1
00:00:16,559 --> 00:00:21,960
So today uh my plan is to finish the

2
00:00:19,000 --> 00:00:24,120
open economy part of the course and uh

3
00:00:21,960 --> 00:00:27,200
we will talk about exchange regimes but

4
00:00:24,120 --> 00:00:28,240
but before I do that, I need to finish

5
00:00:27,199 --> 00:00:29,960
uh

6
00:00:28,239 --> 00:00:31,439
a few things that we didn't in the

7
00:00:29,960 --> 00:00:32,920
previous lecture

8
00:00:31,440 --> 00:00:34,120
and that will help us an introduction

9
00:00:32,920 --> 00:00:35,719
for the kind of things I want to talk

10
00:00:34,119 --> 00:00:37,559
about today.

11
00:00:35,719 --> 00:00:40,960
And uh

12
00:00:37,560 --> 00:00:43,640
let me start just reviewing that last uh

13
00:00:40,960 --> 00:00:45,280
slide with that we discussed

14
00:00:43,640 --> 00:00:46,480
uh which is the Mundell-Fleming model.

15
00:00:45,280 --> 00:00:49,799
And the Mundell-Fleming model

16
00:00:46,479 --> 00:00:51,439
essentially is our old IS-LM model in

17
00:00:49,799 --> 00:00:54,159
which the IS is a little different

18
00:00:51,439 --> 00:00:54,879
because now we have a net exports term

19
00:00:54,159 --> 00:00:57,119
uh

20
00:00:54,880 --> 00:01:01,280
which is a function of new things like

21
00:00:57,119 --> 00:01:03,159
uh foreign output foreign income and

22
00:01:01,280 --> 00:01:05,000
uh and most importantly the real

23
00:01:03,159 --> 00:01:08,159
exchange rate and the real exchange rate

24
00:01:05,000 --> 00:01:09,799
in itself because of the UIP uncovered

25
00:01:08,159 --> 00:01:11,879
interest parity condition is a function

26
00:01:09,799 --> 00:01:14,079
of expected exchange rate

27
00:01:11,879 --> 00:01:17,199
the the

28
00:01:14,079 --> 00:01:19,239
internal foreign in- interest rate

29
00:01:17,200 --> 00:01:20,799
and it also gives us yet another reason

30
00:01:19,239 --> 00:01:23,919
for why

31
00:01:20,799 --> 00:01:25,439
uh the interest rate affects uh domestic

32
00:01:23,920 --> 00:01:27,400
aggregate demand. Okay? There's a

33
00:01:25,439 --> 00:01:29,200
There's a There's a the traditional

34
00:01:27,400 --> 00:01:32,560
investment effect of a increase in

35
00:01:29,200 --> 00:01:34,200
interest rate but we also get um the

36
00:01:32,560 --> 00:01:35,680
appreciation effect of an increase in

37
00:01:34,200 --> 00:01:37,320
the interest rate which is

38
00:01:35,680 --> 00:01:39,760
contractionary from the point of view of

39
00:01:37,319 --> 00:01:42,839
aggregate demand. So but this is like

40
00:01:39,760 --> 00:01:45,080
that with uh this extra net export term

41
00:01:42,840 --> 00:01:47,320
and and in this diagram, you know, for

42
00:01:45,079 --> 00:01:50,879
this we have the same interest rate here

43
00:01:47,319 --> 00:01:52,319
uh from this diagram which which

44
00:01:50,879 --> 00:01:54,359
portrays the

45
00:01:52,319 --> 00:01:56,879
uh uncovered interest parity condition,

46
00:01:54,359 --> 00:01:59,480
we can get for any given international

47
00:01:56,879 --> 00:02:01,359
interest rate and expected exchange rate

48
00:01:59,480 --> 00:02:03,280
for next period uh

49
00:02:01,359 --> 00:02:04,879
we can get the current exchange rate.

50
00:02:03,280 --> 00:02:07,480
Okay? So

51
00:02:04,879 --> 00:02:10,118
that was our model and we did a few

52
00:02:07,480 --> 00:02:11,400
experiments here. The first one was

53
00:02:10,118 --> 00:02:13,120
well, what happens if the expected

54
00:02:11,400 --> 00:02:15,200
exchange rate goes up?

55
00:02:13,120 --> 00:02:16,960
The first thing is which curves move?

56
00:02:15,199 --> 00:02:20,199
Well, if the expected exchange rate goes

57
00:02:16,960 --> 00:02:21,560
up, then I know that for any given

58
00:02:20,199 --> 00:02:24,439
interest rate

59
00:02:21,560 --> 00:02:25,479
uh the current exchange rate will go up.

60
00:02:24,439 --> 00:02:27,039
Okay?

61
00:02:25,479 --> 00:02:29,039
I know that this curve, in other words,

62
00:02:27,039 --> 00:02:31,039
will shift to the right.

63
00:02:29,039 --> 00:02:32,400
Why do I know that? Well, because if the

64
00:02:31,039 --> 00:02:34,079
current exchange rate doesn't move by

65
00:02:32,400 --> 00:02:36,240
the same amount of expected exchange

66
00:02:34,080 --> 00:02:37,440
rate, now I'm on a expected

67
00:02:36,240 --> 00:02:39,840
I'm going to have a expected capital

68
00:02:37,439 --> 00:02:42,919
gain or loss which will be inconsistent

69
00:02:39,840 --> 00:02:45,520
with the previous uh parity of interest

70
00:02:42,919 --> 00:02:47,039
rate, you know? So we had agreed that

71
00:02:45,520 --> 00:02:48,960
uh you know, that we had certain

72
00:02:47,039 --> 00:02:50,479
expected appreciation. So let's make it

73
00:02:48,960 --> 00:02:51,640
very simple. Suppose that this interest

74
00:02:50,479 --> 00:02:53,759
rate happens to be equal to the

75
00:02:51,639 --> 00:02:55,319
international interest rate then we know

76
00:02:53,759 --> 00:02:56,679
that this exchange rate has to be equal

77
00:02:55,319 --> 00:02:57,919
to the expected exchange rate because

78
00:02:56,680 --> 00:02:59,080
you cannot expect an appreciation or

79
00:02:57,919 --> 00:03:00,719
depreciation of the currency if the

80
00:02:59,080 --> 00:03:02,320
interest rates are the same.

