International Monetary Systems: Global Imbalances And The Policy Trilemma

Question 1

What is the internal balance?

Answer 1

• macroeconomic goals of producing at potential/full employment level of output and of price stability (low inflation)

Question 2

What is external balance?

Answer 2

• achieved when CA is neither so deeply in deficit that the country may be unable to replay its foreign debt
• not so strongly in surplus that foreigners are put in that position

Question 3

What is the policy Trilemma?

Answer 3

Impossible for a country to achieve more than 2/3 from the following list:

1: Fixed E (Ee-E/E=0)
- promote stability in trade and investment

2. International capital mobility
   R=R*+Ee-E/E
   - promotes integration, efficiency and risk sharing
   - improves diversification
3. Monetary policy independence
   R=\R*
   - manage fluctuations

Question 4

Describe historical overview

Answer 4

• gold standard era 1870-1914
• IMS 1918-1939
• Bretton Woods 1944-1973
• collapse of Bretton Woods

Question 5

4 reasons supporting floating exchange rates ?

Answer 5

1. Monetary policy independence
2. Automatic stabilisation
3. Flexible Exchange rates may prevent speculation
4. symmetry

Question 6

If USA increases Ms AA-DD model predicts an increase in US output and income in the SR. What would be the effects for Japan?

Answer 6

• increase in US output and income would raise demand for Japanese products
• inc. AD and output in Japan
• depreciation of USD means appreciation of yen
• lowering demand for Japanese product
• decreasing AD and output in Japan
• total effect is ambiguous

Question 7

USA permanently increases government purchases, AA-DD model predicts an appreciation of USD. What are the effects for Japan and subsequent effects for USA?

Answer 7

• USD appreciation means a depreciation of the yen
• raising demand for Japanese’s products
• increasing AD and output in Japan

Subsequent effects for USA

• higher Japanese output and income means that more income is spent on US products
• inc. AD and output in USA in the SR

Question 8

Describe how the internal balance can be restored after a fiscal expansion?

Answer 8

• fiscal expansion increases AD so Y>Yf
• revaluation of domestic currency must occur (fall in E)
• revaluation makes unit of domestic currency more valuable
• dkwmstic goods more expensive
• CAB falls
• Y falls until it =Yf

Question 9

Describe how after a fiscal expansion the external balance can be restored

Answer 9

• fiscal expansion increases AD and output Y>Yf
• domestic currency appreciates and CAB worsens
• devaluation of domestic currency
• rise in E required to restore external balance