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Principles 4 and 5 are used to discuss the advantages and disadvantages of market intervention by policymakers in order to influence market outcomes and maintain a fixed exchange rate.•To begin this material you might find it helpful to start with a review of the material on purchasing power parity from Chapter 10.Features in this ChapterYour Financial World: Emerging-Markets Crises and You (page 459) If your portfolio is well-diversified, a financial crisis in an emerging market should have little effect on your investments.Applying the Concept: Malaysia Imposes Capital Controls (page 461) At the end of the 1990’s Malaysia believed that its economy was fundamentally sound and that its financial crises was similar to a bank panic. Its officials therefore took the extreme step of implementing strict capital controls, limiting investors’ ability to move funds out of the country. This also allowed them to fix the value of their currency and lower domestic interest rates. Though critics condemned the policy, Malaysia recovered in less than half the time of other countries in crisis.Applying the Concept: The Gold Standard: An Exchange-Rate Regime Whose Time Has Passed (page 468) Those who advocate a return to the gold standard claim that it would eliminate inflation. But no economist today advocates a return to the gold standard because it obligates the central bank to fix the price of something we don’t really care about. There is also the fact that under the gold standard the amount of money in the economy would depend on Instructor’s Manual t/a Cecchetti: Money, Banking, and Financial Markets14
Chapter 19 Exchange-Rate Policy and the Central Bank the amount of gold available, and any disruption in supply would have dramatic monetary policy effects. The case for the gold standard grows less persuasive when we realize that it is an exchange rate policy too. A country with a trade deficit would lose gold and be forced into deflation (and the reverse for those with a surplus). Economic historians believe that gold played a central role in spreading the Great Depression of the 1930s throughout the world. It is hard to understand why anyone would want to bring it back.Your Financial World: Should You Buy Gold? (page 470) Americans have been legally allowed to own gold since 1974, but that doesn’t mean it’s a good idea. Gold doesn’t pay interest like a bond or dividends like a stock and its price is highly volatile. Moreover, some of the largest holders of gold are today its largest sellers. Gold appears to be a hedge against inflation, but there are other better ways to manage inflation risk.Applying the Concept: China’s Fixed Exchange Rate (page 471) In the spring of 2005, people in business and government, including the U.S. Treasury Secretary, were calling for China to move away from its fixed-exchange rate regime. For a decade, China’s central bank (the People’s Bank of China) pegged the value of the Chinese currency (the yuan) at a level well below where it should be according to purchasing power parity (PPP).