81
00:03:00,719 --> 00:03:04,599
But if now the expected exchange in the

82
00:03:02,319 --> 00:03:06,400
next period goes up and if the exchange

83
00:03:04,599 --> 00:03:08,519
rate today doesn't move, that would mean

84
00:03:06,400 --> 00:03:10,599
that you expect also capital uh uh

85
00:03:08,520 --> 00:03:12,520
an appreciation of the currency which

86
00:03:10,599 --> 00:03:13,879
means that investing in domestic bonds

87
00:03:12,520 --> 00:03:15,719
would give you a higher return because

88
00:03:13,879 --> 00:03:17,479
of the same interest rate plus expected

89
00:03:15,719 --> 00:03:19,000
appreciation. So we know that the

90
00:03:17,479 --> 00:03:21,599
uncovered interest parity condition will

91
00:03:19,000 --> 00:03:22,919
move to the right. You know, as a result

92
00:03:21,599 --> 00:03:24,840
of the increase in expected exchange

93
00:03:22,919 --> 00:03:27,399
rate. But it also means that at any

94
00:03:24,840 --> 00:03:29,599
given interest rate you get a higher an

95
00:03:27,400 --> 00:03:31,319
appreciated exchange rate relative to

96
00:03:29,599 --> 00:03:33,400
the previous one before the increase in

97
00:03:31,319 --> 00:03:35,680
expected exchange rate which means that

98
00:03:33,400 --> 00:03:36,640
the IS will shift to the left.

99
00:03:35,680 --> 00:03:38,760
Okay.

100
00:03:36,639 --> 00:03:40,199
So if the expected exchange rate goes

101
00:03:38,759 --> 00:03:41,599
up, that leads to an appreciation and

102
00:03:40,199 --> 00:03:44,000
that leads to

103
00:03:41,599 --> 00:03:44,919
contraction in aggregate demand.

104
00:03:44,000 --> 00:03:46,520
Okay.

105
00:03:44,919 --> 00:03:48,239
Good.

106
00:03:46,520 --> 00:03:50,320
Next experiment was well, what happens

107
00:03:48,240 --> 00:03:52,400
if foreign output comes down? Well, if

108
00:03:50,319 --> 00:03:53,759
foreign output comes down, then that has

109
00:03:52,400 --> 00:03:55,760
nothing to do with the interest parity

110
00:03:53,759 --> 00:03:57,879
condition. It's not

111
00:03:55,759 --> 00:03:59,519
doesn't show up in this expression. But

112
00:03:57,879 --> 00:04:01,719
it does shift this, you know, because it

113
00:03:59,520 --> 00:04:03,920
reduces our exports for any given level

114
00:04:01,719 --> 00:04:05,599
of interest rate and output and so the

115
00:04:03,919 --> 00:04:07,239
IS shifts to the left. So that's

116
00:04:05,599 --> 00:04:09,159
contractionary. That's a way you import

117
00:04:07,240 --> 00:04:12,040
a recession from the rest of the world.

118
00:04:09,159 --> 00:04:14,960
Okay? Uh as I said before

119
00:04:12,039 --> 00:04:16,560
people around Asia and and Latin America

120
00:04:14,960 --> 00:04:18,480
very very worried about the Chinese

121
00:04:16,560 --> 00:04:21,160
actually the Europeans as well because

122
00:04:18,480 --> 00:04:22,920
Germany exports a lot to China are very

123
00:04:21,160 --> 00:04:24,560
worried about contractions in China and

124
00:04:22,920 --> 00:04:27,040
so on because through that channel it's

125
00:04:24,560 --> 00:04:29,079
contractionary as well. Now we're in the

126
00:04:27,040 --> 00:04:31,840
other part of the

127
00:04:29,079 --> 00:04:33,919
of the cycle because China is reopening

128
00:04:31,839 --> 00:04:36,000
uh and and that sort of gives lots of

129
00:04:33,920 --> 00:04:37,640
hope to Europe and so on.

130
00:04:36,000 --> 00:04:39,920
And that's one of the reasons why the

131
00:04:37,639 --> 00:04:41,519
euro has appreciated vis-à-vis the the

132
00:04:39,920 --> 00:04:42,400
dollar recently.

133
00:04:41,519 --> 00:04:43,639
Okay.

134
00:04:42,399 --> 00:04:45,759
Um

135
00:04:43,639 --> 00:04:47,360
and then the the last experiment that I

136
00:04:45,759 --> 00:04:49,360
don't remember whether we finished or

137
00:04:47,360 --> 00:04:50,680
not, I think I said it very quickly is

138
00:04:49,360 --> 00:04:53,400
well, what happens if the international

139
00:04:50,680 --> 00:04:54,800
interest rate goes up?

140
00:04:53,399 --> 00:04:56,599
What moves? Well, the first thing that

141
00:04:54,800 --> 00:04:58,600
will move is this. This was a parameter,

142
00:04:56,600 --> 00:05:00,160
okay? So

143
00:04:58,600 --> 00:05:02,000
what do I know that if I keep the

144
00:05:00,160 --> 00:05:04,280
interest rate constant and the

145
00:05:02,000 --> 00:05:05,680
international interest rate went up what

146
00:05:04,279 --> 00:05:07,679
has to happen to the exchange and the

147
00:05:05,680 --> 00:05:09,160
expected exchange rate hasn't changed?

148
00:05:07,680 --> 00:05:10,959
What has to happen to the exchange rate

149
00:05:09,160 --> 00:05:11,920
today to be indifferent between the two

150
00:05:10,959 --> 00:05:14,879
things?

151
00:05:11,920 --> 00:05:16,319
The the two bonds.

152
00:05:14,879 --> 00:05:18,159
So this is experiment. Suppose that

153
00:05:16,319 --> 00:05:20,279
we're at any domestic interest rate, we

154
00:05:18,160 --> 00:05:22,760
don't touch that. Now I increase

155
00:05:20,279 --> 00:05:25,000
international interest rate

156
00:05:22,759 --> 00:05:27,199
and I say the expected exchange rate

157
00:05:25,000 --> 00:05:29,240
is the same as it used to be, what has

158
00:05:27,199 --> 00:05:30,759
to happen to the current exchange rate

159
00:05:29,240 --> 00:05:32,600
in order to be indifferent between

160
00:05:30,759 --> 00:05:35,159
investing in the US bond or the other

161
00:05:32,600 --> 00:05:35,160
foreign bond?

162
00:05:36,360 --> 00:05:40,000
Exactly, it has to depreciate. Why?

163
00:05:42,279 --> 00:05:45,479
That's correct but but why is it that

164
00:05:44,040 --> 00:05:47,680
you need an

165
00:05:45,480 --> 00:05:50,800
that the exchange rate falls today in

166
00:05:47,680 --> 00:05:52,720
order to restore to have the the

167
00:05:50,800 --> 00:05:55,120
interest parity condition

168
00:05:52,720 --> 00:05:55,120
holding?

169
00:05:55,279 --> 00:05:59,919
Okay. So remember what happened is that

170
00:05:58,040 --> 00:06:01,160
you had the same interest rate and now

171
00:05:59,920 --> 00:06:02,360
that the international interest rate

172
00:06:01,160 --> 00:06:04,400
went up.

