Theory of International Monetary Relations - Literature review Example

Money and Finance Introduction - Theory of International Monetary Relations Integration in capital markets has resulted in political ramifications in many countries, as well as alterations in the macroeconomic behavior. With the increased movement of capital across borders, the macroeconomic policies available to states are methodically restricted. With the enhanced integration of finance worldwide, there has been increase in the cost of implementing monetary policies that have expanded from regional to international trends. While acceptance and implementation of policies hold different concepts in different nations, it is the external controls that shape the changing pattern of monetary policy behavior of states. Although there is a common accepted theory regarding the impact of international monetary movement on politics and policy, there are various opinions about the type of changes that occur in the international financial environment, the limitations that policy makers experience and the changes in the economic connections between states. One argument has stated that although there is restricting impacts of global financial integration on macroeconomic policies, the national policies nevertheless to a large extent remain unaffected. The impact of capital movement on people of different social and economic backgrounds has also been analyzed along with its influence on national policy makers. Moreover, with increased mobility of capital in international level, there has been growing competition between countries to access international capital and monitor it. In essential, capital mobility refers to “the capacity of capital to cross borders rather than to actual flows of money” (Andrews, 195). In other words, movement capital indicates the absence of restrictions and hindrances for smooth flow of capital across borders. Since different countries have different expectations of returns from capital, therefore the ability of capital movement is not always implicitly expressive. However since countries have freedom in following monetary policies, their different objectives generally generate profit incentives. Capital movement is determined by the various rates of expected profit from different levels of asset mobility. In the foreign exchange market, the balance can be negatively affected with the various degrees of asset movement like there can be excessive supply or demand in the foreign exchange market. In reality, governments cannot remain ignorant about the external values of their currencies nor can they ignore the extent of accumulation of foreign exchange. Therefore, lack of stability in the foreign exchange market will most probably affect the “combination of changes in both the exchange rate and reserves” (Andrews, 195). Thus, it has been established that following monetary policies that have been structured by global trends can lead to unwanted pressures from the foreign exchange market. Therefore, nations feel the motivation to solve that discrepancy. Therefore, the extent of capital movement across international borders causes a direct relation between exchange rate controls of different states and their follow up of monetary policies that they have selected independently. This relation is maintained by the economic model that affects the decision making process of policy makers and also the extent to which they prefer any particular monetary policy. In short, it can be deduced that “the degree of international capital mobility systematically constraints state behavior by rewarding some actions and punishing others” (Andrews, 197). However, there is a second perspective. It states that the extent of capability of capital movement across international borders is affected by the decisions made by the national level policy makers about liberalization of national financial markets. According to this view, it is the decisions made by the national policy makers that make international financial integration possible. In respect to increase in capital movement not affected by national regulatory frameworks, the author has stated three well defined causes. Firstly, there is technological and communication development that smoothens the international mobilization of private capital. Technology plays a significant role in modifying the environment within which both private and public firms operate. Secondly, technological developments have contributed towards introduction of new financial instruments by financial firms that also enhance the movement of capital across international borders. The Euro market has developed because of such development. Finally, the political parties play an important role in removing all barriers that impede the movement of capital across border, i.e. liberalization of domestic capital market. This further facilitates international capital movements (Andrews, 198). On the other hand, liberalization of national level capital market or the decisions of the governments regarding regularization of financial market often occurs due to pressure from the system. A system “consists of a structure and interacting units” (Andrews, 199). This structure is subjected to change depending on technological innovations and changes in capital mobility across borders. Thus a change in the system takes place that leads to new kinds of adjustment and adaptation. From the discussion so far, it can be seen that today’s international economic market is characterized by greater mobility of capital across borders. This is enhanced by technological developments, national level decisions to regulate financial markets and economic conditions. Today many business organizations and political leaders have observed that such ease of capital mobility makes industrial nations subsets on one international market. Such vast change in the international economy has led to “European Community (EC) movement toward a single currency, harmonization of taxes across national borders, and international convergence of macroeconomic policies” (Frieden, 425). The economic and political ramifications of global movement of capital are immense and require further research. Although Andrews (1994) in his article have explored the impacts of capital mobility across borders on politics and government financial market policies, Frieden (1991) mentions other types of capital like equity and sector specific capital that have limited mobility. Sectoral policies and exchange rate policies remain possible in the context of international capital mobility. Frieden has also explored the preference level of groups from different social and economic backgrounds regarding financial integration policies. He has focused on the various influences of global movement of capital on the groups and whether the groups are more positively affected after financial integration than before. In response to the influences, respective groups also react politically differently within the changing economic environment. Firstly, it has been seen that in the long run international financial integration has more impact on capital than labour especially in the developed countries. However, it is the short run impact of international financial integration that influences the politics and policies. In the short run, international financial integration “favors capitalists with mobile or diversified assets and disfavors those with assets tied to specific locations and activities such as manufacturing or farming” (Frieden, 426). The different impacts of international capital market integration on various social and economic groups can be studied only if national level economic policies can be implemented on global integrated financial market. During the 1970s and 1980s, it was observed that increased capital mobility across borders has great impact on national level economic policies. For instance, between the years 1978 to 1982 the huge inflow of private finances drowned the conservative policies of Chile. In the middle of 1981, the French socialist government strived towards inflating its economy and this resulted in massive outflow of capital leading to crisis of franc. Therefore, immediately the government was forced to withdraw its economic expansion policy. There are numerous such instances that prove that global mobilization of capital in the international financial integrated market can positively or negatively affect government policies. Regarding the impact of global mobilization of capital John Freeman stated, “the nation state has become at best immobilized and at worst obsolete” (Frieden, 427). In order to compare the current impact of global capital mobilization with the past, it has been observed that in the aftermath of World War II long-term capital movement was based only on foreign direct investment. In the past few decades, such investments have become massive, and direct investment is often replaced by other forms of cross border capital movements. The constant development of technology and communication has resulted in facilitating numerous short term global financial transactions leading to growing demand of short term financial instruments. Although in recent years there have tremendous increase in capital movement between countries, it is still observed that international borders acts as barriers to free movement of capital to a large extent leading to reduced international investments. One reason behind this is currency risks that exist when capital moves from one country to the other. The fluctuations in exchange rates can disturb the expected returns on international investments. Secondly, it is also the type of capital that decides its movement across borders. While some forms of capital like bonds and bank claims have greater cross border mobility, there are other forms of capital like managerial and technological skills that are more geographically oriented (Frieden, 429). Conclusion Therefore, it can be concluded that although global capital movement can affect the politics and policies of governments, it is nevertheless dependent on the type of capital and the level of currency risks due to fluctuating exchange rates. Therefore these factors along with the interests of different socioeconomic groups must be taken into account in order to assess the position of national policies in the context of international economy. References Andrews, David M. “Capital Mobility and State Autonomy: Toward a Structural Theory of International Monetary Relations”, International Studies Quarterly, 38.2 (1994) 193-218 Frieden, Jeffry A. “Invested interests: the politics of national economic policies in a world of global finance”, International Organization, 45.4 (1991) 425-451 Read More