Foundations of Monetary and Exchange Rate Policy PDF

Foundations of Monetary and Exchange Rate Policy Block II 2024 Dr. Toenshoff Review Questions What is the main reason discussed in class why Latin America pursued ISI while East Asia pursued EOI? - Latin America had more entrenched political interests in the manufacturing sectors -...

Foundations of Monetary and Exchange Rate Policy Block II 2024 Dr. Toenshoff Review Questions What is the main reason discussed in class why Latin America pursued ISI while East Asia pursued EOI? - Latin America had more entrenched political interests in the manufacturing sectors - East Asia is closer to large export markets - East Asia had more unskilled labor they could use to produce exports - Latin America had larger home markets for manufactured goods What is NOT true about comprehensive sanctions? - They are less humane than targeted sanctions - They work better in democracies - They could benefit elites through corruption - They have only been used since after 9/11 The Plan What is Money (and an exchange rate regime) Good For? Domestic Monetary Policy International Monetary Exchange Balance of Payments Adjustment The Unholy Trinity 3 The Function of Money: Money serves THREE functions: 1. A medium of exchange 1. Money resolves the “double coincidence of wants problem” 2. Store of value 1. Money allows individuals to convert perishable goods into more durable goods 3. Unit of account 1. Money provides a standard relationship between various goods in the economy 4 The Function of Money: Having a Currency is a PUBLIC GOOD!!! It benefits everyone! nonrival and nonexcludable Its creation and maintenance suffer from the collective action problem (both internationally and domestically) 5 Money is a Good Money responds to the same forces of supply & demand as other goods. Supply up, value down Supply down, value up Demand up, value up Demand down, value down Just because we use currency to assign value, doesn’t mean currency’s value doesn’t change. Domestically, price of money = interest rates (% you pay to borrow a Euro) Internationally, price of money = exchange rates (how many e.g. USD you need to get a Euro) 6  A Note on Terminology Terminology for changes in the international value of a currency:  Appreciate = gain value = you can purchase more foreign currency for one unit of domestic currency  Depreciate = loose value = you can purchase less foreign currency for one unit of domestic currency Exchange rate goes from 100€ = 100$ to 80€ = 100$ Did the Euro appreciate or depreciate? 7  Domestic Monetary Policy Definition:  Adjustment of the money supply in order to change domestic price levels (inflation) and economic output Whois in charge of Monetary Policy in Europe?  The European Central Bank 8  How do Central Banks do it? Interest Rates = the price of domestic money Production, employment Money supply Interest rate Consumption Inflation Dom. Investment Price (input costs, wages) The Central Production, Bank employment Money supply Consumption Inflation Interest rate Dom. Investment Price (input costs, wages) 9  Let’s see if we got that As a central bank, you increase money supply and decrease interest rates to boost production and employment As a central bank, you decrease money supply and increase interest rates to fight high inflation Employment and domestic production decrease when the central bank raises interest rates to fight inflation 10 The Phillips Curve This tells us that there is a trade off between inflation and unemployment. Rate of Inflation Unemployment 11 International Monetary Exchange 12  International Monetary Exchange For the same reason why individuals need a common medium of exchange within in a country or economy, an international medium of exchange is beneficial for interactions between countries and economies. When it’s easy to determine the value of goods in two different countries it’s easier to engage in Trade and Investment. 13  Think about about Europe w/o the Euro With different & floating currencies. A Dutch firm makes a contract to purchase a boat for 1000 Belgian Francs from a Belgium firm with delivery in 7 months At the time, the exchange rate is 1000 Belgian Francs = 500 Guilders, so the Dutch firm expects to pay the equivalent of 500 Guilders In the intervening months the exchange rate changes in favor of the Belgian Franc  1000 B. Francs = 550 Guilders  The Dutch firm still needs to pay 1000 Francs for its contract. It has just lost money.  The Belgian firm gets richer, because the Belgian Francs it gets from the contract can buy more Dutch products in return. Uncertainty over the profitability of investment will prevent firms from exploiting comparative advantage. Purchases from domestic firms don’t have the same uncertainty but come with lost gains from trade. 