173
00:06:02,360 --> 00:06:06,160
That means if nothing moves, now you

174
00:06:04,399 --> 00:06:07,919
preferred you were indifferent before.

175
00:06:06,160 --> 00:06:09,520
Now you would prefer to invest in the

176
00:06:07,920 --> 00:06:11,759
international bond.

177
00:06:09,519 --> 00:06:13,919
If I don't change the the the US rate,

178
00:06:11,759 --> 00:06:15,399
then I have to compensate you by some

179
00:06:13,920 --> 00:06:16,879
other mean.

180
00:06:15,399 --> 00:06:17,759
The only way I can compensate you in

181
00:06:16,879 --> 00:06:20,639
this model, the only thing that's

182
00:06:17,759 --> 00:06:22,480
endogenous is by an expected

183
00:06:20,639 --> 00:06:23,599
appreciation of the exchange rate

184
00:06:22,480 --> 00:06:27,000
because that would give you a capital

185
00:06:23,600 --> 00:06:29,720
gain from holding the bond the US bond,

186
00:06:27,000 --> 00:06:31,000
a currency capital gain. Now

187
00:06:29,720 --> 00:06:32,560
since the expected exchange rate is

188
00:06:31,000 --> 00:06:34,600
given, the only way I can give you that

189
00:06:32,560 --> 00:06:36,000
is depreciating the currency today so

190
00:06:34,600 --> 00:06:36,840
then you can expect an appreciation

191
00:06:36,000 --> 00:06:38,319
tomorrow.

192
00:06:36,839 --> 00:06:39,759
From today to tomorrow. Okay, that's

193
00:06:38,319 --> 00:06:42,319
that's the mechanism.

194
00:06:39,759 --> 00:06:45,319
Okay, so that means that this

195
00:06:42,319 --> 00:06:46,680
uh curve here will shift to the right.

196
00:06:45,319 --> 00:06:49,000
Okay? For any given interest rate you

197
00:06:46,680 --> 00:06:50,199
need a sorry, to the left. For any given

198
00:06:49,000 --> 00:06:52,480
I made that mistake in the previous

199
00:06:50,199 --> 00:06:54,159
lecture as well. So for any given level

200
00:06:52,480 --> 00:06:55,960
of interest rate, this curve will have

201
00:06:54,160 --> 00:06:57,520
to move to the left.

202
00:06:55,959 --> 00:06:58,839
Okay? So if the interest rate doesn't

203
00:06:57,519 --> 00:07:00,839
change and international interest rate

204
00:06:58,839 --> 00:07:02,679
is up, you need an exchange rate today

205
00:07:00,839 --> 00:07:04,679
that is lower than it used to be so you

206
00:07:02,680 --> 00:07:05,879
can expect an appreciation from now to

207
00:07:04,680 --> 00:07:07,480
the next period.

208
00:07:05,879 --> 00:07:09,079
Okay?

209
00:07:07,480 --> 00:07:10,759
So that's what moves to the left. Now

210
00:07:09,079 --> 00:07:13,159
what happens? What else moves in that

211
00:07:10,759 --> 00:07:13,159
case?

212
00:07:15,480 --> 00:07:19,879
I remember when I'm I'm asking the

213
00:07:17,519 --> 00:07:22,079
question, what else moves?

214
00:07:19,879 --> 00:07:23,719
Uh I mean what other curve moves? What

215
00:07:22,079 --> 00:07:25,879
you need to do is just take something as

216
00:07:23,720 --> 00:07:27,400
given and then see what whether we get

217
00:07:25,879 --> 00:07:28,920
the same equilibrium output or not or

218
00:07:27,399 --> 00:07:30,879
not. So I'll take an interest rate as

219
00:07:28,920 --> 00:07:32,720
given as IS

220
00:07:30,879 --> 00:07:34,839
and then ask the question, well, will I

221
00:07:32,720 --> 00:07:36,040
get the same equilibrium output or not?

222
00:07:34,839 --> 00:07:38,399
If I get the same equilibrium output,

223
00:07:36,040 --> 00:07:39,480
that means the IS hasn't moved.

224
00:07:38,399 --> 00:07:40,839
But if I get a different equilibrium

225
00:07:39,480 --> 00:07:42,120
output, it means the IS has moved

226
00:07:40,839 --> 00:07:44,119
because for the same interest rate I'm

227
00:07:42,120 --> 00:07:47,439
getting a different equilibrium output.

228
00:07:44,120 --> 00:07:47,439
So what happens in this case?

229
00:07:48,480 --> 00:07:54,720
Does the IS move or not?

230
00:07:51,399 --> 00:07:54,719
When I star goes up?

231
00:08:05,000 --> 00:08:10,560
Going to simplify the question. Yes, it

232
00:08:07,120 --> 00:08:10,560
does. Which way?

233
00:08:15,920 --> 00:08:19,480
Will I get more or less output?

234
00:08:18,439 --> 00:08:20,920
When the international interest rate

235
00:08:19,480 --> 00:08:22,480
goes up?

236
00:08:20,920 --> 00:08:24,400
And I'm taking Look the kind of things

237
00:08:22,480 --> 00:08:26,439
I'm taking as given. I'm also taking as

238
00:08:24,399 --> 00:08:29,159
given international output.

239
00:08:26,439 --> 00:08:31,680
So I I'm not moving Y star.

240
00:08:29,160 --> 00:08:33,360
I'm not moving expected exchange rate.

241
00:08:31,680 --> 00:08:34,960
Uh

242
00:08:33,360 --> 00:08:36,560
and I'm asking the question

243
00:08:34,960 --> 00:08:38,519
is the domestic

244
00:08:36,559 --> 00:08:40,359
central bank, the Fed in the case of the

245
00:08:38,519 --> 00:08:41,960
US, does not change the interest rate,

246
00:08:40,360 --> 00:08:45,200
what happens to equilibrium output? Does

247
00:08:41,960 --> 00:08:46,600
it go down or up?

248
00:08:45,200 --> 00:08:48,640
If the other if the international

249
00:08:46,600 --> 00:08:50,399
interest rate goes up, the domestic

250
00:08:48,639 --> 00:08:53,840
interest does not

251
00:08:50,399 --> 00:08:53,840
what has to happen to exchange rate?

252
00:08:55,360 --> 00:08:58,480
You answered it before.

253
00:08:57,200 --> 00:09:01,120
Has to go down. That means it has to

254
00:08:58,480 --> 00:09:04,480
depreciate. What happens to net exports

255
00:09:01,120 --> 00:09:04,480
when the exchange rate depreciates?

256
00:09:06,759 --> 00:09:09,679
What does it mean that the exchange rate

257
00:09:07,879 --> 00:09:11,439
depreciates? Especially if you have the

258
00:09:09,679 --> 00:09:13,359
In this case we have the prices

259
00:09:11,440 --> 00:09:14,880
completely fixed. So now if the nominal

260
00:09:13,360 --> 00:09:16,919
exchange rate depreciates, means that

261
00:09:14,879 --> 00:09:19,840
the real exchange rate depreciates.

