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Operation of Fixed Exchange Rate Systems Review the ppt module.  Be comfortable explaining the operation of fixed exchange rates using supply and demand analysis.  Understand how exchange market intervention affects the supplies of money in private circulation and how this would affect price levels. Explain the benefits and costs of fixed exchange rates. The International Gold Standard, the Bretton Woods System How did the International Gold Standard provide a system of fixed exchange rates?  Was it successful?  What were its limitations?  Why did it disappear as an international monetary system? How was the Bretton Woods System designed to improve upon the Gold Standard?  Why did the Bretton Woods System collapse? Optimal Currency Areas and the Euro Review the ppt module on this topic.  Under what conditions are a group of countries likely to benefit from sharing a common currency?  Is Europe an optimal currency area?

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Fixed Exchange Rate Systems
The Gold Standard, 1870-1913
Bretton Woods System, 1947-1973
European Monetary System

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How Can a Government Fix the Foreign Exchange Value of its
Currency?
Case A:
Sell dollars for pounds when there is excess demand for
dollars
Case B:
Buy dollars with pound reserves when there is excess
supply
The system is self-correcting and workable.
In case A:
M
$
=>
P
$
=>
Excess Demand
In case B:
M
$
=>
P
$
=>
Excess Supply

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The International Gold Standard,
1870-1913

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How it worked
Each country allows the public to freely convert paper
currency into gold (or vice versa) at a fixed rate.
This fixes
the price of gold in terms of the domestic currency.
Because of the potential for international arbitrage, this
establishes a system of fixed exchange rates.
ex–
in Britain
1 ounce = £4.248
in U.S.
1 ounce = $20.67
which implies a gold parity exchange rate = 20.67/4.248,
or 4.87 dollars per pound
Exchange rates in currency markets stayed within +/-1% of
the gold parity rates

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Optimal Currency Areas
and the Euro

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Benefits and Costs of a Common Currency

Advantages

facilitates trade and investment

provides monetary discipline and price stability to
inflation-prone countries

Disadvantages

inability to use monetary policy (interest rate and
exchange rate adjustment) to manage uneven national
recessions and internal competitive imbalances

may lose lender of last resort protection for national
banks and national governments

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