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49:38
Transcript
0:16
So today uh my plan is to finish the
0:19
open economy part of the course and uh
0:21
we will talk about exchange regimes but
0:24
but before I do that, I need to finish
0:27
uh
0:28
a few things that we didn't in the
0:29
previous lecture
0:31
and that will help us an introduction
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0:32
for the kind of things I want to talk
0:34
about today.
0:35
And uh
0:37
let me start just reviewing that last uh
0:40
slide with that we discussed
0:43
uh which is the Mundell-Fleming model.
0:45
And the Mundell-Fleming model
0:46
essentially is our old IS-LM model in
0:49
which the IS is a little different
0:51
because now we have a net exports term
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0:54
uh
0:54
which is a function of new things like
0:57
uh foreign output foreign income and
1:01
uh and most importantly the real
1:03
exchange rate and the real exchange rate
1:05
in itself because of the UIP uncovered
1:08
interest parity condition is a function
1:09
of expected exchange rate
1:11
the the
1:14
internal foreign in- interest rate
1:17
and it also gives us yet another reason
1:19
for why
1:20
uh the interest rate affects uh domestic
1:23
aggregate demand. Okay? There's a
1:25
There's a There's a the traditional
1:27
investment effect of a increase in
1:29
interest rate but we also get um the
1:32
appreciation effect of an increase in
1:34
the interest rate which is
1:35
contractionary from the point of view of
1:37
aggregate demand. So but this is like
1:39
that with uh this extra net export term
1:42
and and in this diagram, you know, for
1:45
this we have the same interest rate here
1:47
uh from this diagram which which
1:50
portrays the
1:52
uh uncovered interest parity condition,
1:54
we can get for any given international
1:56
interest rate and expected exchange rate
1:59
for next period uh
2:01
we can get the current exchange rate.
2:03
Okay? So
2:04
that was our model and we did a few
2:07
experiments here. The first one was
2:10
well, what happens if the expected
2:11
exchange rate goes up?
2:13
The first thing is which curves move?
2:15
Well, if the expected exchange rate goes
2:16
up, then I know that for any given
2:20
interest rate
2:21
uh the current exchange rate will go up.
2:24
Okay?
2:25
I know that this curve, in other words,
2:27
will shift to the right.
2:29
Why do I know that? Well, because if the
2:31
current exchange rate doesn't move by
2:32
the same amount of expected exchange
2:34
rate, now I'm on a expected
2:36
I'm going to have a expected capital
2:37
gain or loss which will be inconsistent
2:39
with the previous uh parity of interest
2:42
rate, you know? So we had agreed that
2:45
uh you know, that we had certain
2:47
expected appreciation. So let's make it
2:48
very simple. Suppose that this interest
2:50
rate happens to be equal to the
2:51
international interest rate then we know
2:53
that this exchange rate has to be equal
2:55
to the expected exchange rate because
2:56
you cannot expect an appreciation or
2:57
depreciation of the currency if the
2:59
interest rates are the same.
3:00
But if now the expected exchange in the
3:02
next period goes up and if the exchange
3:04
rate today doesn't move, that would mean
3:06
that you expect also capital uh uh
3:08
an appreciation of the currency which
3:10
means that investing in domestic bonds
3:12
would give you a higher return because
3:13
of the same interest rate plus expected
3:15
appreciation. So we know that the
3:17
uncovered interest parity condition will
3:19
move to the right. You know, as a result
3:21
of the increase in expected exchange
3:22
rate. But it also means that at any
3:24
given interest rate you get a higher an
3:27
appreciated exchange rate relative to
3:29
the previous one before the increase in
3:31
expected exchange rate which means that
3:33
the IS will shift to the left.
3:35
Okay.
3:36
So if the expected exchange rate goes
3:38
up, that leads to an appreciation and
3:40
that leads to
3:41
contraction in aggregate demand.
3:44
Okay.
3:44
Good.
3:46
Next experiment was well, what happens
3:48
if foreign output comes down? Well, if
3:50
foreign output comes down, then that has
3:52
nothing to do with the interest parity
3:53
condition. It's not
3:55
doesn't show up in this expression. But
3:57
it does shift this, you know, because it
3:59
reduces our exports for any given level
4:01
of interest rate and output and so the
4:03
IS shifts to the left. So that's
4:05
contractionary. That's a way you import
4:07
a recession from the rest of the world.
4:09
Okay? Uh as I said before
4:12
people around Asia and and Latin America
4:14
very very worried about the Chinese
4:16
actually the Europeans as well because
4:18
Germany exports a lot to China are very
4:21
worried about contractions in China and
4:22
so on because through that channel it's
4:24
contractionary as well. Now we're in the
4:27
other part of the
4:29
of the cycle because China is reopening
4:31
uh and and that sort of gives lots of
4:33
hope to Europe and so on.
4:36
And that's one of the reasons why the
4:37
euro has appreciated vis-à-vis the the
4:39
dollar recently.
4:41
Okay.
4:42
Um
4:43
and then the the last experiment that I
4:45
don't remember whether we finished or
4:47
not, I think I said it very quickly is
4:49
well, what happens if the international
4:50
interest rate goes up?
4:53
What moves? Well, the first thing that
4:54
will move is this. This was a parameter,
4:56
okay? So
4:58
what do I know that if I keep the
5:00
interest rate constant and the
5:02
international interest rate went up what
5:04
has to happen to the exchange and the
5:05
expected exchange rate hasn't changed?
5:07
What has to happen to the exchange rate
5:09
today to be indifferent between the two
5:10
things?
5:11
The the two bonds.
5:14
So this is experiment. Suppose that
5:16
we're at any domestic interest rate, we
5:18
don't touch that. Now I increase
5:20
international interest rate
5:22
and I say the expected exchange rate
5:25
is the same as it used to be, what has
5:27
to happen to the current exchange rate
5:29
in order to be indifferent between
5:30
investing in the US bond or the other
5:32
foreign bond?
5:36
Exactly, it has to depreciate. Why?
5:42
That's correct but but why is it that
5:44
you need an
5:45
that the exchange rate falls today in
5:47
order to restore to have the the
5:50
interest parity condition
5:52
holding?
5:55
Okay. So remember what happened is that
5:58
you had the same interest rate and now
5:59
that the international interest rate
6:01
went up.
6:02
That means if nothing moves, now you
6:04
preferred you were indifferent before.
6:06
Now you would prefer to invest in the
6:07
international bond.
6:09
If I don't change the the the US rate,
6:11
then I have to compensate you by some
6:13
other mean.