262
00:09:16,919 --> 00:09:19,839
What does that mean?

263
00:09:21,799 --> 00:09:24,679
What got cheaper?

264
00:09:26,639 --> 00:09:30,639
Okay, you need a lot of to study for the

265
00:09:28,320 --> 00:09:33,040
quiz. Uh

266
00:09:30,639 --> 00:09:34,360
domestic goods are cheaper. So so that

267
00:09:33,039 --> 00:09:35,480
means that the

268
00:09:34,360 --> 00:09:37,000
and

269
00:09:35,480 --> 00:09:38,320
equivalently foreign goods got more

270
00:09:37,000 --> 00:09:39,759
expensive.

271
00:09:38,320 --> 00:09:41,640
That means for any given level of

272
00:09:39,759 --> 00:09:43,960
domestic interest rate, now there will

273
00:09:41,639 --> 00:09:45,879
be less imports and more exports. That

274
00:09:43,960 --> 00:09:48,720
means net exports will be more which

275
00:09:45,879 --> 00:09:50,960
means the IS will shift to the right.

276
00:09:48,720 --> 00:09:50,960
Okay.

277
00:09:56,080 --> 00:10:00,280
Good. So these things you you need to

278
00:09:58,919 --> 00:10:02,079
control. I understand that this is a

279
00:10:00,279 --> 00:10:03,839
little confusing to think about exchange

280
00:10:02,080 --> 00:10:06,320
rate and so on, but

281
00:10:03,840 --> 00:10:06,320
but uh

282
00:10:08,240 --> 00:10:12,519
So, anything that happens here with

283
00:10:09,960 --> 00:10:15,360
exchange rate is just a relative price.

284
00:10:12,519 --> 00:10:18,079
The more expensive are your goods,

285
00:10:15,360 --> 00:10:19,759
the harder it will be to sell them, you

286
00:10:18,080 --> 00:10:21,720
And and the more tempted you will be to

287
00:10:19,759 --> 00:10:23,319
buy foreign goods. That's That's That's

288
00:10:21,720 --> 00:10:24,960
what it does. So, it's

289
00:10:23,320 --> 00:10:27,040
So, that's contraction. Appreciation of

290
00:10:24,960 --> 00:10:29,120
contraction here or not. Here, the story

291
00:10:27,039 --> 00:10:31,599
is a little different. It's all about

292
00:10:29,120 --> 00:10:32,960
equalizing expected returns. So, you

293
00:10:31,600 --> 00:10:34,759
need to have an equal movement in the

294
00:10:32,960 --> 00:10:36,320
exchange rate today so that you are

295
00:10:34,759 --> 00:10:38,000
always indifferent between investing in

296
00:10:36,320 --> 00:10:39,600
one side or the other. It's about the

297
00:10:38,000 --> 00:10:41,200
return, the expected exchange in the

298
00:10:39,600 --> 00:10:44,600
exchange rate.

299
00:10:41,200 --> 00:10:44,600
So, okay, good.

300
00:10:46,279 --> 00:10:49,600
Okay, I got it. It's a little unclear,

301
00:10:48,039 --> 00:10:52,279
but

302
00:10:49,600 --> 00:10:52,279
we'll keep trying.

303
00:10:54,000 --> 00:11:00,039
Is there anything particularly unclear?

304
00:10:56,759 --> 00:11:00,039
Or is all a blur here?

305
00:11:00,080 --> 00:11:05,800
Okay, got it.

306
00:11:03,080 --> 00:11:05,800
Um

307
00:11:06,159 --> 00:11:09,838
Well, let me So, all that is I describe

308
00:11:08,679 --> 00:11:13,079
here

309
00:11:09,839 --> 00:11:14,680
is is um

310
00:11:13,080 --> 00:11:17,160
is allowing the exchange rate to move.

311
00:11:14,679 --> 00:11:19,399
We're saying, "Look, if we move

312
00:11:17,159 --> 00:11:20,919
something or the foreign foreigners move

313
00:11:19,399 --> 00:11:22,799
something, then we ask the question,

314
00:11:20,919 --> 00:11:24,319
"Well, what does exchange rate has to do

315
00:11:22,799 --> 00:11:27,759
here?"

316
00:11:24,320 --> 00:11:29,320
Okay? And typically when when when

317
00:11:27,759 --> 00:11:31,960
that's done,

318
00:11:29,320 --> 00:11:34,000
we call those regimes floating exchange

319
00:11:31,960 --> 00:11:36,280
rate systems, meaning exchange rate can

320
00:11:34,000 --> 00:11:37,799
float, can move around. As interest

321
00:11:36,279 --> 00:11:40,279
rates in different parts of the world

322
00:11:37,799 --> 00:11:41,879
change, then the exchange rate moves

323
00:11:40,279 --> 00:11:43,559
around. Okay?

324
00:11:41,879 --> 00:11:44,919
Typically call that flexible exchange

325
00:11:43,559 --> 00:11:47,519
rate. I think the distinction is a lot

326
00:11:44,919 --> 00:11:50,279
harder to make in practice, but for

327
00:11:47,519 --> 00:11:52,360
reasons I'll explain later, but but

328
00:11:50,279 --> 00:11:54,319
that's what is meant as a as a floating

329
00:11:52,360 --> 00:11:56,759
exchange rate system, one in which

330
00:11:54,320 --> 00:11:58,320
really you're doing your Each country is

331
00:11:56,759 --> 00:11:59,679
doing its own policies and so on, and

332
00:11:58,320 --> 00:12:05,040
the exchange rate does what it needs to

333
00:11:59,679 --> 00:12:07,039
do so so so the financial markets clear.

334
00:12:05,039 --> 00:12:09,159
Many countries, however, do something

335
00:12:07,039 --> 00:12:11,000
which is a the polar opposite of that,

336
00:12:09,159 --> 00:12:12,838
which is called a fixed exchange rate

337
00:12:11,000 --> 00:12:15,279
regime. Okay?

338
00:12:12,839 --> 00:12:18,760
So, some countries really peg their

339
00:12:15,279 --> 00:12:21,279
currencies to a major currency.

340
00:12:18,759 --> 00:12:24,200
An extreme case is the Eurozone, where

341
00:12:21,279 --> 00:12:26,159
they gave up their individual currencies

342
00:12:24,200 --> 00:12:30,320
and they have a common currency. Okay?

343
00:12:26,159 --> 00:12:31,799
So, so Germany and and and and and and

344
00:12:30,320 --> 00:12:33,640
Italy have a

345
00:12:31,799 --> 00:12:35,519
ultra pegged exchange rate because they

346
00:12:33,639 --> 00:12:36,720
have the same currency. Okay?