14  International Monetary Exchange For most of modern history, Gold and Silver backed paper currencies and served as the common medium of exchange between economies Each country’s currency was worth a fixed amount of gold or silver (specie) This made it easy to determine the value of goods relative to each other domestically and internationally Still, it required cooperation (More on that when we talk history) Today, most states have a floating currency system where the value of currency is determined by the market… The US dollar serves as the primary unit of account and store of value 15  International Monetary Exchange Exchange rate regime: A set of rules governing how much national currencies can appreciate and depreciate in the foreign exchange market. The relationship between a country’s currency and a foreign/international currency/commodity Types of exchange rate regimes: Fixed Floating Fixed-but-Adjustable Managed Float 16  Exchange Rate Regimes Fixed Fixed but Managed Float adjustable Float Fixed  Government allows for only very small changes. The government maintains this fixed price by buying & selling currencies in the foreign exchange market (Ex. Gold Standard) – more on this later (hard peg) Floating  Governments do not intervene. There are no limits on how much XR can move up or down (US$, EURO – externally) Fixed-but-Adjustable  Governments intervene under a set of well-defined circumstances (ex. Bretton Woods for non-US countries). (soft peg) Managed Float  Governments intervene but there are no clear rules. Most governments do this today. MAIN THING TO KNOW: DIFFERENCE BETWEEN FIXED AND FLOATING 17 18 Balance of Payments 19 Balance of Payments The difference between the money entering and leaving the country. The Balance of Payments Explained (0:50-4:10) Current Account: Records all current (non-financial) transactions between the home country and rest of the world Imports & exports of goods & services, royalties, fees, interest payments, profits, remittances, foreign aid grants Capital and Financial Accounts: Records all financial flows between the home country and the rest of the world FDI, portfolio investment, loans & other investments Current & Capital/Financial Accounts are the mirror image of each other When they don’t match up, a government has an imbalance of payments 20 10 Minute Break Balance of Payments The exchange rate regime determines, in part, how balance in the BoP is maintained…. In Floating XR regimes:  BoP adjustment occurs through exchange rate movements. In Fixed XR regimes:  BoP adjustment occurs through changes in domestic prices. 22 Current Account Exchange Rate When you export, the buyers exchange their currency for your currency to purchase your products more demand for your currency When you import, you exchange your home currency for another country’s currency to purchase their products more supply of your currency So, when you export more than you import, relative demand for your home currency increases. That means there is pressure for your home currency to appreciate. When you import more than you export, relative demand for your home currency decreases. That means there is pressure for your home currency to depreciate. Exchange Rate Current Account When your currency appreciates, your exports become more expensive and imports become less expensive When your currency depreciates, your exports become less expensive and imports become more expensive So, when your currency appreciates, your exports decrease and your imports increase When your currency depreciates, your exports increase and your imports decrease Balance of Payments, Floating XR: The adjustment occurs through Exchange Rate Movements Deficit countries see a depreciation in their currency on global markets (less demand of currency lowers the “price” or XR of the currency) Prices of exports fall for foreign consumers – demand for exports rises Prices of imports rise for domestic consumers – demand for imports drops Surplus countries see an appreciation in their currency (excess demand for the currency increases the “price” or XR of the currency) Prices of exports rise for foreign consumers – demand for exports drops Prices of imports fall for domestic consumers – demand for imports rises 25  BoP Adjustment, Floating XR EZ has Excessive Demand Disproportionate Appreciation of in EZ for British Demand for British GBP vis-à-vis Euro Pounds (GBP) Goods/Services Higher Relative Contraction of BoP Cost of British Surplus Goods In Floating XR systems, the adjustment occurs through exchange rate movements. 