6:15
The only way I can compensate you in
6:16
this model, the only thing that's
6:17
endogenous is by an expected
6:20
appreciation of the exchange rate
6:22
because that would give you a capital
6:23
gain from holding the bond the US bond,
6:27
a currency capital gain. Now
6:29
since the expected exchange rate is
6:31
given, the only way I can give you that
6:32
is depreciating the currency today so
6:34
then you can expect an appreciation
6:36
tomorrow.
6:36
From today to tomorrow. Okay, that's
6:38
that's the mechanism.
6:39
Okay, so that means that this
6:42
uh curve here will shift to the right.
6:45
Okay? For any given interest rate you
6:46
need a sorry, to the left. For any given
6:49
I made that mistake in the previous
6:50
lecture as well. So for any given level
6:52
of interest rate, this curve will have
6:54
to move to the left.
6:55
Okay? So if the interest rate doesn't
6:57
change and international interest rate
6:58
is up, you need an exchange rate today
7:00
that is lower than it used to be so you
7:02
can expect an appreciation from now to
7:04
the next period.
7:05
Okay?
7:07
So that's what moves to the left. Now
7:09
what happens? What else moves in that
7:10
case?
7:15
I remember when I'm I'm asking the
7:17
question, what else moves?
7:19
Uh I mean what other curve moves? What
7:22
you need to do is just take something as
7:23
given and then see what whether we get
7:25
the same equilibrium output or not or
7:27
not. So I'll take an interest rate as
7:28
given as IS
7:30
and then ask the question, well, will I
7:32
get the same equilibrium output or not?
7:34
If I get the same equilibrium output,
7:36
that means the IS hasn't moved.
7:38
But if I get a different equilibrium
7:39
output, it means the IS has moved
7:40
because for the same interest rate I'm
7:42
getting a different equilibrium output.
7:44
So what happens in this case?
7:48
Does the IS move or not?
7:51
When I star goes up?
8:05
Going to simplify the question. Yes, it
8:07
does. Which way?
8:15
Will I get more or less output?
8:18
When the international interest rate
8:19
goes up?
8:20
And I'm taking Look the kind of things
8:22
I'm taking as given. I'm also taking as
8:24
given international output.
8:26
So I I'm not moving Y star.
8:29
I'm not moving expected exchange rate.
8:31
Uh
8:33
and I'm asking the question
8:34
is the domestic
8:36
central bank, the Fed in the case of the
8:38
US, does not change the interest rate,
8:40
what happens to equilibrium output? Does
8:41
it go down or up?
8:45
If the other if the international
8:46
interest rate goes up, the domestic
8:48
interest does not
8:50
what has to happen to exchange rate?
8:55
You answered it before.
8:57
Has to go down. That means it has to
8:58
depreciate. What happens to net exports
9:01
when the exchange rate depreciates?
9:06
What does it mean that the exchange rate
9:07
depreciates? Especially if you have the
9:09
In this case we have the prices
9:11
completely fixed. So now if the nominal
9:13
exchange rate depreciates, means that
9:14
the real exchange rate depreciates.
9:16
What does that mean?
9:21
What got cheaper?
9:26
Okay, you need a lot of to study for the
9:28
quiz. Uh
9:30
domestic goods are cheaper. So so that
9:33
means that the
9:34
and
9:35
equivalently foreign goods got more
9:37
expensive.
9:38
That means for any given level of
9:39
domestic interest rate, now there will
9:41
be less imports and more exports. That
9:43
means net exports will be more which
9:45
means the IS will shift to the right.
9:48
Okay.
9:56
Good. So these things you you need to
9:58
control. I understand that this is a
10:00
little confusing to think about exchange
10:02
rate and so on, but
10:03
but uh
10:08
So, anything that happens here with
10:09
exchange rate is just a relative price.
10:12
The more expensive are your goods,
10:15
the harder it will be to sell them, you
10:18
And and the more tempted you will be to
10:19
buy foreign goods. That's That's That's
10:21
what it does. So, it's
10:23
So, that's contraction. Appreciation of
10:24
contraction here or not. Here, the story
10:27
is a little different. It's all about
10:29
equalizing expected returns. So, you
10:31
need to have an equal movement in the
10:32
exchange rate today so that you are
10:34
always indifferent between investing in
10:36
one side or the other. It's about the
10:38
return, the expected exchange in the
10:39
exchange rate.
10:41
So, okay, good.
10:46
Okay, I got it. It's a little unclear,
10:48
but
10:49
we'll keep trying.
10:54
Is there anything particularly unclear?
10:56
Or is all a blur here?
11:00
Okay, got it.
11:03
Um
11:06
Well, let me So, all that is I describe
11:08
here
11:09
is is um
11:13
is allowing the exchange rate to move.
11:14
We're saying, "Look, if we move
11:17
something or the foreign foreigners move
11:19
something, then we ask the question,
11:20
"Well, what does exchange rate has to do
11:22
here?"
11:24
Okay? And typically when when when
11:27
that's done,
11:29
we call those regimes floating exchange
11:31
rate systems, meaning exchange rate can
11:34
float, can move around. As interest
11:36
rates in different parts of the world
11:37
change, then the exchange rate moves
11:40
around. Okay?
11:41
Typically call that flexible exchange
11:43
rate. I think the distinction is a lot
11:44
harder to make in practice, but for
11:47
reasons I'll explain later, but but
11:50
that's what is meant as a as a floating
11:52
exchange rate system, one in which
11:54
really you're doing your Each country is
11:56
doing its own policies and so on, and
11:58
the exchange rate does what it needs to
11:59
do so so so the financial markets clear.
12:05
Many countries, however, do something
12:07
which is a the polar opposite of that,
12:09
which is called a fixed exchange rate
12:11
regime. Okay?
12:12
So, some countries really peg their
12:15
currencies to a major currency.
12:18
An extreme case is the Eurozone, where
12:21
they gave up their individual currencies
12:24
and they have a common currency. Okay?
12:26
So, so Germany and and and and and and
12:30
Italy have a
12:31
ultra pegged exchange rate because they
12:33
have the same currency. Okay?
12:35
Now,
12:36
most of the times fixed exchange rates
12:38
are
12:39
are a little weaker than that.
12:41
For example, the Hong Kong dollar has
12:42
been pegged to the dollar for a long
12:44
time, for the US dollar for a long time.
12:46
Okay? And we'll show you a few others.
12:48
Many countries go through some phase
12:50
where they try to peg the currency
12:52
and it typically fails at some point,
12:54
but but they have periods in which the
12:56
currency is pegged.
12:58
But so, let me
12:59
Suppose that you have a pegged exchange
13:01
rate, let me show you
13:02
some features of it. Suppose you are in
13:05
a peg in a peg or a fixed exchange rate
13:08
regime pegged to another currency, and
13:10
suppose it's credible. That's a big
13:12
issue with fixed exchange rate, but
13:14
suppose it's credible. There are some
13:15
countries that have credible fixed
13:16
exchange rate.