347
00:12:35,519 --> 00:12:38,360
Now,

348
00:12:36,720 --> 00:12:39,320
most of the times fixed exchange rates

349
00:12:38,360 --> 00:12:41,279
are

350
00:12:39,320 --> 00:12:42,879
are a little weaker than that.

351
00:12:41,279 --> 00:12:44,279
For example, the Hong Kong dollar has

352
00:12:42,879 --> 00:12:46,559
been pegged to the dollar for a long

353
00:12:44,279 --> 00:12:48,720
time, for the US dollar for a long time.

354
00:12:46,559 --> 00:12:50,599
Okay? And we'll show you a few others.

355
00:12:48,720 --> 00:12:52,839
Many countries go through some phase

356
00:12:50,600 --> 00:12:54,560
where they try to peg the currency

357
00:12:52,839 --> 00:12:56,240
and it typically fails at some point,

358
00:12:54,559 --> 00:12:58,279
but but they have periods in which the

359
00:12:56,240 --> 00:12:59,879
currency is pegged.

360
00:12:58,279 --> 00:13:01,480
But so, let me

361
00:12:59,879 --> 00:13:02,960
Suppose that you have a pegged exchange

362
00:13:01,480 --> 00:13:05,600
rate, let me show you

363
00:13:02,960 --> 00:13:08,480
some features of it. Suppose you are in

364
00:13:05,600 --> 00:13:10,879
a peg in a peg or a fixed exchange rate

365
00:13:08,480 --> 00:13:12,639
regime pegged to another currency, and

366
00:13:10,879 --> 00:13:14,039
suppose it's credible. That's a big

367
00:13:12,639 --> 00:13:15,240
issue with fixed exchange rate, but

368
00:13:14,039 --> 00:13:16,759
suppose it's credible. There are some

369
00:13:15,240 --> 00:13:18,360
countries that have credible fixed

370
00:13:16,759 --> 00:13:20,799
exchange rate.

371
00:13:18,360 --> 00:13:23,360
Well, if if you have a fixed exchange

372
00:13:20,799 --> 00:13:25,399
rate with respect to some other currency

373
00:13:23,360 --> 00:13:26,960
and it's credible, then you know that

374
00:13:25,399 --> 00:13:28,480
the expected exchange rate is equal to

375
00:13:26,960 --> 00:13:29,600
exchange rate and equal to a constant.

376
00:13:28,480 --> 00:13:33,240
That's what it means to have a fixed

377
00:13:29,600 --> 00:13:35,399
exchange rate. Okay? It's constant.

378
00:13:33,240 --> 00:13:36,600
But if this is constant, means you never

379
00:13:35,399 --> 00:13:38,639
can expect an appreciation or

380
00:13:36,600 --> 00:13:41,399
depreciation

381
00:13:38,639 --> 00:13:43,000
because it's constant. It's fixed.

382
00:13:41,399 --> 00:13:45,159
And if you can't expect an appreciation

383
00:13:43,000 --> 00:13:48,200
or depreciation, the uncovered interest

384
00:13:45,159 --> 00:13:50,719
parity condition tells you that you

385
00:13:48,200 --> 00:13:51,879
know, what does it tell you?

386
00:13:50,720 --> 00:13:55,240
That your interest rate has to be the

387
00:13:51,879 --> 00:13:55,240
same as the foreign interest rate.

388
00:13:56,200 --> 00:14:01,120
Why?

389
00:13:58,320 --> 00:14:03,560
What would happen in a credible

390
00:14:01,120 --> 00:14:05,039
uh peg in a credible fixed exchange rate

391
00:14:03,559 --> 00:14:06,359
if the domestic interest rate is higher

392
00:14:05,039 --> 00:14:08,959
than the international

393
00:14:06,360 --> 00:14:12,240
than the currency the interest rate

394
00:14:08,960 --> 00:14:14,079
of the country you're pegging to?

395
00:14:12,240 --> 00:14:15,720
What would happen? Suppose that

396
00:14:14,078 --> 00:14:17,599
I'm in a fixed exchange rate and and we

397
00:14:15,720 --> 00:14:19,200
have the same interest rate and now I

398
00:14:17,600 --> 00:14:21,320
unilaterally decide to raise interest

399
00:14:19,200 --> 00:14:22,440
rates.

400
00:14:21,320 --> 00:14:24,079
What do you think would happen with

401
00:14:22,440 --> 00:14:25,200
capital flows?

402
00:14:24,078 --> 00:14:27,759
How would What would you do to your

403
00:14:25,200 --> 00:14:27,759
portfolio?

404
00:14:28,440 --> 00:14:31,280
If the currency is exchange rate is

405
00:14:29,919 --> 00:14:32,838
pegged

406
00:14:31,279 --> 00:14:35,000
and it's credible,

407
00:14:32,839 --> 00:14:36,880
it is as if they were issuing the same

408
00:14:35,000 --> 00:14:38,399
currency because it's the same It's a

409
00:14:36,879 --> 00:14:41,159
different currency, different name, but

410
00:14:38,399 --> 00:14:42,838
it has a constant in front of it. Okay?

411
00:14:41,159 --> 00:14:45,958
So, it's as if it was issuing the same

412
00:14:42,839 --> 00:14:47,400
currency. Two bonds that are identical

413
00:14:45,958 --> 00:14:48,519
and issued in the same currency cannot

414
00:14:47,399 --> 00:14:51,240
be paying different interest rate

415
00:14:48,519 --> 00:14:53,078
because you would go invest all your

416
00:14:51,240 --> 00:14:55,519
money, you know, in the in the bond that

417
00:14:53,078 --> 00:14:58,279
is paying a higher interest rate.

418
00:14:55,519 --> 00:15:00,039
And that's what happens here. So, it's

419
00:14:58,279 --> 00:15:01,759
Mechanically, what would happen is for

420
00:15:00,039 --> 00:15:03,078
some crazy reason a country has a fixed

421
00:15:01,759 --> 00:15:04,838
exchange rate, credible fixed exchange

422
00:15:03,078 --> 00:15:07,159
rate, decides to have an interest rate

423
00:15:04,839 --> 00:15:09,000
higher than the currency the the the

424
00:15:07,159 --> 00:15:10,879
interest rate in the currency it's it's

425
00:15:09,000 --> 00:15:12,839
being pegged to,

426
00:15:10,879 --> 00:15:14,039
then you would see massive capital flows

427
00:15:12,839 --> 00:15:16,240
to that country. So, there would be an

428
00:15:14,039 --> 00:15:18,120
enormous pressure for an appreciation of

429
00:15:16,240 --> 00:15:19,480
that currency.

430
00:15:18,120 --> 00:15:21,200
Okay?

