Lecture 6 - EC 60: Lecture 19 April 16, 2009 The...

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EC 60: Lecture 19 April 16, 2009 The International Monetary  System The Floating Exchange Rate  Period 1973-present
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The fiscal expansion started to  push up interest rates in the  U.S. 1967-68 The Federal Reserve tried to  bring interest rates down with a monetary  expansion. The monetary expansion coupled with the  fiscal expansion began to push up prices. The rise in prices in the U.S. eroded our  international competitiveness. The U.S. current account went into a  deficit.
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The U.S. is in trouble The rise in prices in the U.S. means that  the dollar is over-valued. The U.S. economy is in fundamental  disequilibrium. The U.S. has been so dominant for so  long that no one really realizes how  serious the situation is. Also, economists don’t completely  understand how a fixed exchange rate  system works.
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But the speculators saw a  weakness Late 1967 – early 1968 London gold market Speculators began buying gold, thinking  that the U.S. might have to raise the price. Massive gold sales by the Federal  Reserve and European Central Banks.
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Two-tiered system Private gold market in which the price  would be allowed to fluctuate. Only central banks could come to the  Federal Reserve and sell dollars for gold  at the fixed $35 per ounce. Without realizing it, the U.S. had jettisoned  the fundamental stabilization mechanism  in the system.
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To make matters worse The U.S. economy slid into a recession in  early 1970. The U.S. economy now had the worst of  all worlds: inflation, unemployment, and a  current account deficit.
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Policy Dilemma Fiscal expansion would help with the  unemployment but worsen the current  account deficit. A monetary expansion might also help  with the unemployment but worsen  inflation and the current account.
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Only one way out: Devaluation
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Only one way out: Devaluation Only one problem: The United States had no  control over its exchange rate.
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The U.S. would have to go to one 
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This note was uploaded on 04/29/2009 for the course ECONOMICS 60 taught by Professor D.brown during the Spring '09 term at Tufts.

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Lecture 6 - EC 60: Lecture 19 April 16, 2009 The...

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