13:18
Well, if if you have a fixed exchange
13:20
rate with respect to some other currency
13:23
and it's credible, then you know that
13:25
the expected exchange rate is equal to
13:26
exchange rate and equal to a constant.
13:28
That's what it means to have a fixed
13:29
exchange rate. Okay? It's constant.
13:33
But if this is constant, means you never
13:35
can expect an appreciation or
13:36
depreciation
13:38
because it's constant. It's fixed.
13:41
And if you can't expect an appreciation
13:43
or depreciation, the uncovered interest
13:45
parity condition tells you that you
13:48
know, what does it tell you?
13:50
That your interest rate has to be the
13:51
same as the foreign interest rate.
13:56
Why?
13:58
What would happen in a credible
14:01
uh peg in a credible fixed exchange rate
14:03
if the domestic interest rate is higher
14:05
than the international
14:06
than the currency the interest rate
14:08
of the country you're pegging to?
14:12
What would happen? Suppose that
14:14
I'm in a fixed exchange rate and and we
14:15
have the same interest rate and now I
14:17
unilaterally decide to raise interest
14:19
rates.
14:21
What do you think would happen with
14:22
capital flows?
14:24
How would What would you do to your
14:25
portfolio?
14:28
If the currency is exchange rate is
14:29
pegged
14:31
and it's credible,
14:32
it is as if they were issuing the same
14:35
currency because it's the same It's a
14:36
different currency, different name, but
14:38
it has a constant in front of it. Okay?
14:41
So, it's as if it was issuing the same
14:42
currency. Two bonds that are identical
14:45
and issued in the same currency cannot
14:47
be paying different interest rate
14:48
because you would go invest all your
14:51
money, you know, in the in the bond that
14:53
is paying a higher interest rate.
14:55
And that's what happens here. So, it's
14:58
Mechanically, what would happen is for
15:00
some crazy reason a country has a fixed
15:01
exchange rate, credible fixed exchange
15:03
rate, decides to have an interest rate
15:04
higher than the currency the the the
15:07
interest rate in the currency it's it's
15:09
being pegged to,
15:10
then you would see massive capital flows
15:12
to that country. So, there would be an
15:14
enormous pressure for an appreciation of
15:16
that currency.
15:18
Okay?
15:19
But but the And what the central bank
15:21
would have to do is start buying massive
15:23
amounts of the of the supplying massive
15:25
amounts of this currency for those that
15:27
want to buy it
15:29
because there will be an infinite demand
15:31
for that. Okay?
15:33
So, in practice, what that means And And
15:36
sometimes
15:38
you can do that for a little while, but
15:40
but but but not in in a sustained
15:43
manner. So, what happens in practice is
15:45
that if you really have a a a a pegged
15:48
exchange rate and you have free capital
15:50
mobility, which is people can move in
15:53
and out of your bonds, China does them,
15:55
for example, so it can allow itself to
15:58
both control a little bit the currency
16:00
and uh uh
16:02
uh
16:03
mean be semi semi pegged and it still
16:06
can move its domestic interest rate
16:07
because they have capital controls, but
16:09
but if you don't have capital controls
16:10
and people can move money in and out, it
16:12
can do portfolio investment as it
16:14
happened with most of the advanced
16:15
economies,
16:16
then effectively uh
16:19
you give up domestic monetary policy.
16:22
Okay? Because whatever the other country
16:24
does, the country you're pegging to
16:26
does, you have to follow.
16:29
So, that's what it means. You peg, you
16:31
give up your domestic monetary policy if
16:35
you choose to peg to another country.
16:37
I'll I'll a little later I'm going to
16:39
tell you why countries may choose to do
16:40
that, but that's what you do.
16:43
Okay? And the the uncovered interest
16:45
parity tells you that's what you do.
16:47
You're not going to be able to deviate
16:48
there significantly from the interest
16:50
rate that the other country is setting
16:53
if you want to maintain your fixed
16:54
exchange rate.
16:56
Now, in practice, there are many hybrid
16:58
regimes. There There are very very few
17:01
pure float regimes.
17:03
Uh
17:04
few. I mean, maybe five or something
17:06
like that. But but but but so, there are
17:09
all sorts of degrees
17:10
of exchange rate regimes and and which
17:13
are hybrids between fixed exchange rates
17:15
and and fully flexible exchange rates.
17:19
Let me show you just a few just
17:21
randomly more or less randomly selected
17:24
in Bloomberg. Uh so, there you have in
17:26
in in in in white is the US euro.
17:31
That's a float. That's a That's a
17:33
cleanest float you can imagine. I mean,
17:34
there's no
17:36
Then, another which is a very clean
17:38
float is the dollar yen,
17:41
Japanese yen.
17:43
Now, that's a currency that has that
17:46
freely floats, but if there's a major
17:48
dislocations, central banks do intervene
17:51
to money So,
17:52
it means
17:53
in normal circumstances, they float. And
17:56
the same is true with the euro. But if
17:57
there's big dislocations, a major bank
17:59
collapses or something like that, then
18:02
there major dislocations in in financial
18:04
markets. They become very segmented.
18:06
Arbitrage is not that easy and so on.
18:08
Then then then central banks intervene.
18:10
But but for the normal business cycle
18:12
and so on, they do not.
18:14
They do not intervene in the currency
18:16
market. They intervene in different ways
18:17
and that's the reason I'll get there.
18:20
And the other one is the the pound, not
18:22
the US dollar versus the British pound.
18:25
Uh then then it's also that's a pure
18:28
float.
18:30
This is also pure float. This is the
18:33
US versus the Aussie dollar
18:36
So, and against the Canadian dollar and
18:39
against the the Swedish krona.
18:43
Okay? Those are pretty floating
18:47
regimes. They are a little different
18:48
from the previous ones I showed you
18:51
because these are currencies that are
18:52
much more prone to sell off
18:56
during risk-off environments. And that's
18:58
the reason you see these spikes here.
19:01
Okay? This was COVID.
19:03
Biggest spike. You didn't see it in the
19:05
in the dollar euro and so on and so
19:07
forth. So, these are currencies that are
19:08
free floaters, but they're very exposed
19:10
to to risk the risk environment in the
19:14
market. But they're still they're free
19:15
floaters.
19:16
Um
19:18
The Swiss are a little bit more of
19:20
independent minded than and but they do
19:22
control a bit more the currency, but
19:23
they're still I I consider those
19:27
a free floaters.
19:30
These are currencies that are a little
19:31
different. This is the Brazilian real.