26  BoP Adjustment, Floating XR UK has Excessive Appreciation of Disproportionate Demand in UK Euro vis-à-vis Demand for EZ for Euro GBP Goods/Services Higher Relative Contraction of Cost of Euro BoP Surplus Goods In Floating XR systems, the adjustment occurs through exchange rate movements. 27 Balance of Payments, Floating XR: Balance is restored as exchange rates adjust and: Deficit countries see imports go  & exports go , Surplus countries see imports go  & exports go  Prices of domestic goods & services remain stable Important Benefit: The government is free to pursue domestic policy goals (employment) by using monetary policy Address recessions by increasing money supply/control inflation by increasing interest rates Changes in money supply/interest rates also affect exchange rates, but that’s ok under a floating XR 28 Balance of Payments, Fixed XR Adjusting the BoP under fixed XR: The government maintains a fixed XR by using monetary policy: It has a couple of avenues: 1. Governments buy/sell each other’s currency (thus changing the money supply and prices in each country) that they store in reserve 2. Countries can change interest rates, thereby also changing domestic prices. 1. Interest rates go up in deficit countries, they go down in surplus countries 3. They can impose capital controls or change commercial policy that limits financial transactions with other countries 29 Changes in Money Supply Exchange Rates Central banks can intervene by manipulating the money supply. E.g. ECB:  To INCREASE the money supply of Euros: print more Euros. Exchange Euros for US Dollar ➔More Euros in global circulation, more US Dollars in ECB’s reserve To DECREASE the money supply of Euros: sell the US Dollars in your reserve for Euros ➔Fewer Euros in global circulation, more US Dollars in circulation, fewer US Dollars in ECB’s reserve NOTE: This is asymmetric: A central bank can always print more, but it can only decrease the money supply if it has enough foreign reserves! 30 1) Adjustment in reserves If XR between Pound and Euro was Fixed: Excessive Upward Bank of England Demand in EZ Pressure on GBP buys Euros for British vis-à-vis Euro using Pounds Pounds (GBP) More currency Market demand but the same Supply in (partly) is offset amount of goods Pounds by Bank’s to sell increases intervention British exports UK Prices Pressure on XR decrease, British Increase is relieved imports increase 31 Changes in Interest Rates Exchange Rates: 2 Types of Investors International Investors Domestic Investors (Portfolio/FDI) Borrow money/use their Take money from their home savings in the home country, exchange it for currency to invest in capital foreign currency to invest in foreign market Interest rates  -> Interest rates  -> Return on borrowing more expensive, foreign investment  & foreign saving more lucrative & investment  domestic investment  Interest rates  -> Return on foreign investment  & foreign Interest rates  -> investment  borrowing less expensive, saving less lucrative & domestic investment  32  Changes in Interest Rates Exchange Rates Interest rates  -> more demand for currency by foreign investors Interest rates  -> less demand for currency by foreign investors 33  2) Changes in Interest Rates Excessive Upward Bank of England Demand in EZ Pressure on GBP lowers interest for British vis-à-vis Euro rates Pounds (GBP) More domestic UK Prices Increase consumption and investment Less demand for GBP by foreign investors Adjustment of Capital Account (less investment) and Current Account (fewer exports, more imports) Pressure on XR is relieved 34 3) Capital Controls Excessive Bank limits EZ Demand in EZ for purchase of British Pounds Sterling (GBP) Market exchange Upward Pressure rate remains on GBP vis-à-vis fixed Euro is restricted 35 Balance of Payments, Fixed XR & No Capital Controls The adjustment occurs through price changes Not through changes in the value of currencies The value of the currency has to remain fixed! (to a precious metal or other currency) Deficit countries see a reduction in the money supply/increase in interest rates The prices of domestic goods fall Surplus countries see an increase in the money supply/decrease in interest rates The prices of domestic goods rise 36 The Unholy Trinity 37  The Unholy Trinity/Trilemma Because the choice of XR relates to policy control, states are faced with a dilemma. They can choose between two of three outcomes Fixed Exchange Rate Monetary Policy Autonomy Free Capital Flow Remember capital controls are one way to manage imbalances Under NO condition can they have all THREE 38  The Unholy Trinity/ Trilemma Financial integration (capital mobility) Classical Gold Standard Floating Rates (1900 - 1914) (1971- ) Trilemma