431
00:15:19,480 --> 00:15:23,279
But but the And what the central bank

432
00:15:21,200 --> 00:15:25,759
would have to do is start buying massive

433
00:15:23,279 --> 00:15:27,799
amounts of the of the supplying massive

434
00:15:25,759 --> 00:15:29,200
amounts of this currency for those that

435
00:15:27,799 --> 00:15:31,159
want to buy it

436
00:15:29,200 --> 00:15:33,680
because there will be an infinite demand

437
00:15:31,159 --> 00:15:36,679
for that. Okay?

438
00:15:33,679 --> 00:15:38,199
So, in practice, what that means And And

439
00:15:36,679 --> 00:15:40,359
sometimes

440
00:15:38,200 --> 00:15:43,280
you can do that for a little while, but

441
00:15:40,360 --> 00:15:45,879
but but but not in in a sustained

442
00:15:43,279 --> 00:15:48,639
manner. So, what happens in practice is

443
00:15:45,879 --> 00:15:50,159
that if you really have a a a a pegged

444
00:15:48,639 --> 00:15:53,319
exchange rate and you have free capital

445
00:15:50,159 --> 00:15:55,879
mobility, which is people can move in

446
00:15:53,320 --> 00:15:58,000
and out of your bonds, China does them,

447
00:15:55,879 --> 00:16:00,240
for example, so it can allow itself to

448
00:15:58,000 --> 00:16:02,320
both control a little bit the currency

449
00:16:00,240 --> 00:16:03,000
and uh uh

450
00:16:02,320 --> 00:16:06,079
uh

451
00:16:03,000 --> 00:16:07,360
mean be semi semi pegged and it still

452
00:16:06,078 --> 00:16:09,159
can move its domestic interest rate

453
00:16:07,360 --> 00:16:10,639
because they have capital controls, but

454
00:16:09,159 --> 00:16:12,958
but if you don't have capital controls

455
00:16:10,639 --> 00:16:14,199
and people can move money in and out, it

456
00:16:12,958 --> 00:16:15,399
can do portfolio investment as it

457
00:16:14,200 --> 00:16:16,520
happened with most of the advanced

458
00:16:15,399 --> 00:16:19,600
economies,

459
00:16:16,519 --> 00:16:22,559
then effectively uh

460
00:16:19,600 --> 00:16:24,279
you give up domestic monetary policy.

461
00:16:22,559 --> 00:16:26,399
Okay? Because whatever the other country

462
00:16:24,279 --> 00:16:29,720
does, the country you're pegging to

463
00:16:26,399 --> 00:16:29,720
does, you have to follow.

464
00:16:29,799 --> 00:16:35,078
So, that's what it means. You peg, you

465
00:16:31,958 --> 00:16:37,879
give up your domestic monetary policy if

466
00:16:35,078 --> 00:16:39,000
you choose to peg to another country.

467
00:16:37,879 --> 00:16:40,600
I'll I'll a little later I'm going to

468
00:16:39,000 --> 00:16:43,120
tell you why countries may choose to do

469
00:16:40,600 --> 00:16:45,079
that, but that's what you do.

470
00:16:43,120 --> 00:16:47,440
Okay? And the the uncovered interest

471
00:16:45,078 --> 00:16:48,838
parity tells you that's what you do.

472
00:16:47,440 --> 00:16:50,800
You're not going to be able to deviate

473
00:16:48,839 --> 00:16:53,079
there significantly from the interest

474
00:16:50,799 --> 00:16:54,359
rate that the other country is setting

475
00:16:53,078 --> 00:16:56,479
if you want to maintain your fixed

476
00:16:54,360 --> 00:16:58,800
exchange rate.

477
00:16:56,480 --> 00:17:01,879
Now, in practice, there are many hybrid

478
00:16:58,799 --> 00:17:03,719
regimes. There There are very very few

479
00:17:01,879 --> 00:17:04,279
pure float regimes.

480
00:17:03,720 --> 00:17:06,679
Uh

481
00:17:04,279 --> 00:17:09,039
few. I mean, maybe five or something

482
00:17:06,679 --> 00:17:10,759
like that. But but but but so, there are

483
00:17:09,039 --> 00:17:13,480
all sorts of degrees

484
00:17:10,759 --> 00:17:15,640
of exchange rate regimes and and which

485
00:17:13,480 --> 00:17:19,000
are hybrids between fixed exchange rates

486
00:17:15,640 --> 00:17:21,720
and and fully flexible exchange rates.

487
00:17:19,000 --> 00:17:24,000
Let me show you just a few just

488
00:17:21,720 --> 00:17:26,799
randomly more or less randomly selected

489
00:17:24,000 --> 00:17:31,519
in Bloomberg. Uh so, there you have in

490
00:17:26,799 --> 00:17:33,119
in in in in white is the US euro.

491
00:17:31,519 --> 00:17:34,639
That's a float. That's a That's a

492
00:17:33,119 --> 00:17:36,799
cleanest float you can imagine. I mean,

493
00:17:34,640 --> 00:17:38,800
there's no

494
00:17:36,799 --> 00:17:41,879
Then, another which is a very clean

495
00:17:38,799 --> 00:17:43,799
float is the dollar yen,

496
00:17:41,880 --> 00:17:46,520
Japanese yen.

497
00:17:43,799 --> 00:17:48,799
Now, that's a currency that has that

498
00:17:46,519 --> 00:17:51,039
freely floats, but if there's a major

499
00:17:48,799 --> 00:17:52,519
dislocations, central banks do intervene

500
00:17:51,039 --> 00:17:53,799
to money So,

501
00:17:52,519 --> 00:17:56,480
it means

502
00:17:53,799 --> 00:17:57,599
in normal circumstances, they float. And

503
00:17:56,480 --> 00:17:59,759
the same is true with the euro. But if

504
00:17:57,599 --> 00:18:02,119
there's big dislocations, a major bank

505
00:17:59,759 --> 00:18:04,720
collapses or something like that, then

506
00:18:02,119 --> 00:18:06,119
there major dislocations in in financial

507
00:18:04,720 --> 00:18:08,079
markets. They become very segmented.

508
00:18:06,119 --> 00:18:10,199
Arbitrage is not that easy and so on.

509
00:18:08,079 --> 00:18:12,119
Then then then central banks intervene.

510
00:18:10,200 --> 00:18:14,519
But but for the normal business cycle

511
00:18:12,119 --> 00:18:16,000
and so on, they do not.

512
00:18:14,519 --> 00:18:17,920
They do not intervene in the currency

513
00:18:16,000 --> 00:18:20,759
market. They intervene in different ways

514
00:18:17,920 --> 00:18:22,840
and that's the reason I'll get there.

515
00:18:20,759 --> 00:18:25,400
And the other one is the the pound, not

516
00:18:22,839 --> 00:18:28,079
the US dollar versus the British pound.