19:34
Uh
19:35
the zar is the South African rand.
19:38
And this is the
19:40
Colombian peso.
19:42
And you see several things here. They
19:43
They do move. So, so they have a big
19:45
component of flexible exchange rate.
19:48
Uh
19:49
They do intervene a lot more, though. Uh
19:52
because they're exposed to much more
19:54
risk off type environment and so on and
19:56
they need to intervene fairly frequently
19:59
to control movements in the exchange
20:00
rate.
20:01
But but you also see a trend
20:04
in these things.
20:05
So, their currencies are becoming
20:07
chronically weaker relative to the
20:09
dollar.
20:12
And the reason for that
20:13
is because they're countries that have
20:15
higher inflation.
20:17
So, if you want to maintain the real
20:18
exchange rate constant and you have high
20:20
inflation than the other country, then
20:22
your nominal exchange rate has to be
20:23
depreciating.
20:24
Okay?
20:25
Because your prices are rising at a
20:27
faster pace than the other one,
20:29
well,
20:30
if the exchange rate was not
20:31
appreciating on average depreciating on
20:33
average, then it would mean that you
20:35
would be coming more and more expensive.
20:36
Okay? So, that's the reason. Countries
20:38
that have higher inflation, they tend to
20:40
have these trends as well.
20:42
Okay?
20:43
But they're still fairly floating.
20:45
Here, these are all
20:47
currencies that are
20:49
uh, to a different degree
20:52
uh,
20:53
um,
20:54
targeted in the sense that they're
20:56
contained in in terms of they're not
20:58
free to float at will.
21:00
Uh, the scale here will mislead you. If
21:03
I had put it in the same scale as the
21:05
the euro dollar or the the euro yen and
21:07
the the dollar yen or the euro yen as
21:09
well,
21:10
then these things would have been looked
21:12
very small. Okay? So, so I should have
21:15
put a a real floater there so you would
21:16
have seen that these guys are moving a
21:18
lot less.
21:19
And these are different kind of
21:20
countries. This is the Hong Kong dollar
21:22
that for all practical purposes pegged.
21:25
Okay? These little wiggles is just
21:27
technical things that happen overnight
21:29
and stuff like that.
21:30
But they're pegged to the dollar.
21:32
Okay? So, the Hong Kong dollar is pegged
21:34
to the dollar.
21:35
Uh,
21:37
that means they really don't have
21:38
independent monetary policy relative to
21:40
the US vis-a-vis the US.
21:43
The This is the CNH. This is the the the
21:47
um,
21:48
the Chinese
21:49
renminbi
21:50
and and and it's a currency again. I
21:52
should have put it with a floated real
21:54
floater there. It's a lot more
21:56
controlled. Okay? So, it moves around
21:59
but but in a much tighter range and and
22:02
and they're thinking about exchange rate
22:04
when part of their policy program and so
22:06
on, the exchange rate is something
22:08
they're thinking about.
22:11
This one here, the blue one is is an
22:13
interesting one.
22:14
Uh,
22:16
um,
22:18
that's the the the the Singaporean
22:21
Okay?
22:22
And the Singaporean dollar, they have a
22:24
very interesting regime.
22:26
They have a a a um,
22:28
a target zone, meaning they let the
22:30
exchange rate move within a range only.
22:34
But it's not pegged against a
22:36
single currency, it's pegged against a
22:38
basket
22:39
of of currencies.
22:41
Okay? And the the recipe is secret.
22:44
So, everyone is always guessing what
22:46
they're doing and so on. They do change
22:48
the weights a little bit to keep the
22:49
markets confused. But but their currency
22:51
is very stable. It's well understood.
22:54
It's a It's a weighted average of the
22:55
euro, the renminbi and the and the
22:57
dollar. But but they they don't disclose
23:00
exactly the thing, but you know, you can
23:02
filter out what they're doing and and
23:04
they they keep things in a range
23:06
uh, and they occasionally change the
23:07
slope of that range, but but it's very
23:10
regulated in that country. And they in
23:12
fact they state their monetary policy in
23:15
terms of the effects. They say, "That's
23:17
our policy."
23:18
Interest rate is what everything needs
23:20
to be so the exchange rate remains in
23:21
that range. That's that's that's the way
23:23
they state the monetary policy. They
23:24
don't even think about
23:26
So, I let the markets determine the
23:28
interest rate, we determine the exchange
23:30
rate here in that range. And it's a
23:31
narrow range.
23:35
Again,
23:36
I should have put
23:38
um,
23:40
a real floater there so you would have
23:41
seen that. Okay? So,
23:43
so the the point is that
23:45
everything goes. They're all sort of
23:47
arrangements happening around the world.
23:50
This is These are different kind of
23:51
currencies, you know?
23:53
Uh, this is the the
23:55
the
23:58
the Turkish lira
24:00
Okay?
24:00
and the Argentinian peso.
24:04
I think through this sample it's been
24:05
called peso since since they have this
24:07
very high inflation, they keep changing
24:08
the name of the currency and so on
24:10
because they have to remove zeros from
24:12
things. So, but but I think through all
24:14
that period it's still the Argentinian
24:15
peso.
24:16
And uh,
24:18
so I mean, look at the scale.
24:21
So,
24:23
you cannot see it, but but all these two
24:25
countries are all the time fighting
24:28
against the exchange rate. In fact,
24:30
Argentina today has like five different
24:31
exchange rates.
24:33
There is the official exchange rate,
24:34
there is the blue exchange rate, there
24:36
is the purple exchange rate, there are
24:37
all sorts of things.
24:39
You should never pay with a credit card
24:40
if you go to Argentina if you do tourism
24:42
because you don't want to pay the
24:43
official exchange rate. You can get
24:45
three times that in the in the blue
24:47
market.
24:48
They don't call it the black market.
24:50
It's Since everyone does it, I think
24:51
it's blue is fine. But but so there are
24:53
all sorts of exchange rates.
24:55
Uh,
24:56
and but it's still This is the official
24:58
one. And even the official one you see
25:00
sort of has completely exploded.
25:03
The Turkish lira looks pretty good here
25:05
just because I put it next to Argentina
25:06
the Argentinian peso. Otherwise, it also
25:08
would look pretty bad.
25:10
Okay? But most of the these countries
25:12
are all the time pegging the exchange
25:13
rate because they use that to stabilize
25:15
inflation, the whole thing breaks up,
25:17
and then they boom, they go through big
25:19
spikes. You see this one here. They're
25:20
trying to stabilize. There you see that
25:22
they're trying to stabilize the
25:23
currency.
25:24
They're not floating there in that
25:26
range.
25:28
And they were a little successful and
25:31
And and and and that's happens all the
25:33
time to them.