Fixed exchange rates Independent monetary policy Bretton Woods (1945-1971) 39  The Unholy Trinity What happens if you try to implement all 3? If you have free capital + MP autonomy + fixed XR, any effort to adjust interest rates or money supply to stimulate (or depress) the economy at home will change the international demand & supply of your currency 40  Monetary Policy to Boost Domestic Economy Central bank lowers interest rates/increases money supply to boost employment and output at home Higher money supply makes currency less valuable internationally Lower interest rates make investment in the currency less valuable Supply of currency up, demand for currency down To maintain a fixed exchange rate while capital is free, the central bank can:  Decrease the money supply to match less demand  Increase interest rates to make investment in the country more attractive and thus increase demand BUT this cancels out the high-interest rates/lower money supply the Central Bank tried to implement domestically OR it can impose capital controls (hard in the long-run) Central Bank has to give up one of the three corners  The Unholy Trinity/ Trilemma Financial integration (capital mobility) Trilemma Fixed exchange rates Independent monetary policy 42  Summary Balance of Payments Adjustment Fixed vs. Floating: Each has different consequences (winners/losers) In a globalized economy, capital controls are very difficult to maintain long- term. Assuming no capital controls: Fixed XR Floating XR Effect on Trade Makes trade very easy Makes trade harder because prices across because prices across countries are stable countries are unstable Effects on Domestic Prices within countries Prices within countries Prices are unstable are stable Monetary Policy No adjustments to Adjustments to improve domestic improve domestic economic conditions economic conditions possible possible The politics of monetary policy largely center around these differences 43 What to Know Well: Types of XR regimes XR regimes determine how states adjust balance of payments and influence price levels at the domestic and international level Adjusting BoP under fixed XR & no capital controls: prices adjust to deal with surplus/deficit Adjusting BoP under floating XR: XR adjusts to deal with surplus/deficit The policy dilemma known as the UNHOLY TRINITY/TRILEMMA 44 Next: History of the Monetary System 45 The History of the International Monetary System Block II 2024 Dr. Toenshoff 1 Review Questions What is NOT a way a Central Bank can react to balance of payments imbalances under fixed exchange rates? Adjust the money supply by selling/buying reserves Introduce tariffs on trade Change the domestic interest rate Impose capital controls Match the type of international transaction with he correct account in the Balance of Payments Trade in goods – Current Account Foreign Direct Investment – Capital and Financial Account 2  Review Questions One more time: the trilemma Financial integration (capital mobility) Trilemma Fixed exchange rates Independent monetary policy Why are capital controls difficult (today)? 3 Game Plan The Gold Standard Bretton Woods and its Fall Central Bank Independence Will Crypto replace Central Bank-backed currencies? 4 A bit of history: 1870-1914: Gold Standard (fixed) + Open Capital Flows 1919 – 1939: Gold Standard reestablished briefly, but abandoned in the Great Depression 1944-1971: Bretton Woods: US-backed fixed (but adjustable) + Low capital flows 1971-Today: Floating XR + High capital flows in most developed countries, peg to dollar/Euro in many developing countries The Puzzle: What Caused The Changes? 5 6  The Unholy Trinity/ Trilemma Financial integration (capital mobility) Classical Gold Standard Floating Rates (1900 - 1914) (1971- ) Trilemma Fixed exchange rates Independent monetary policy Bretton Woods (1945-1971) 7 Pure Gold Standard in Theory Country A imports more from Country B Gold moves from A to B (re-coined/minted) Less money in A ➔ lower prices More money in B ➔ higher prices ➔ Country B imports more from Country A Balance is restored Remember, this is the same story as we saw on Monday: fixed XR, BOP restored as domestic prices adjust 8 Reality with Paper Money Gold didn’t actually flow (that would require huge transaction costs and a lot of gold at the bottom of the Atlantic Ocean). Central Banks fix the value of their currency to gold  E.g. 1 Pound sterling = 7.322g of gold  People could, in theory, exchange their paper money for gold When imbalances arose, Central Banks intervened by adjusting the money supply and interest rates (remember adjustment under fixed exchange rate regimes…) Gold Standard ➔ strict discipline! 