517
00:18:25,400 --> 00:18:30,480
Uh then then it's also that's a pure

518
00:18:28,079 --> 00:18:33,199
float.

519
00:18:30,480 --> 00:18:36,519
This is also pure float. This is the

520
00:18:33,200 --> 00:18:39,480
US versus the Aussie dollar

521
00:18:36,519 --> 00:18:43,599
So, and against the Canadian dollar and

522
00:18:39,480 --> 00:18:47,079
against the the Swedish krona.

523
00:18:43,599 --> 00:18:48,839
Okay? Those are pretty floating

524
00:18:47,079 --> 00:18:51,000
regimes. They are a little different

525
00:18:48,839 --> 00:18:52,720
from the previous ones I showed you

526
00:18:51,000 --> 00:18:56,240
because these are currencies that are

527
00:18:52,720 --> 00:18:58,919
much more prone to sell off

528
00:18:56,240 --> 00:19:01,120
during risk-off environments. And that's

529
00:18:58,919 --> 00:19:03,480
the reason you see these spikes here.

530
00:19:01,119 --> 00:19:05,839
Okay? This was COVID.

531
00:19:03,480 --> 00:19:07,519
Biggest spike. You didn't see it in the

532
00:19:05,839 --> 00:19:08,759
in the dollar euro and so on and so

533
00:19:07,519 --> 00:19:10,879
forth. So, these are currencies that are

534
00:19:08,759 --> 00:19:14,039
free floaters, but they're very exposed

535
00:19:10,880 --> 00:19:15,240
to to risk the risk environment in the

536
00:19:14,039 --> 00:19:16,559
market. But they're still they're free

537
00:19:15,240 --> 00:19:18,919
floaters.

538
00:19:16,559 --> 00:19:20,200
Um

539
00:19:18,919 --> 00:19:22,280
The Swiss are a little bit more of

540
00:19:20,200 --> 00:19:23,679
independent minded than and but they do

541
00:19:22,279 --> 00:19:27,240
control a bit more the currency, but

542
00:19:23,679 --> 00:19:30,000
they're still I I consider those

543
00:19:27,240 --> 00:19:31,359
a free floaters.

544
00:19:30,000 --> 00:19:34,679
These are currencies that are a little

545
00:19:31,359 --> 00:19:35,599
different. This is the Brazilian real.

546
00:19:34,679 --> 00:19:38,600
Uh

547
00:19:35,599 --> 00:19:40,480
the zar is the South African rand.

548
00:19:38,599 --> 00:19:42,240
And this is the

549
00:19:40,480 --> 00:19:43,679
Colombian peso.

550
00:19:42,240 --> 00:19:45,679
And you see several things here. They

551
00:19:43,679 --> 00:19:48,120
They do move. So, so they have a big

552
00:19:45,679 --> 00:19:49,720
component of flexible exchange rate.

553
00:19:48,119 --> 00:19:52,879
Uh

554
00:19:49,720 --> 00:19:54,880
They do intervene a lot more, though. Uh

555
00:19:52,880 --> 00:19:56,880
because they're exposed to much more

556
00:19:54,880 --> 00:19:59,200
risk off type environment and so on and

557
00:19:56,880 --> 00:20:00,800
they need to intervene fairly frequently

558
00:19:59,200 --> 00:20:01,720
to control movements in the exchange

559
00:20:00,799 --> 00:20:04,720
rate.

560
00:20:01,720 --> 00:20:05,880
But but you also see a trend

561
00:20:04,720 --> 00:20:07,960
in these things.

562
00:20:05,880 --> 00:20:09,880
So, their currencies are becoming

563
00:20:07,960 --> 00:20:12,160
chronically weaker relative to the

564
00:20:09,880 --> 00:20:13,920
dollar.

565
00:20:12,160 --> 00:20:15,800
And the reason for that

566
00:20:13,920 --> 00:20:17,400
is because they're countries that have

567
00:20:15,799 --> 00:20:18,639
higher inflation.

568
00:20:17,400 --> 00:20:20,080
So, if you want to maintain the real

569
00:20:18,640 --> 00:20:22,080
exchange rate constant and you have high

570
00:20:20,079 --> 00:20:23,480
inflation than the other country, then

571
00:20:22,079 --> 00:20:24,879
your nominal exchange rate has to be

572
00:20:23,480 --> 00:20:25,839
depreciating.

573
00:20:24,880 --> 00:20:27,040
Okay?

574
00:20:25,839 --> 00:20:29,079
Because your prices are rising at a

575
00:20:27,039 --> 00:20:30,000
faster pace than the other one,

576
00:20:29,079 --> 00:20:31,879
well,

577
00:20:30,000 --> 00:20:33,920
if the exchange rate was not

578
00:20:31,880 --> 00:20:35,080
appreciating on average depreciating on

579
00:20:33,920 --> 00:20:36,800
average, then it would mean that you

580
00:20:35,079 --> 00:20:38,519
would be coming more and more expensive.

581
00:20:36,799 --> 00:20:40,599
Okay? So, that's the reason. Countries

582
00:20:38,519 --> 00:20:42,680
that have higher inflation, they tend to

583
00:20:40,599 --> 00:20:43,639
have these trends as well.

584
00:20:42,680 --> 00:20:45,799
Okay?

585
00:20:43,640 --> 00:20:47,800
But they're still fairly floating.

586
00:20:45,799 --> 00:20:49,759
Here, these are all

587
00:20:47,799 --> 00:20:52,200
currencies that are

588
00:20:49,759 --> 00:20:53,279
uh, to a different degree

589
00:20:52,200 --> 00:20:54,519
uh,

590
00:20:53,279 --> 00:20:56,000
um,

591
00:20:54,519 --> 00:20:58,160
targeted in the sense that they're

592
00:20:56,000 --> 00:21:00,640
contained in in terms of they're not

593
00:20:58,160 --> 00:21:03,000
free to float at will.

594
00:21:00,640 --> 00:21:05,320
Uh, the scale here will mislead you. If

595
00:21:03,000 --> 00:21:07,680
I had put it in the same scale as the

596
00:21:05,319 --> 00:21:09,759
the euro dollar or the the euro yen and

597
00:21:07,680 --> 00:21:10,799
the the dollar yen or the euro yen as

598
00:21:09,759 --> 00:21:12,759
well,

599
00:21:10,799 --> 00:21:15,200
then these things would have been looked

600
00:21:12,759 --> 00:21:16,839
very small. Okay? So, so I should have

601
00:21:15,200 --> 00:21:18,000
put a a real floater there so you would

602
00:21:16,839 --> 00:21:19,399
have seen that these guys are moving a

603
00:21:18,000 --> 00:21:20,160
lot less.