25:36
And now obviously,
25:38
I mean, look at this the size of this.
25:40
This is an appreciation of the dollar
25:42
relative So, it's a depreciation of the
25:43
Argentinian peso.
25:45
What do you think is happening here?
25:49
Looks very smooth, by the way.
25:51
It's not that it's moving around. It's
25:52
just
25:55
What do you think is happening?
26:01
Very high inflation in the thousands,
26:03
you know?
26:04
And that's what that's what is happening
26:05
here. But but again, this is a hybrid
26:08
system. They They try to stabilize
26:10
frequently the exchange rate. The thing
26:12
goes and then they stabilize it again
26:13
and and so on and so forth. But you
26:15
can't fight
26:17
just having much higher inflation than
26:18
the rest of the world. You have higher
26:19
inflation, then there's no way around
26:21
that your currency is going to
26:22
depreciate. They try to,
26:24
but they can't.
26:27
Anyways,
26:28
uh,
26:31
so let me let me go back to this model
26:32
and and and and think a little bit more
26:35
about the decision to
26:37
have one kind of exchange rate or the
26:38
other one and therefore everything that
26:40
goes in between.
26:42
So, remember I just to remind you that's
26:44
that's the model we have.
26:46
Um,
26:48
so let me think about policy first and
26:49
then then let's think how
26:51
how how do you deal with policy in the
26:53
different exchange rate regimes.
26:55
And and then we'll see why would
26:56
countries would want thing or the other.
26:59
So, suppose a country's in a recession.
27:01
We're in this model.
27:02
Uh,
27:04
and suppose that we are in the flexible
27:06
exchange rate regime.
27:08
So, what should the fis- fiscal policy
27:10
do?
27:11
Suppose you're in a recession.
27:13
What what should fiscal fiscal policy
27:15
do?
27:18
There's nothing unique of closed economy
27:20
here.
27:21
You know,
27:22
of open economy. In closed economy you
27:24
would have given me the same answer.
27:25
You're in a recession, what will you do
27:27
with fiscal policy?
27:29
Have expansionary fiscal policy.
27:31
Increase G. So, that means you move the
27:33
IS to the right.
27:35
Nothing changes in the open economy. You
27:36
keep doing that.
27:38
The only thing that you get is a little
27:39
smaller multiplier because part of that
27:41
will go to imports.
27:43
But but it still it moves in the right
27:45
direction. Okay?
27:47
And and and yes, if countries rely on
27:49
other countries doing also their own
27:50
expansionary fiscal policy, but suppose
27:52
we're talking about a recession that is
27:54
unique to this country. Then you're
27:55
going to do an expansionary fiscal
27:57
policy.
27:59
What would the central bank do?
28:02
In closed economy.
28:04
What?
28:06
Drop interest rate. Well, in open
28:07
economy does the same.
28:09
You you just drop interest rate.
28:12
It turns out that that will depreciate
28:13
your currency,
28:15
uh,
28:15
which will help you
28:17
as well. So, it's very expansionary
28:19
because of that. You know, because it
28:20
your currency depreciates, so net export
28:22
goes up as a result of that. So, you get
28:24
the investment kick. You lose a little
28:26
bit because part of it goes to import,
28:28
but then you also get the effect of net
28:31
exports that come from the exchange
28:32
rate. Okay?
28:33
So, monetary policy is a great policy
28:36
in open economy because it gets
28:37
reinforced by the exchange rate.
28:40
It's even better than fiscal other
28:41
things equal when you compare the two.
28:44
The two policies lose power relative to
28:46
the closed economy because the
28:48
multiplier is smaller.
28:49
But the difference is that the interest
28:51
rate policy gets the extra kick that
28:53
comes from the depreciation of the
28:54
currency.
28:55
Okay? So, it's a very powerful tool.
29:00
Okay.
29:02
So, that's what you would do if you have
29:03
a
29:04
uh, flexible exchange rate.
29:07
And that's what countries do in practice
29:09
when they are free floaters.
29:11
Suppose you have a fixed exchange rate
29:13
regime.
29:14
Okay?
29:16
So, and it's a credible fixed exchange
29:17
rate regime.
29:19
Then I asked you again the question.
29:21
What
29:23
uh, what kind of fiscal policy would you
29:24
run in that country?
29:29
The same.
29:30
Expansionary. That's what you would do.
29:32
And it's effective as it was in closed
29:34
economy. A little less because the
29:36
multiplier is a little less. That's it.
29:38
But no difference in the analysis.
29:41
In fact,
29:42
fiscal policy has exactly the same
29:43
effect as as as fiscal policy in the
29:45
flexible exchange rate in this case
29:47
because I haven't moved the exchange
29:48
rate in any event in either of the two
29:50
cases. Okay?
29:52
What should the central bank do?
29:58
That's a tricky question.
30:05
Hm? Yes, if the central bank knows. So,
30:07
it would have to match. Yeah, exactly.
30:09
Uh so, the central bank cannot do
30:11
anything. I'm saying suppose this is a
30:12
neo-Keynesian recession. This country's
30:14
in recession.
30:15
Now, now it wants to use its policy
30:18
tools to deal with that. It has fiscal,
30:21
but it doesn't have monetary policy.
30:23
Unless
30:24
the cycle of the other country coincides
30:26
with your cycle. So, if it's a global
30:27
recession or something like that, then
30:30
then you're doomed because the other
30:31
country's doing the monetary policy for
30:32
what they're doing, what they need, not
30:34
for what you need. And therefore, you
30:36
don't have monetary policy. So, that's a
30:37
costly thing of a fixed exchange rate.
30:40
We already said it, but you now we're
30:42
making it very concrete because we are
30:43
in a recession,
30:45
and you realize now that you don't have
30:46
a tool that you had before.
30:48
Okay?
30:49
So, that's a cost
30:50
of a fixed exchange rate.
30:54
Here's an example. Uh here what I'm
30:56
plotting
30:57
is the the policy rate in the US.
31:01
That's the blue one.
31:02
And that's the policy rate in Hong Kong.
31:04
There's a small difference, but you can
31:05
see that the
31:06
These are technical things. But you can
31:08
see that that Hong Kong has to follow
31:10
the US essentially. It's exactly the
31:12
same shape.
31:14
So, Hong Kong doesn't have independent
31:16
policy.
31:18
Okay?
31:19
It Again, those are technical gaps.
31:20
They're not really
31:22
But just look at the shape. It's exactly
31:24
the same, moving around. So, Hong Kong
31:26
doesn't have monetary policy.
31:28
Period.
