Week 8: Not Managing the Global Economy

Question 1

How has global trade risen over time?

Answer 1

-exported goods as a share of GDP has risen

-lower than today

-all regions, usually more rapidly than income

Question 2

Who dominates trade?

Answer 2

Western Europe

Question 3

Why did trade rise?

Answer 3

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​

Question 4

Trade facts and stats in Britain 1871-1914?

Answer 4

-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

Question 5

Name two international economic institutions?

Answer 5

-Multilateral settlements

-Gold Standard

Question 6

How do we make multilateral settlements work?

Answer 6

-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’

Question 7

What is the gold standard?

Answer 7

-Currencies worth a fixed amount of gold.​

Question 8

How was the Gold standard enforced?

Answer 8

-Price-specie flow
-‘Rules of the game’

Question 9

How does price-specie flow 7 steps?

Answer 9

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

Question 10

What are effects of price-specie flow?

Answer 10

Depends on how flexible prices and wages are​

Less flexibility -> real income follows changes in nominal income​

Less flexibility -> Deficit countries suffer unemployment​

Question 11

What are the ‘Rules of the game’

Answer 11

Central banks supposed to reinforce the adjustment process with monetary policy​

​

Question 12

What are the 7 steps of the rules of the game?

Answer 12

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

Question 13

Rules of the game effects?

Answer 13

-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​

Question 14

Why play by the rules?

Answer 14

-Less pressure not to in limited democracy​

-Kramer and Milionis more democratic countries less likely to stay on gold.​

Question 15

Advantages to Gold?

Answer 15

-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 0.235 oz of gold when the debt matured

Useful to peripheral nations such that lacked credibility

Question 16

Why did the Gold Standard work?

Answer 16

-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, as they had to make fewer adjustments.​

Gold standard in effect a sterling standard​

Question 17

How did Britain settle trade surplus?

Answer 17

-through capital outflows

-instead of asking for money, uses the money owed as capital investment

Question 18

Why did the Gold Standard not work?

Answer 18

-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

Question 19

Explain macro trilemma?

Answer 19

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

Question 20

Macro Trilemma in relation to Gold Standard?

Answer 20

sacrificed independent monetary policy to maintain fixed exchange rates and allow free capital mobility.

Question 21

Challenges of gold standard and trilemma?

Answer 21

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.

Question 22

How do multilateral payment networks occur?

Answer 22

-organically

-driven by the evolving trade patterns and economic relationships between nations