Ch 19

Question 1

Internal balance

Answer 1

Macroeconomic goal of producing at potential output (full employment) and of price stability (low inflation)

Question 2

Y > Yf

Answer 2

Overemployment -> P rises -> inflation rises

Question 3

Hi inflation

Answer 3

Pi > 10!! Price volatility (std deviation less predictable) + borrower wins

Question 4

Y < Yf

Answer 4

Underemployment -> P falls -> possible recession/deflation

Question 5

Low inflation

Answer 5

Borrowers LOSE and LIQUIDITY TRAP (economy slowing and cannot lower R further)

Question 6

External Balance

Answer 6

Achieved when CA is balanced

Question 7

Negative CA

Answer 7

Pros: financing + good investment projects
Cons: borrower to rest of world, can lose in bad investment project, and paying interest on debt (accumulating debt piles R further)

Question 8

Positive CA

Answer 8

Pros: You’d rather be a lender for more power + investment opportunities
Cons: Money doesn’t go into domestic (losing K), cannot collect taxes from abroad, recovery issues, and trade wars

Question 9

Sudden Stop

Answer 9

County unable to pay debt -> foreigners reluctant to lend new funds + possible demand repayment of earlier funds (take back their money -> shrink GDP)

Question 10

Intertemporal consumption smoothing

Answer 10

Limits each country’s spending over time to levels it can repay w interest (borrowing -> make consumption smoother)

Question 11

Can a country borrow forever?

Answer 11

Yes, if it’s growth rate is near the interest it’s paying on its debt (I.e. New Zealand)

Question 12

Open economy trilemma

Answer 12

Can only achieve two of the following:
1) Exchange Rate stability
2) MP (oriented towards domestic goals)
3) Freedom of Intl K movements

Question 13

Under Breton Woods System, where on trilemma are we?

Answer 13

IMF took freedom of financial flows (we have MP and fixed E)

Question 14

Gold Standard (1870-1914

Answer 14

Prices adjusted according to amount of good circulating in economy which affected CA

Question 15

Price specie flow mechanism

Answer 15

Adjustment of prices as gold flows in/out of country, reducing CA surplus/deficit
Inflows -> Inflate P
Outflows -> deflate P

Question 16

If UK had CA > 0 how does it go back to CA = 0?

Answer 16

Gold earned from X flows into UK > Raises Puk lowers foreign P > goods from UK become expensive + foreign cheap > reduces CA surplus of UK (and deficits of foreign countries)

Question 17

Did UK CA SURPLUS go away in reality?

Answer 17

NO, kept gold by keeping high R using sterilized intervention to pay w comp of assets

Question 18

Rules of Game

Answer 18

Another adjustment process carried out by CBS
1) sell domestic assets to get money when imports cause gold outflows. Ms falls and R rises, attracting financial inflows to match CA deficit (REVERSED outflows)

2) buy d assets w gold inflow-> Ms rise and R falls -> reduces inflows to match surplus

Question 19

Who had the strongest incentive to practice rules of the game?

Answer 19

Banks with low gold reserves -> cannot redeem currency w/o gold and gold earns no interest

Question 20

GS in practice + drawbacks

Answer 20

CBS w hi gold reserves seldom followed rules and often sterilized gold flows to prevent affects on Ms and P. Caused recession + higher unemployment

Drawbacks: NO MP and limited gold

Question 21

Interwar Years

Answer 21

GS stopped in 1914 and resumed 19-33. Halves:
1: Churchill messed up > pulled £ from market to get to prewar levels of E > recession
2: countries that left GS did better > created beggar thy neighbor policies to benefit their currencies at others expense (ie Arg > Bra) and countries became islands to counter this

Question 22

Breton Woods System (1944 - 1973)

Answer 22

Just like GS but w $ > fixed E against US $ and fixed $ price of gold
Established
1) IMF (international monetary fund)
2) WB (world bank)
3) GATT (general agreement on trade and tariffs)

Question 23

IMF role?

Answer 23

Central role w 3 facilities:
1) conditionality > lend to countries to devalue their currency
2) fundamental disequilibrium > sustained inflow ≠ outflow; devaluation/revaluation permission
3) capital control > CANNOT freely flow (trilemma)

Question 24

Principal tools for external/internal balance?

Answer 24

Internal: FP

External: borrow from IMF + restrict financial flows + infrequent changes in E

Question 25

Policies for internal + external balance

Answer 25

1) Expenditure switching > E, depends on IMF
2) Expenditure changing > G (lose MP, only move horizontal on graph)

Question 26

Why did BW collapse?

Answer 26

Capital controls breached > leads and lags in trade > heavy speculation US currency would depr by fundamental disequilibrium so investors bought large quantities of foreign currency to SHORTSELL

Question 27

How is Great Depression linked to GS?

Answer 27

GS played a central role in starting GP and spreading it. US tried to slow economy by lowering Ms while France faced larger fin inflows after an inflationary period and both countries absorbed gold at alarming rates. Other GS countries had to sell domestic assets to raise R and conserve their gold. Result: WW Ms contraction and recession

Question 28

Case for Floating Exchange Rates (did they hold after 1973?)

Answer 28

1) MP Autonomy (YES)
2) Automatic Stabilization (Yes - Reagan FP expansion)
3) prevent speculation (no)
4) symmetry (no - $ still held as reserved currency and foreigners affected by US policy)

Question 29

GS vs BW

Answer 29

GS = free flow of K + G
BW = MP but no free K flow

Question 30

Case Study: 1933 - 85

Answer 30

OPEC shock > Us lowers R and EU raises R > EU angry since dollar is weaker
2nd shock: US rises R which appreciates dollar, EU imports inflation and raises R which causes WW recession
Reagan fixes this through FP expansion

Question 31

Case Study: 85 - Now

Answer 31

1) JP depr currency by lowering Ms too much > asset price bubble > recession > spreads to East Asia (trilemma)
2) ERM crisis > speculation > Germany reunification raises R > UK had to raise R since they are pegged
3) Saving Glut > Chinese growth > $ assets bought > lots of inflow to Us
4) 2008-9 crisis > asset bubbles in housing > lower R > P lowers > crisis
5) Pandemic > deep recession > inflation rises > Trump: cut taxes and import tariffs