31:30
Not something they have. So, if they get
31:31
a recession that has to do with their
31:32
own cycle,
31:33
and that is not a result of something
31:35
that's happening in the US,
31:37
they don't have that that tool to deal
31:39
with that.
31:41
Of course, during COVID and and during
31:43
the global financial crisis, they were
31:45
aligned. So, they you know,
31:47
they would have moved it in the same
31:48
direction. That worked.
31:50
But if there's a shock that is
31:51
Chinese-centric, that is affecting Hong
31:53
Kong,
31:55
the US monetary policy is not going to
31:56
react to that.
31:58
And that that's a problem for Hong Kong
32:00
Hong Kong.
32:01
And still, they choose to do it. And the
32:03
good question is why?
32:06
Always there's politics that is more
32:07
than than the kind of thing, but there
32:09
are also economic arguments for why you
32:11
may want to do these things.
32:13
Another situation that I mentioned
32:16
happens all the time every other day in
32:18
Argentina, for example,
32:20
is speculative attacks on the currency.
32:22
So, you want to have a fixed exchange
32:23
rate, but the markets don't believe you
32:25
that you're going to be able to keep it
32:26
there.
32:27
And uh
32:29
And so, what happens? So, look at this
32:31
equation here. Suppose that that
32:33
that you have a fixed exchange rate, but
32:36
now the markets think you're not going
32:37
to be able to sustain it.
32:39
Okay?
32:40
So, that means suppose that this guy is
32:42
just going down.
32:44
That happens again in Argentina every
32:45
other day.
32:47
Probably today, every single day. No?
32:49
They want to say that they want to sign
32:50
the exchange rate, but the markets don't
32:52
believe you, and they expect your
32:53
currency to lose value in the next few
32:56
hours in the case of Argentina.
32:58
So, this guy is going down.
33:03
What happens to the current to the to
33:04
the current exchange rate? So, expected
33:06
exchange rate goes down. Big
33:08
The The everyone expects your currency
33:10
to drop.
33:13
What What will tend to happen to
33:16
the
33:17
currency today?
33:18
To the Argentinian peso today?
33:23
It drops, but you have a fixed exchange
33:25
rate, you can't let it drop.
33:28
I I'm So, if you're going to maintain an
33:30
exchange a fixed exchange rate, and now
33:32
you have a speculative attack, people
33:33
think your currency is going to drop,
33:35
and you want to maintain your peg,
33:36
that's called defending the peg. If you
33:39
want to defend the peg, then the only
33:41
option you have if this guy is dropping
33:42
to keep the exchange rate is to raise
33:44
interest rates a lot.
33:46
That's the way you fight the main way
33:47
you fight it. I mean, you fight it by
33:49
closing capital accounts and so on, but
33:52
that's the last resort. You first try to
33:54
fight it with monetary policy. So, if
33:56
this thing is dropping, you fight it by
33:58
increasing interest rate a lot.
34:00
And that's the way you stabilize the
34:01
currency.
34:03
But what happens when you raise interest
34:04
rate a lot to defend the parity, the
34:06
peg?
34:08
What is the problem of that?
34:17
Yeah, you generate a domestic recession.
34:19
Okay? Because just to defend your
34:21
currency, your peg,
34:23
you had to raise interest rate a lot.
34:25
No?
34:26
So, it means you're going to have a
34:27
recession at home.
34:29
Okay?
34:31
So, that's another problem of fixed
34:32
exchange. It's a problem That's not a
34:34
problem for Hong Kong. It was in 1997.
34:37
They did have a speculative attack
34:38
despite the fact that they had
34:40
twice the number of reserves relative to
34:42
their money base, but still they had
34:44
speculative problem there. But it rarely
34:46
happens in Hong Kong. In Argentina,
34:47
again, every other day, but but in
34:51
same in Turkey.
34:52
In Turkey, it's every 15 days, but but
34:55
but
34:56
but it's happening all the time.
34:59
So, that's a problem as well, because if
35:01
you have
35:02
to spend a lot of energy defending your
35:04
peg, then you're going to be causing
35:06
lots of recessions at home just to
35:08
stabilize the currency. Okay?
35:13
That's That's bigger economies. They
35:15
were okay. Well, Argentina, Turkey, and
35:16
so on, no? But these are
35:19
bigger boys, no? Here we have a
35:21
a
35:23
This is the ERM crisis. So, before the
35:25
euro,
35:26
uh
35:27
more or less the Eurozone plus the UK
35:30
uh
35:30
had a system called the ERM.
35:33
The EM EMS ERM ERM is the Well, anyway.
35:37
EMS is European Monetary System. ERM is
35:40
Exchange Rate Mechanism or something
35:42
like that. And they're both linked. But
35:45
let's call it the
35:46
European Monetary System. And the basic
35:49
idea of the European Monetary System
35:52
was that that
35:54
they behave very much like Singapore
35:56
with respect to each other. Meaning,
35:58
they allow themselves to
36:00
move around, but only in narrow bands.
36:03
The The countries that had the more
36:05
stable
36:09
domestic monetary position, like France
36:11
vis-à-vis the
36:12
Germany, the Deutschmark, and the French
36:15
franc, but they had these bands of 2 and
36:18
1/2% up and down, and they moved within
36:20
those those ranges. They didn't have a
36:22
full peg, but they allowed themselves to
36:24
move a little bit. Portugal, which it
36:26
was a little bit had a little bit less
36:27
discipline, they had 5% for each side
36:30
and stuff like that. But the point is,
36:32
they would have narrow bands. Okay? And
36:34
they moved around in those narrow bands,
36:36
and they kept their
36:38
uh
36:39
kept it for quite a while
36:41
before the euro.
36:43
Now, here the whole system came under a
36:46
speculative attack.
36:50
What happened around there?
36:52
You You probably have no idea.
36:58
Well, it's really linked to that, yes.
37:02
Yeah. It's the German re- reunification.
37:04
So, what happened is
37:06
when
37:07
East Germany and and West Germany unify,
37:10
they had to have a massive fiscal
37:12
policy, massive expansionary fiscal
37:13
policy.
37:15
And that big expansion put lots of
37:17
upward pressure on the on on on
37:20
on German interest rates.
37:22
And And that led to big appreciations
37:25
uh of the Deutschmark.
37:27
And And the other countries tried to
37:28
fight it because they had to be in this
37:30
very narrow band.
37:32
But they were experiencing these big
37:33
speculative attacks.
37:35
And so, they had to raise their interest
37:36
rate enormously.
37:38
Uh
37:39
the UK tried to do it for a while, and
37:40
they essentially said, "I we give up."
37:42
And then they they they they abandoned
37:44
the the system.
37:45
The French tried to stay in there for
37:47
quite a bit. Okay? You can see the
37:49
French franc. They didn't move. They
37:50
didn't move.
