Week 4 Flashcards
What are the 3 liberalisms and their time period
1) Classical liberalism (late 1800s until ww1) Gold standard was present
2) embedded liberalism (Bretton woods) from 1945 - 1972
3) Neo liberalism 1972 onwards
What is the impossible trinity
It is an economic concept that dictates that a state cannot have all 3 policy conditions at the same time. You can have 2 but would need to surrender 1 of the following…
1) Free K mobility ( top of the pyramid)
a) classical liberalism (eurozone members) in between 1 and 3
2)independent monetary policy (policy autonomy)
b) embedded liberalism/ Bretton woods (china?) in between 2 and 3
3) Fixed exchange rates
c) most countries today eurozone (collectively) “neoliberal” in between 1 and 2
How did the impossible trinity develop across different time periods
The “impossible trinity,” also known as the “trilemma,” refers to the notion that it is impossible to simultaneously achieve three goals: a fixed foreign exchange rate, free capital movement, and an independent monetary policy. Over time, the dynamics of the impossible trinity have evolved in response to global economic developments. Here’s a brief overview of its evolution:
Pre-Bretton Woods Era (Pre-1944): Before the establishment of the Bretton Woods system, countries largely operated under the gold standard, where currencies were fixed to gold. At that time, capital movements were limited, and countries generally maintained fixed exchange rates. Central banks prioritized maintaining exchange rate stability over independent monetary policy.
Bretton Woods System (1944-1971): The Bretton Woods system emerged after World War II, with the U.S. dollar as the international reserve currency pegged to gold, while other currencies were fixed to the dollar. During this period, countries aimed to maintain exchange rate stability and limit capital flows. However, as outlined earlier, the system faced challenges and eventually collapsed due to exchange rate pressures and the strain on the U.S. gold reserves.
Flexible Exchange Rates and Capital Controls (1970s-1990s): Following the breakdown of the Bretton Woods system, countries increasingly shifted toward flexible exchange rate regimes. This allowed for greater adjustment to economic shocks and reduced the need for large-scale intervention to defend fixed exchange rates. Additionally, some countries implemented capital controls to manage capital flows and reduce volatility.
Financial Globalization and Floating Exchange Rates (Late 1990s-Present): The rise of financial globalization, advancements in technology, and liberalization of capital flows led to a trend towards floating exchange rate regimes. Many countries embraced market-determined exchange rates, allowing currencies to float freely. Central banks focused on inflation targeting and independent monetary policy to stabilize domestic economies.
Managed Float and Exchange Rate Regimes (Present): While floating exchange rates have become more prevalent, some countries still manage their exchange rates to varying degrees. Some employ managed float regimes, where central banks intervene in the foreign exchange market to influence their currency’s value. Others adopt currency pegs or bands within which exchange rates are allowed to fluctuate.
example countries:
Fixed Exchange Rate and Free Capital Movement (Sacrificing Monetary Policy Autonomy):
Hong Kong: Hong Kong operates under a currency board system where its currency, the Hong Kong dollar (HKD), is pegged to the U.S. dollar (USD). This maintains a fixed exchange rate and allows for free capital movement, but it limits the ability of the Hong Kong Monetary Authority to conduct an independent monetary policy.
Fixed Exchange Rate and Independent Monetary Policy (Restricting Capital Movement):
China (prior to 2005): Before 2005, China maintained a fixed exchange rate regime by pegging its currency, the Chinese yuan (CNY), to the U.S. dollar. To maintain the peg, China implemented capital controls, restricting the movement of capital in and out of the country. This allowed for a fixed exchange rate and an independent monetary policy, but limited capital flows.
Free Capital Movement and Independent Monetary Policy (Allowing Flexible Exchange Rates):
United States: The United States, with a floating exchange rate regime, allows for free capital movement and an independent monetary policy. The Federal Reserve has the authority to adjust interest rates and implement monetary policy measures without being constrained by fixed exchange rates.
Fixed Exchange Rate and Free Capital Movement (Sacrificing Monetary Policy Autonomy):
Eurozone Countries: The majority of EU member states within the Eurozone have adopted the euro as their common currency. This entails a fixed exchange rate arrangement within the Eurozone, as the euro’s value remains consistent across member countries. As a result, these countries give up independent monetary policy, which is determined by the European Central Bank (ECB). Free capital movement is facilitated among Eurozone countries.