9 What is “discipline”? Central Bank has to cause deflation in times of deficit to lower prices What do “lower prices in Country A” mean? Supply of money down If you expect prices to fall in the future, you don’t buy anything today More expensive to borrow BAD economic crisis! Jobs cut! People don't eat! Kids die! 10  Side-Note: Beyond Imbalances, the Gold Standard is Inherently Deflationary: World’s supply of gold is fixed With economic growth, eventually more goods chase less money -> prices fall, growth constrained The gold standard was able to be established and persist pre-WWI partly because of new gold discoveries 11 How did the Gold Standard End? Breaks down with WWI Countries re-establish it after the war Exacerbated the Great Depression in the early 1930s (more on that in week 6) Countries abandon it again in response to the crisis  Bank of England first because it was running out of gold  Chain reaction across the world, rush on gold, other countries abandon the gold standard 12 Bretton Woods 13  The Unholy Trinity/ Trilemma Financial integration (capital mobility) Classical Gold Standard Floating Rates (1900 - 1914) (1971- ) Trilemma Fixed exchange rates Independent monetary policy Bretton Woods (1945-1971) 14 Why not back to Gold Standard? Remember, Gold Standard dependent on policy “discipline” and deflationary periods Many countries had become more democratic since the 19 th century + stronger labour unions When people don’t eat… Autocracies Democracies Let them eat cake Politicians voted out of office 15 Also: Enter Keynesianism Based on observation of high unemployment in Britain 1920s&30s Alternative to neoclassical economics (“the market will fix it”) Governments can (should) use monetary and fiscal policy to help the economy out of crises 16 What Was “Bretton Woods”? A hotel in New Hampshire… Agreement on the Post WWII monetary system A monetary system is a public good… Coordinating on a common system allowed for: increased international trade and finance a way to manage crises so they didn’t spread Attempted to solve a global problem: How to keep monetary policy autonomy and a fixed XR? 17  What Was “Bretton Woods”? How did Bretton Woods (try to) achieve exchange rate stability and monetary policy autonomy? FOUR INNOVATIONS: 1. Fixed but adjustable XR 2. Capital Controls 3. Stabilization Funds 4. The IMF 18  What Was “Bretton Woods”? Fixed but adjustable XR: The US had a hard peg to gold ($35 an ounce) Other countries were fixed to the US dollar but could adjust within a band to correct an imbalance Capital Controls: Stabilization Funds: The IMF: 19  What Was “Bretton Woods”? Fixed but adjustable XR: Capital Controls: Not total control, but allowed governments to impose controls when faced with speculative threats Current accounts (no controls) Capital accounts (controls) Stabilization Funds: The IMF: 20  What Was “Bretton Woods”? Fixed but adjustable XR: Capital Controls: Stabilization Funds: Provide a fund to help governments avoid controls or devaluation when faced with short-term imbalances The IMF: 21  What Was “Bretton Woods”? Fixed but adjustable XR: Capital Controls: Stabilization Funds: The IMF: Created to monitor state behavior (XR rate changes) and manage stabilization fund. Loans were conditional on policy actions (the teeth!) Made sure governments didn’t undermine system by devaluing for an export advantage… 22  Why did the Bretton Woods system fail? The institutions didn’t work: IMF lacked true authority over XR policy. Governments didn’t comply, they did what they wanted Governments didn’t like conditionality (still don’t) The stabilization fund wasn’t large enough to deal with the new imbalances caused by globalization 23 US Privileged Country holding currency used as reserve (dollar) has an “exorbitant privilege”: Federal Reserve could run BoP deficits and conduct monetary policy to influence aggregate demand, output and employment But US monetary policy influenced economies of other countries, especially as capital mobility rose 24 US Privileged Suppose USA increased its money supply: lower US interest rates, putting downward pressure on the value of the US dollar if other central banks maintain their fixed exchange rates, need to buy dollar-denominated (foreign) assets, increasing their money supplies 25 Why did the Bretton Woods system fail? US unwilling/unable to maintain system: Bretton Woods depended on the US to exchange $ for gold. US was spending more money than was entering the country Expansionary Macroeconomic Policy: More spending Vietnam War + social spending, without higher taxes US dollars left the country (high imports + US investors invest more abroad) Increased claims on US gold by foreigners who received dollars. Eventually… dollars > actual gold. If confidence in peg was in question, investors would rush to sell dollars (speculation), heightened by newly dynamic capital markets. 