Week 8: Not Managing the Global Economy Flashcards
How has global trade risen over time?
-exported goods as a share of GDP has risen
-lower than today
Who dominates trade?
Western Europe
Why did trade rise?
Peace 1871-1913 (third parties affected by war, influencing trade)
Transport costs fell – railways, steam ships as well as refrigeration
Communication costs fell – telegraphs
Specialisation
Trade facts and stats in Britain 1871-1914?
-Committed to free trade
-UK exports manufactures, and imports food
-UK food prices halved, 1870-1900, raising average living standards
-UK remains the world’s largest importer until 1939
Name two international economic institutions?
-Multilateral settlements
-Gold Standard
How do we make multilateral settlements work?
-everyone is happy to accept everyone else’s currency at a predictable rate
-the gold standard a mechanism to fix exchange rates and make currencies ‘good as gold’
What is the gold standard?
-Currencies worth a fixed amount of gold.
How was the Gold standard enforced?
-Price-specie flow
-‘Rules of the game’
How does price-specie flow 7 steps?
1) Imagine economy with balance of payments deficit: imports exceed exports.
2) Excess imports paid for with gold outflows
3) Money supply falls
4) Money income and prices fall
5)Fall in prices makes domestic goods more competitive at home and abroad
6) Imports fall and exports rise
7)Balance of payments deficit disappears back to equilibrium
What are effects of price-specie flow?
Depends on how flexible prices and wages are
Less flexibility -> real income follows changes in nominal income
Less flexibility -> Deficit countries suffer unemployment
What are the ‘Rules of the game’
Central banks supposed to reinforce the adjustment process with monetary policy
What are the 7 steps of the rules of the game?
1) Balance of payments deficit
2) Government RAISES interest rates
3)Investment falls
4)Output falls
5)Domestically produced product prices FALL
6)Imports fall and exports rise
7)Balance of payments return to equilibrium
Rules of the game effects?
-Applying the rules of the game implies lower output and higher unemployment
-A price (some) countries were prepared to pay to remain on the gold standard
Why play by the rules?
-Milionis more democratic countries less likely to stay on gold.
Advantages to Gold?
-Macroeconomic “Good Housekeeping seal of approval”
Perceived security for foreign investors
Useful in a world of big global capital flows, especially for capital poor peripheral countries
Good Housekeeping seal of approval” meant that investors would fund the national debt
£1 would still be worth same amount of gold when the debt matured
Useful to peripheral nations such that lacked credibility
Why did the Gold Standard work?
-Britain was Committed to Gold Standard, global trade
Ran a steady balance of payments surplus
Surplus recycled through capital flows - investing in railways (etc)
Other countries found it easier to stay on Gold
Gold standard in effect a sterling standard
How did Britain settle trade surplus?
-through capital outflows
-instead of asking for money, uses the money owed as capital investment
Why did the Gold Standard not work?
-Core countries could attract a lot of gold (money as gold backs it) by raising interest rates a tiny amount
-Peripheral countries with unclear commitments to the GS needed big interest rate premia to attract gold
-Many economies did not play by the “rules of the game”: sterilization of gold flows was common
Explain macro trilemma?
In international macro, countries can choose 2 and only 2 of:
1)Free movement of capital
2)Fixed exchange rate
3)Independent Monetary Policy (interest rate)
Key Mechanisms: Capital follows higher returns and capital flows determine the exchange rate
Macro Trilemma in relation to Gold Standard?
sacrificed independent monetary policy to maintain fixed exchange rates and allow free capital mobility.
Challenges of gold standard and trilemma?
The rigidity of the gold standard meant countries struggled to respond to economic shocks.
During a recession, a country couldn’t devalue its currency or cut interest rates to stimulate growth without abandoning the gold peg.
How do multilateral payment networks occur?
-organically
-driven by the evolving trade patterns and economic relationships between nations
