1.3 different ER regimes: from free floats to monetary unions Flashcards
what are the two major disadvantages of fixed ERs
MP unavailable for countercyclical macroec. policy,
nominal ER no longer a “real-shocks absorber”
difference between speculative attack and devaluation under flexible
runs on currency happen for both,
not as likely under flexible and typically not as big,
once currency under pressure to lose value will lose value now,
however under fixed and gov. committed could be under pressure for years and then sharp drop when it does
what is competitive devaluation and what can it cause
when say Argentina devalues currency relative to Brazil (biggest trading partner),
can cause tension between trading partners,
Brazil may then retaliate by say increasing their money supply
what is the equation that shows why Greek and Italian yields are higher than German
under fixed, it=i*t+ρ,
ρ higher for these countries
under flexible what does a positive ε shock do
upward pressure on it,
downward pressure on st,
on AA-DD diagram, pressure for AA to shift leftward/downward
under fixed what does a positive ε shock do
cannot be absorbed by upward pressure on it,
CB must absorb shock with an automatic increase in mt and shifts AA rightward/upward (output unchanged) (in diagram the curve hasn’t actually shifted just weird arrow 6/44 1.3)
why does fixed ER make sense for Argentina
lack of confidence in domestic monetary institutions,
inflation 3,000% 1989
example of country that has benefited from a weak currency
China have allowed the currency to depreciate substantially in real terms, this has made the country more competitive and has facilitated growth
under fixed how do they do a devaluation
CB do this by simply announcing that it is willing to buy and sell FOREX reserves against domestic currency at a new higher value
pros of flexible
independent monetary policy,
nominal ER can act as a real-shocks absorber,
currency crises less likely
negative of flexible
ER variability act as barrier to trade and investment flows,
nominal ER can be a source of shocks to real ER,
regime not perfectly insulate economy from negative effects of a “currency crash” (dollar denominated debt)
what is the theory of optimum currency areas
the theory of OCAs argues that the optimal area for a system of fixed exchange rates, or a common currency, is one that is highly economically integrated
what does economic integration mean
free flows of:
goods and services (trade),
financial capital (assets) and physical capital,
workers/labour
when is joining a fixed ER system beneficial for a country
if`:
trade is extensive between it and member countries,
financial assets flow freely between it and member countries,
people migrate freely between it and member countries
what else does high economic integration allow
prices to converge btw. members of a fixed ER system and a potential member
what happens if after joining a fixed exchange rate system, the new member faces a fall in aggregate demand (at)
relative prices tend to fall (pt down as long as yt