Fixed Exchange Rate and Independent Monet
What was the role of the USD and its evolution across periods (EXPLAIN)
What is Free movement of capital (trinity)
Free movement of money.
benefits: facilitates growth through investment, diversification of investment portfolio, awaiting foreign currency. Thus more opportunities
Negatives:
risk for capital flight (if large scale event happens that causes people to withdraw money and currency devaluates or capital controls will be imposed)
- speculation leads to capital flight, large changes.
What is monetary policy autonomy (trinity)
Autonomy over a states own monetary policies and choices.
Benefit: can print money alone
- in a recession you can depreciate your own currency and lower interest rates so as to speed up growth.
negatives:
- exchange rate volatility: When a country adjusts its interests rate or money s supply due to domestic conditions, it could impact its currency value in comparison to others
- inflation risk if monetary policy too unregulated and CB prints too much money as an example, or interest rates too low
What are fixed exchange rates (trinity)
Benefits:
- more predictable
- stable
- inflation control as monetary policies can help support the peg to a certain currency.
- reduced transaction costs
- no exchange rate risk
Negatives:
- loss of monetary policy autonomy
- more vulnerable to shocks as it becomes hard to adjust fixed exchange rate to remain competitive and address economic imbalances.
Why can you not have all 3 in the impossible trinity:
Because not all 3 can be satisfied at once. Lesson can be found within France in 1981, under the leader Mitterrand:
They wanted to achieve all 3, thus have free policy autonomy, free capital flows while having a fixed exchange rate.
Maintaining fixed exchange rate became difficult once currency was under pressure after increased government spending and borrowing which put pressure on interest rates, since government wanted to fulfill monetary policies.
- then tried to maintain fixed exchange rates by using reserves, but this was not possible in the long run.
- then exchange rate became more flexible and proved impossible trinity.
Why is Switzerland often referred to as a “dirty floater”
their exchange rate regime often combines both fixed and floating exchange rates. The CB sells or buys its currency in large quantities to maintain a desired exchange rate level or prevent excessive currency appreciation.
- Market intervention that makes them not a fully floating currency
Classical liberalism
- Free K movement
- fixed exchange rates
rigidly fixed rates of all currencies to Gold
What was the Gold standard and what were the problems with the Gold standard?
The gold standard, a monetary system in which the value of a country’s currency is directly linked to a specific quantity of gold.
Problems:
- Internal devaluation
- Devalue internal labour cost (cut wages)
- Money supply limited by the availability of Gold
- inflexibility in monetary policy
- speculative attacks
Eichengreen said that Gold Standard does not work with democracy
however, countries were not democracies back then
Embedded liberalism
During the war:
states changed the value of currency and gave it their own currency.
- then tried to go back to Gold standard but there was too much money and not enough Gold
-BRETTON WOODS AGREEMENT: (US,UK agreement) 1944 to 1971
It was:
-fixed exchange rate
-monetary autonomy
in order to pursue full employment as it created jobs, however, no free capital movement
all currencies were fixed to USD and the USD were fixed to Gold.
Problem with this:
Inflation was extremely rapid, capital mobility came back and the fixed exchange rate starts to mess up.US was also waging war in Vietnam.
- Dollar overvaluation: trad deficits for U.S and faced pressure on its gold reserves. Confidence in the system dropped as US dollar was overvalued.
- Drain in Gold reserves due to speculators.
- Bretton woods limited countries’ ability to conduct independent monetary policy as they were pegged to U.S dollar.
- increase demand for gold as distrust in US dollar rose effectively resulted in end of Bretton woods system.
FPI and others not allowed during BWS. IMF and world bank created to protect exchange of currencies.
What is internal devaluation?
internal devaluation: instead of
devaluating currency, you devaluate wages that make the currency
B. EICHENGREEN said: forcing a gold standard on all countries will only lead to pressure
to put wages down, which is too intense for a country
What is stackflation?
Unemployment and inflation suddenly together
Neoliberalism
Monetary Policy Autonomy + Free Movement of Capital
aka no fixed exchange rate
● international financial crises are endemic to international economy
● Fiat money with USD as most important currency
o Fiat money = money that has no anchor, no tangible thing that it is linked to (so no gold standard e.g.,) money that is worth what the market says
