Lecture 10 - webnotes - Introduction Organizing principles...

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Lecture 10: Globalization & international monetary regimes Introduction Organizing principles The rise & fall of the gold standard Woods
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Introduction There has been tremendous variety in international monetary regimes… Silver/bimetallic/gold standards and floats in the first wave of globalization. Floats and the gold standard in the interwar. Floats, a gold exchange standard, and various pegs in the second wave.
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Introduction The history of international monetary regimes summed up in one picture:
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Introduction The key policy issue here is whether countries fix (or peg) their exchange rate or let it to be determined by the market (float). If we understand countries’ constraints and subsequent decisions, we might be able to explain historical patterns like: • GS (70%) versus pure float, 1913 • GS (0%) versus pure float, 1939
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Introduction We want to examine in more detail countries’ experience with international monetary regimes. We also want to answer the question of why countries fix their exchange rates. We also want to answer the question of what allows countries to fix their exchange rates. But first, some organizing principles.
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Organizing principles First, let’s define what we mean by a fixed exchange rate regime. This is a policy adopted by a country in which the relative value of their currency is fixed in terms of another currency (or basket of currencies).
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Organizing principles Second, let’s consider why a country might peg their exchange rate. Simply, a peg might boost trade and capital flows (especially long-term). Why? A reduction in uncertainty over payments and profits; also, a reduction in transaction costs.
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Organizing principles But do countries that have a peg trade more with each other (all else equal)? Use a gravity model: 1 2 12 12 12 1 1 2 2 12 3 12 ln( ) ( ) ln( ) ( ) n n GDP GDP Trade d Trade GDP GDP d peg β = = - +
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Organizing principles
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Organizing principles Gains from a peg are larger when cross- border transactions are larger in size. That is, a country is more likely to enter a pegged exchange rate with another country if they already trade a lot with one another. This is another problem with endogeneity: • establishing a peg generates more trade
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Organizing principles If pegs stimulate trade and investment (and provided these are good things), then why don’t all countries peg their exchange rates? As it turns out, there are costs associated with a fixed exchange rate regime. This is referred to as the open economy trilemma (or the “unholy trinity”).
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Organizing principles So, what is this trilemma business? A trilemma is when there are three options
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This note was uploaded on 09/13/2009 for the course ECONOMICS Econ 382 taught by Professor Davidjack during the Spring '09 term at Simon Fraser.

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Lecture 10 - webnotes - Introduction Organizing principles...

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