37:51
But it was extremely costly for them
37:53
because the interest rate has to go up a
37:54
lot, and sort of like got into a big
37:56
recession and so on. Eventually, the
37:58
whole system broke up broke down. I
38:00
mean, everyone left. And eventually,
38:02
they rejoined, but now in the euro. And
38:05
the euro is a little different because
38:06
in the euro, you give up There's no
38:08
space for the speculative attacks
38:11
because there's a single currency.
38:13
Okay?
38:14
So, that's the that's the most extreme
38:15
form.
38:17
Speculative attacks nowadays in Europe
38:18
happen through different means. It's
38:20
It's It's the
38:22
Well, anyways, let me not get into that
38:24
for
38:24
But but
38:26
But here you have So, what I'm saying,
38:28
having a fixed exchange rate is not
38:29
easy, even for countries that have sort
38:31
of very well-developed financial
38:33
markets, and so on and so forth.
38:37
Now, it would seem,
38:39
given all that I said,
38:41
that
38:42
I mean, there's no reason to have a
38:43
fixed exchange rate. It's something you
38:45
you give up an an instrument, and on top
38:48
of that,
38:49
you're subject to speculative attacks
38:50
all the time. Okay? Not all the time.
38:53
Well, it depends on how bad you are. But
38:55
but you know, you have to be very
38:57
well-behaved because otherwise, you're
38:59
subject to speculative attacks all the
39:00
time.
39:01
So,
39:03
So, why not do flexible exchange rate?
39:05
Why Why What is wrong with flexible
39:07
exchange rate?
39:08
Well, I think the main problem of
39:10
flexible exchange rate
39:11
is that it tends to move a lot.
39:13
I mean, we know that it moves a lot more
39:15
than fundamentals, meaning
39:17
you know, productivity is a little
39:18
higher in one country than the other,
39:20
demand is a little higher in the other
39:21
in the other country, but the exchange
39:23
rate moves a lot more than those little
39:25
differences justify.
39:28
And the reason one way of understanding
39:29
this is the following.
39:31
And this it will serve as an
39:32
introduction to the next topic of the
39:34
course, which will be asset pricing and
39:36
things like that.
39:37
So, let's look at revisit our interest
39:39
parity condition, but now let's not
39:41
assume
39:42
that that that the next the the the
39:46
expected exchange rate is fixed.
39:48
I mean, that was an assumption just to
39:49
make our life simple, but but it it's
39:51
not be. So, that's a that's a then
39:53
covered interest rate condition is this.
39:56
Well, you see, I can replace this guy
39:58
here for what will happen next period.
40:00
It's the same thing shifted by a period
40:02
with an expectation there.
40:04
So, ET + 1 expected, this guy here is
40:07
equal to 1 +
40:09
expected domestic interest rate 1 period
40:12
from now
40:13
divided by 1 + international interest
40:15
rate expected 1 period from now
40:17
times the expected exchange rate for T +
40:20
2
40:20
2 years from now.
40:22
And I can keep doing this. I can replace
40:23
this by something equivalent to that
40:25
with all the sub index shifted by 1
40:27
year, blah blah blah blah blah blah.
40:29
And so, I can end up writing this
40:30
exchange rate
40:32
as
40:33
this product of lots of things that can
40:35
happen in the future. The the monetary
40:37
policy path
40:38
at home, the monetary policy path, not
40:41
the next period, the path for years to
40:43
come
40:44
of
40:45
monetary policy in the other country,
40:47
and there's always an expected exchange
40:49
rate at the end there
40:51
that is free. It can move around.
40:55
So, the problem of this exchange is that
40:57
the future matters too much
41:00
in a sense. And you know, people have
41:02
lots of imagination, so
41:03
all sorts of weird things they imagine.
41:05
And and when you people have lots of
41:07
imagination, then these things are
41:08
moving a lot. And that's the reason do
41:10
you see enormous fluctuations in nominal
41:12
exchange rate.
41:13
Now,
41:15
uh
41:17
And that's the problem. It's a problem
41:18
to have a very volatile exchange rate
41:20
because it it makes transactions more
41:22
difficult. I mean, you know, if you the
41:24
price of things are ready price of
41:26
things are changing all the time, it's a
41:27
little bit more difficult to plan.
41:29
Uh
41:30
financial investments become more
41:31
because you get all this exchange rate
41:33
volatility in between. So, that's one of
41:35
the main reasons
41:37
uh
41:38
you would prefer, if you could to have a
41:41
more
41:42
managed exchange rate. It's because you
41:44
don't want this all this artificial
41:46
volatility that comes from behavioral
41:48
traits and things of that kind. Okay?
41:50
That's the main reason.
41:53
Uh
41:54
Look at this example, for example.
41:57
Example, for example, sorry about that.
41:58
But
41:59
this is Russia during the the the war.
42:03
This was the the the the ruble, the the
42:06
the the Russian currency.
42:09
And
42:10
when they invaded, of course, this thing
42:12
collapsed.
42:13
The currency collapsed. Okay?
42:16
Uh
42:16
this period is a is a little longer than
42:18
you think, but but it collapsed for for
42:20
quite a while.
42:21
And then it recovered a lot, actually
42:23
overshot and came down.
42:25
So, this is not because the Central Bank
42:27
said, you know,
42:29
we're going to
42:31
devalue the currency. It's just people
42:34
said, "Wow, this a country going into
42:35
war. It's going to be a mess, blah blah
42:37
blah blah."
42:38
So, all that future I talk about
42:40
uh
42:43
essentially destroyed the currency.
42:45
Okay?
42:46
Now, a lot of that recovery happened
42:48
there not because people now
42:50
began to see the future as a better
42:52
future or anything like that.
42:53
It's because
42:54
they had to hike interest rate
42:56
massively. They were around 4 or 5% and
42:58
they had to go to 20% interest rate to
43:00
defend the exchange rate. Remember I
43:01
told you have a speculative attack and
43:03
you have enormous pressure on your
43:04
currency. Well, the main tool you have
43:06
to offset that is to raise interest
43:08
rate.
43:09
They had they had interest rate
43:11
massively. They did a lot of other
43:12
things as well. They
43:14
put capital controls and lots of things.
43:16
But but but this was the main thing they
43:17
did. And so, they dragged the recession
43:19
the economy into recession for war
43:21
related reasons and because of the
43:23
monetary policy response they had to do
43:25
with that.
43:25
Okay? So, that's an extreme case of a
43:28
war. But but that's the kind of things
43:29
that can happen. Uh
43:32
in in in in an in a floating exchange
43:35
rate.