26 US Balance of Payments Deficit = More Dollars leaving US than coming in 27  Why Speculate? I earned $3500 from selling goods I have the right to 100 ounces of to the US. Gold from Fort Knox If I don’t believe the peg to gold Demand for gold goes up, will last, I buy the gold. demand for dollars goes down If the US has to give up the I sell all my gold for dollars = dollar-gold exchange rate, dollar $5000 falls to $50 – 1 ounce Note: Same with speculation between currencies: Self-fulfilling You foresee an increase in value = buy prophecy! You foresee a decrease in value = sell 28 Why did the Bretton Woods system fail? To “fix” the problem: The US would have to constrain US economy, run trade-surpluses, change foreign policy Adjust the peg to gold (requires coordination, can’t be done unilaterally) Expand economic activity in the rest of the world (many states unwilling to experience inflation). None of these options was politically popular 29  The End of BW First, speculation about devaluation of the dollar caused large purchase of gold by investors  Federal Reserve sold huge quantities of gold in March 1968  US President Nixon “closes the gold window” on August 15 1971 = no more gold-US dollar exchange Second, speculation about devaluation of dollar caused investors to purchase large quantities of foreign currency assets  Coordinated devaluation of the dollar against foreign currencies of about 8% occurred in December 1971  Speculation about another devaluation occurred: European central banks sold huge quantities of European currencies in February 1973  Japan and Europe stopped selling their currencies and purchasing of dollars in March 1973, allowing the value of the dollar to fall End of BW monetary system 30  (Gold Finger Wins After All) Before collapse of BW, imports and exports of gold had to be limited through capital controls to allow for Fixed XR & Domestic Monetary Policies As soon as BW system collapses, gold became freely tradeable, and prices shot up: 31 Core Take Aways Bretton Woods Fixed exchange rate hard to maintain with increasing capital mobility + democratic demands for domestic monetary policy Gold standard had been backed by the British, BW had been backed by the US (remember hegemonic stability theory from trade lectures…) While it would’ve been nice to have XR stability, The US was no longer in a position/willing to enforce cooperation.  US acted in self-interested way  As did other countries 32 POST BW Post BW most major economies floated their currency Europe tried to organize a regional monetary cooperation around German policy Eventually, adopt a monetary union (the EURO) More on this next week Other countries floated or pegged to the $US/European currencies Dollar remains world’s reserve currency Despite floating XR, global imbalances still pose a threat to the global economy… Uncoordinated macroeconomic policy still has the potential for large problems… 33  Summary: Increasing Democracy & Capital Mobility Few democracies Growing #’s of democracies + LABOR UNIONS! Fixed Degree of exchange Fixed Floating global rates exchange exchange capital + rates rates mobility Open + + capital Capital Open flows controls capital flows 1870 Interwar period 1944 1971-3 Capital Mobility = Speculation if Fixed XR not deemed to be credible 34 10 Minute Break 35 Central Banks 36 Central Banks: The Problem We just argued that democracy -> demand for monetary policy autonomy. With the fall of BW and floating exchange rates, Central banks were free to use monetary policy domestically Yet, monetary manipulation can lead to runaway inflation: This drags on growth and investment in the long run despite short-run benefits. 37 Upward spiral of inflation Keynes had assumed a stable relationship between unemployment and inflation “Stagflation” in 1970s showed that that assumption could be wrong 38 Upward spiral of inflation Long-run Short-run 39  The Problem: Time Inconsistency In the long-run, governments want price stability, but in the short-run, boosting employment is tempting How can we avoid this problem? Adopt a fixed exchange rate? Ties your hands to stop using expansionary monetary policy This is the choice many developing countries make Democracies don’t do well with fixed XR and free capital flows Domestic price instability… Inability to deal with real crises 40  The Solution: Governments might adopt an INDEPENDENT CENTRAL BANK Appointed for long terms Don’t face electoral pressures Or are distanced from them 41 Central banks as commitment