Ch 19 Flashcards
(31 cards)
Internal balance
Macroeconomic goal of producing at potential output (full employment) and of price stability (low inflation)
Y > Yf
Overemployment -> P rises -> inflation rises
Hi inflation
Pi > 10!! Price volatility (std deviation less predictable) + borrower wins
Y < Yf
Underemployment -> P falls -> possible recession/deflation
Low inflation
Borrowers LOSE and LIQUIDITY TRAP (economy slowing and cannot lower R further)
External Balance
Achieved when CA is balanced
Negative CA
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)
Positive CA
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
Sudden Stop
County unable to pay debt -> foreigners reluctant to lend new funds + possible demand repayment of earlier funds (take back their money -> shrink GDP)
Intertemporal consumption smoothing
Limits each country’s spending over time to levels it can repay w interest (borrowing -> make consumption smoother)
Can a country borrow forever?
Yes, if it’s growth rate is near the interest it’s paying on its debt (I.e. New Zealand)
Open economy trilemma
Can only achieve two of the following:
1) Exchange Rate stability
2) MP (oriented towards domestic goals)
3) Freedom of Intl K movements
Under Breton Woods System, where on trilemma are we?
IMF took freedom of financial flows (we have MP and fixed E)
Gold Standard (1870-1914
Prices adjusted according to amount of good circulating in economy which affected CA
Price specie flow mechanism
Adjustment of prices as gold flows in/out of country, reducing CA surplus/deficit
Inflows -> Inflate P
Outflows -> deflate P
If UK had CA > 0 how does it go back to CA = 0?
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)
Did UK CA SURPLUS go away in reality?
NO, kept gold by keeping high R using sterilized intervention to pay w comp of assets
Rules of Game
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
Who had the strongest incentive to practice rules of the game?
Banks with low gold reserves -> cannot redeem currency w/o gold and gold earns no interest
GS in practice + drawbacks
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
Interwar Years
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
Breton Woods System (1944 - 1973)
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)
IMF role?
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)
Principal tools for external/internal balance?
Internal: FP
External: borrow from IMF + restrict financial flows + infrequent changes in E