43:36
Even when
43:38
uh
43:41
I mean, the main constraint in Argentina
43:43
and Turkey and so on is reserves. They
43:44
don't have enough reserves. So, if you
43:46
have to defend your currency
43:48
by intervening in the in the in the
43:50
FX market
43:52
if you don't have enough, then you're
43:53
not credible. I mean,
43:54
if you have massive capital outflows and
43:56
you have a few billion dollars there,
43:59
it's not going to work.
44:01
That's not the case of Russia. They had
44:02
massive amount of reserves. So, that
44:04
that was not the issue. It was all about
44:05
expectations of things that happen in
44:07
the future. It was all about
44:09
this kind of terms. Okay?
44:14
Anyway, so so that added to the cost
44:16
they had.
44:18
So,
44:20
so how do we choose these things then in
44:22
practice?
44:23
Again, there are lots of things and
44:24
politics plays play role and so on.
44:27
Uh
44:28
but this this a case to so so again
44:32
I would put it even the other way
44:33
around. I think that if you could, you
44:35
would like to have a fixed exchange
44:37
rate.
44:38
If you could,
44:40
you would like to have a fixed exchange
44:41
rate because then you remove all this
44:42
spurious noise that happens every single
44:44
day because of exchange rate volatility
44:46
that complicates your life.
44:49
Uh
44:51
But so, when can you do that?
44:53
Well, first, you can do it with respect
44:54
to some other country
44:56
where the shocks are very similar.
44:59
You know, because
45:00
you you know, if you know that that that
45:03
say you're Mexico, but
45:05
or the north of Mexico, something like
45:06
that, and you know that all your shocks
45:08
are really shocks to the US.
45:10
Then the US can do the monetary policy
45:11
for you.
45:13
You know, because you have the same
45:14
shocks.
45:15
I'm exaggerating. So, if you're very
45:17
similar
45:19
then it makes sense to have a fixed
45:20
exchange rate because why pay for all
45:22
that volatility when you're going to be
45:23
doing the same policies
45:25
in both countries more or less at the
45:26
same time because you're exposed to the
45:27
same shocks.
45:29
So, that's one thing. That's one reason
45:30
why the Eurozone is a Eurozone because
45:33
they're European countries that have
45:35
very similar business cycles and so on.
45:37
Germany is a little different. That's
45:38
the reason they always have some
45:39
problem. I mean, the north and the
45:41
south, they're a little different. But
45:43
but but they're much more similar
45:46
than than other countries. Uh
45:50
Uh so so that's that's what they have
45:53
want.
45:55
Another option is is is when you have
45:59
lots of fiscal capacity.
46:01
Because if you have lots of fiscal
46:02
capacity, then the cost of not having
46:04
monetary policy is not that large
46:05
because you can fight your business
46:06
cycle with fiscal policy.
46:09
That's the case of Hong Kong, for
46:10
example. Hong Kong
46:12
Hong Kong, first of all, is not subject
46:13
to speculative attack because they have
46:14
massive amount of reserves. So, anyone
46:16
that dares attacking them is going to
46:18
lose their shirt. So, so they're safe.
46:21
Uh
46:22
uh
46:23
Soros tried many years back and he
46:25
didn't do as well as he did attacking
46:26
the British pound.
46:28
Uh
46:29
um
46:29
then then but they also have lots of
46:32
fiscal resources, so they can
46:33
fight their domestic recessions and so
46:35
on with fiscal policy.
46:37
The other factor, which also applies to
46:39
Hong Kong
46:41
if you have very flexible factor
46:43
markets. So, if wages move very easily,
46:45
if prices move very easily domestically
46:48
then you don't care about
46:50
having a fixed nominal exchange rate
46:51
because a fixed nominal exchange rate is
46:53
not the same as a fixed real exchange
46:55
rate, which is what you really need to
46:56
move around.
46:57
If your prices are flexible
46:59
doesn't matter that nominal exchange
47:00
doesn't move because the prices are
47:01
moving around.
47:02
And so, you you still have lots of
47:04
flexibility in the real exchange rate.
47:06
And that's the reason I would say is one
47:08
of the reasons uh political reasons as
47:09
well, but but why they can afford it.
47:11
Why I think in the case of Hong Kong
47:12
it's the other way around. It was some
47:13
political reasons
47:15
uh and and and the and then they build a
47:18
system so that
47:20
is is a is a coherent system because
47:22
they have lots of fiscal capacity, can
47:24
defend the currency well
47:26
and they have very flexible markets.
47:30
Uh
47:33
This is
47:34
Well, this again, this is what I said
47:36
before. If you if you
47:38
if this is what I said before. If you if
47:40
you have you don't like that noise. If
47:42
you especially you're going to be
47:42
trading a lot with people and so on.
47:45
You know,
47:46
in Europe, many people cross the border
47:48
many times a day and then you want to go
47:50
shopping one way or the other. It's a
47:52
it's a pain if the exchange rate is
47:54
moving all the time. You know? It's much
47:55
easier if things are stable. And the
47:57
same apply to financial transactions.
47:59
People have deposits in different banks
48:00
and stuff like that.
48:02
It's it's better if you don't have all
48:04
that fluctuation. And the case of the
48:06
Euro area, they decided that
48:08
uh
48:10
that the advantage of having a very
48:11
fixed exchange rate
48:13
uh
48:14
uh were more than the cost for
48:16
individual countries of not having
48:17
independent monetary policy.
48:20
It's still a work in progress. They're
48:21
building that is not finished.
48:24
But but but they're working at it.
48:26
The other reason why
48:28
uh countries fix exchange rate
48:30
uh and that's the Argentinian reason and
48:32
so on
48:33
is is when when they have no control in
48:35
inflation.
48:37
They have no credibility.
48:38
And so, if you peg to another currency
48:40
that has credibility, then the idea, the
48:42
hope at least, is that you will inherit
48:45
the credibility of the other currency.
48:47
And that's what they tried to
48:49
uh Ar- Argentina had a currency board
48:51
like Hong Kong for a while. The whole
48:53
idea was to control inflation. Well,
48:56
let's peg to someone.
48:58
Uh and and and if they if the markets
49:00
believe you, then it will work because
49:02
then you inherit the the credibility of
49:04
the You're saying, when you take a fixed
49:06
exchange rate, I'm not going to run
49:07
monetary policy, which is the main
49:08
source of inflation.
49:10
So, I'm going to let the credible
49:11
country run the monetary policy for me.
49:13
That's what gives you credibility.
49:15
As long as somebody believes that you're
49:16
not going to
49:18
quit the thing.
49:19
But but but that's the reason countries
49:21
do it, often to stabilize inflation as
49:24
well.
49:25
Okay.
— end of transcript —
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