Lecture 21
FLOATING EXCHANGE RATES: 1973 - PRESENT

1973: Collapse of the Bretton Woods system

• Exchange rates were allowed to float

• Supply-side shocks
  • First oil shock
    • OPEC oil embargo
    • Price of oil quadrupled, from $3 to $12 a barrel

  • Poor farm harvests
    • Farm prices went up

  • Results in the industrialized countries:
    • High inflation
    • Recession
    • Current account deficits

  • How did the U.S. react?
    • Expansionary monetary and fiscal policies
    • GNP increased
    • Inflation remained high (the dollar depreciated)
    • The CA remained in deficit

1979: Paul Volcker became Chairman of the Fed

• Second oil shock
  • Fall of the Shah of Iran; threat of spreading revolution
  • Oil price went from $13 to $32 a barrel

• Results
  • Inflation and recession
  • The Fed used contractionary monetary policy
  • High interest rates and high unemployment
  • The dollar started to rise

1981-1985: Expansionary fiscal policy in the U.S.

• Also, looser monetary policy
• GNP rose; inflation slowed down
• Dollar appreciated considerably
• CA deficit increased

1985: The Plaza accord

• The G5 countries decided to drive the $ down
• The $ declined through 1986 and 1987

1987: The Louvre accord

• The G5 and Canada decided to stabilize nominal exchange rates
• Target zones were set up; to be defended by intervention

The 1990s: Infrequent intervention

• The Era of Robert Rubin