mechanisms Political independence provides the mechanism to maintain monetary policy autonomy but not tempt politicians (too much) to abuse it. Central banks differ in their independence Freedom to choose economic objectives to pursue Inflation and/or employment Freedom to set monetary policy to pursue that objective Whether the policy can be reversed by politicians in government 42  Garriga 2016 43 European Central Bank Mandate for price stability primarily Each country appoints a governing member An executive council sets decisions Appointed to non-renewable 8-year terms Appointed by “common accord” of member governments Can’t be removed by politicians ECB President Lagarde 44 The US Federal Reserve President appoints a Fed Chair every four years (in non-presidential election years) Confirmed by the Senate Can’t be removed Must “report” to Congress bi-yearly Now has a dual mandate to pursue low unemployment and stable prices and interest rates This set -up allows it to act in times of crisis but avoid political time inconsistency problems. 45 Federal Reserve's Jerome Powell Won't Resign Under Trump 46  Other Examples: Swiss National Bank No provision whatsoever for the government to influence monetary policy Highly independent Reserve Bank of Australia Highly subordinate Secretary of Treasury has final authority on monetary policy decisions and interest rate changes Reserve Bank of India Government appoints governor and board of directors to 4-year terms Not constitutionally independent, government can overrule Faces political pressure 47 Other Examples: Central Bank of the Republic of Turkey : highly subordinate Erdogan – “enemy of interest rates” – has fired three central bank chiefs 48 Central banks as commitment mechanisms Does Central Bank Independence Work? Provides greater certainty over monetary policy This Should lead to decreased inflation and greater growth? Does it? 49 Inflation & CBI in Developing Countries 1980-2013 Garriga and Rodriguez 2020 50 Oatley Fig 13.6 Central-Bank Independence and Economic Growth, 1969–1995 51 Crypto = Future of Currencies? 52 What is Cryptocurrency? Decentralized currencies based on the ‘blockchain’ (Typically) not backed by Central Banks Some (e.g. Bitcoin) supposed to be finite in number = meant to combat inflation 53  Crypto = The future of money? Remember the three functions of money: Medium of exchange:  Transactions are VERY computationally expensive - Not clear that blockchains can handle enough transactions & huge energy demands Store of Value and Unit of Exchange = shouldn’t be too volatile 54  Crypto = The future of money? Fixed supply of money is not a good thing:  Fixed money supply = lower growth and/or deflation  See: Gold standard People’s willingness to use a currency to save and invest depends on TRUST 55 Conclusion: To the Moon?  Crypto is one speculative asset you can bet on to make (or lose) money  Under Trump, crypto will likely be deregulated and become a more common asset in mainstream banks’ portfolios HOWEVER:  Not ideal as your MAIN investment for retirement  Cannot fulfill the function of a government-backed currency 56 Example Short Answers Qs Question 2 (out of a choice of 3 questions, 300-500 words) The Doha Round at the WTO has been stalled for the past two decades. a) Outline the main objectives of the Doha Round. b) Name and explain two reasons why the negotiations have stalled. c) Countries have turned to RTAs since the failure of the Doha Round. Give one reason why you think that RTAs are better or worse for developing countries than an agreement at the WTO level. 57 Answer The Doha Round at the WTO has been stalled for the past two decades. Outline the main objectives of the Doha Round. Name and explain two reasons why the negotiations have stalled. Doha’s main objectives:  Main objective: Focus on economic development  (bonus points for also mentioning anti-dumping rules, intellectual property rights, environmental protections etc.) Reasons for failure you could list:  Unwillingness of advanced industrialized countries to liberalize agriculture  First time developed and developing countries pitted against each other  Procedural difficulties: single undertaking & unanimity  Outside options: Developed countries turn to FTAs instead Arguments you could list for c:  Better: Easier to liberalize with only some agreement partners, rather than whole world  Worse: Large developed countries more powerful in RTA negotiations  Worse: RTAs between developed countries might divert trade away from developing countries  Worse: (For all countries) RTAs go beyond tariffs more than WTO would, may not be welfare- enhancing 58 Next up: Societal Interests in Monetary Policy & EMU 59