, and others are considering this link.
Another type of regional fixed-rate system involves the linking of a number of regional currencies to one another, often as a step toward adoption of a common currency. This has been the case with European monetary integration, which began with a limited regional agreement, evolved into something like a Deutsche mark link, and eventually became a monetary union with a single currency and a common European central bank.
Countries in the Eastern Caribbean and southern Africa have also developed monetary unions. Our dependent variables, then, are (a) the national exchange rate policies of articular national governments, especially their choice of the level and regime of their currencies; and (b) the international monetary regime, especially the degree to which currencies are fixed against one another. To be sure, these two dependent variables are Jointly determined.
National policy choices depend on the character of the international monetary system, and the evolution of global monetary relations is powerfully affected by the decisions of the major trading and investing nations. By the same token, international monetary relations interact with other economic policies. Currency misalignments have often led to protectionist pressures and even trade wars, Just as the evolution of trade relations affects exchange rate policy choices.
Policies toward international financial and investment flows are similarly affected by, and affect, exchange rate movements. These complex interactive effects are important, but we do not know how to think about them in an integrated and systematic way. This essay focuses on the political economy of international monetary policy in and of itself, emphasizing potential answers to our two more narrowly defined explanatory questions.
Cognate literatures on the political economy of other important international economic policies are useful to the analysis of international monetary policy. Analyses of international trade and investment begin with a prior notion of the distributional interests at stake??”factoral, sectoral, and firm-specific??”derived either from theory or from empirical investigation. They then explore how these interests are aggregated and mediated by such sociopolitical institutions as labor unions and business associations, political parties, electoral systems, legislatures, and ureaucracies.
Finally, they explore the interactions between these nationally derived policies and those of other countries, especially in contexts in which interstate strategic interaction is likely to be important, such as where national government policies depend on the responses of other governments. The emerging structure of analysis and explanation of international monetary and financial politics follows this pattern. In the next section, we summarize the domestic level of analysis, especially how interests and institutions interact in the formation of national policy.