604
00:21:19,400 --> 00:21:22,840
And these are different kind of

605
00:21:20,160 --> 00:21:25,720
countries. This is the Hong Kong dollar

606
00:21:22,839 --> 00:21:27,519
that for all practical purposes pegged.

607
00:21:25,720 --> 00:21:29,120
Okay? These little wiggles is just

608
00:21:27,519 --> 00:21:30,559
technical things that happen overnight

609
00:21:29,119 --> 00:21:32,639
and stuff like that.

610
00:21:30,559 --> 00:21:34,279
But they're pegged to the dollar.

611
00:21:32,640 --> 00:21:35,840
Okay? So, the Hong Kong dollar is pegged

612
00:21:34,279 --> 00:21:37,000
to the dollar.

613
00:21:35,839 --> 00:21:38,839
Uh,

614
00:21:37,000 --> 00:21:40,400
that means they really don't have

615
00:21:38,839 --> 00:21:43,480
independent monetary policy relative to

616
00:21:40,400 --> 00:21:47,040
the US vis-a-vis the US.

617
00:21:43,480 --> 00:21:48,079
The This is the CNH. This is the the the

618
00:21:47,039 --> 00:21:49,639
um,

619
00:21:48,079 --> 00:21:50,879
the Chinese

620
00:21:49,640 --> 00:21:52,880
renminbi

621
00:21:50,880 --> 00:21:54,600
and and and it's a currency again. I

622
00:21:52,880 --> 00:21:56,360
should have put it with a floated real

623
00:21:54,599 --> 00:21:59,480
floater there. It's a lot more

624
00:21:56,359 --> 00:22:02,759
controlled. Okay? So, it moves around

625
00:21:59,480 --> 00:22:04,319
but but in a much tighter range and and

626
00:22:02,759 --> 00:22:06,480
and they're thinking about exchange rate

627
00:22:04,319 --> 00:22:08,159
when part of their policy program and so

628
00:22:06,480 --> 00:22:11,079
on, the exchange rate is something

629
00:22:08,160 --> 00:22:11,080
they're thinking about.

630
00:22:11,240 --> 00:22:14,559
This one here, the blue one is is an

631
00:22:13,119 --> 00:22:16,159
interesting one.

632
00:22:14,559 --> 00:22:18,159
Uh,

633
00:22:16,160 --> 00:22:21,519
um,

634
00:22:18,160 --> 00:22:22,400
that's the the the the Singaporean

635
00:22:21,519 --> 00:22:24,160
Okay?

636
00:22:22,400 --> 00:22:26,040
And the Singaporean dollar, they have a

637
00:22:24,160 --> 00:22:28,960
very interesting regime.

638
00:22:26,039 --> 00:22:30,759
They have a a a um,

639
00:22:28,960 --> 00:22:34,600
a target zone, meaning they let the

640
00:22:30,759 --> 00:22:36,720
exchange rate move within a range only.

641
00:22:34,599 --> 00:22:38,480
But it's not pegged against a

642
00:22:36,720 --> 00:22:39,679
single currency, it's pegged against a

643
00:22:38,480 --> 00:22:41,160
basket

644
00:22:39,679 --> 00:22:44,480
of of currencies.

645
00:22:41,160 --> 00:22:46,600
Okay? And the the recipe is secret.

646
00:22:44,480 --> 00:22:48,559
So, everyone is always guessing what

647
00:22:46,599 --> 00:22:49,759
they're doing and so on. They do change

648
00:22:48,559 --> 00:22:51,919
the weights a little bit to keep the

649
00:22:49,759 --> 00:22:54,279
markets confused. But but their currency

650
00:22:51,920 --> 00:22:55,679
is very stable. It's well understood.

651
00:22:54,279 --> 00:22:57,920
It's a It's a weighted average of the

652
00:22:55,679 --> 00:23:00,160
euro, the renminbi and the and the

653
00:22:57,920 --> 00:23:02,480
dollar. But but they they don't disclose

654
00:23:00,160 --> 00:23:04,200
exactly the thing, but you know, you can

655
00:23:02,480 --> 00:23:06,319
filter out what they're doing and and

656
00:23:04,200 --> 00:23:07,880
they they keep things in a range

657
00:23:06,319 --> 00:23:10,599
uh, and they occasionally change the

658
00:23:07,880 --> 00:23:12,760
slope of that range, but but it's very

659
00:23:10,599 --> 00:23:15,159
regulated in that country. And they in

660
00:23:12,759 --> 00:23:17,079
fact they state their monetary policy in

661
00:23:15,160 --> 00:23:18,560
terms of the effects. They say, "That's

662
00:23:17,079 --> 00:23:20,359
our policy."

663
00:23:18,559 --> 00:23:21,839
Interest rate is what everything needs

664
00:23:20,359 --> 00:23:23,839
to be so the exchange rate remains in

665
00:23:21,839 --> 00:23:24,959
that range. That's that's that's the way

666
00:23:23,839 --> 00:23:26,559
they state the monetary policy. They

667
00:23:24,960 --> 00:23:28,120
don't even think about

668
00:23:26,559 --> 00:23:30,240
So, I let the markets determine the

669
00:23:28,119 --> 00:23:31,799
interest rate, we determine the exchange

670
00:23:30,240 --> 00:23:34,519
rate here in that range. And it's a

671
00:23:31,799 --> 00:23:34,519
narrow range.

672
00:23:35,279 --> 00:23:38,799
Again,

673
00:23:36,440 --> 00:23:40,120
I should have put

674
00:23:38,799 --> 00:23:41,480
um,

675
00:23:40,119 --> 00:23:43,319
a real floater there so you would have

676
00:23:41,480 --> 00:23:45,559
seen that. Okay? So,

677
00:23:43,319 --> 00:23:47,240
so the the point is that

678
00:23:45,559 --> 00:23:50,720
everything goes. They're all sort of

679
00:23:47,240 --> 00:23:51,880
arrangements happening around the world.

680
00:23:50,720 --> 00:23:53,759
This is These are different kind of

681
00:23:51,880 --> 00:23:55,880
currencies, you know?

682
00:23:53,759 --> 00:23:58,160
Uh, this is the the

683
00:23:55,880 --> 00:24:00,040
the

684
00:23:58,160 --> 00:24:00,960
the Turkish lira

685
00:24:00,039 --> 00:24:04,079
Okay?

686
00:24:00,960 --> 00:24:05,400
and the Argentinian peso.

687
00:24:04,079 --> 00:24:07,000
I think through this sample it's been

688
00:24:05,400 --> 00:24:08,679
called peso since since they have this

689
00:24:07,000 --> 00:24:10,759
very high inflation, they keep changing

690
00:24:08,679 --> 00:24:12,480
the name of the currency and so on

691
00:24:10,759 --> 00:24:14,279
because they have to remove zeros from

692
00:24:12,480 --> 00:24:15,839
things. So, but but I think through all

693
00:24:14,279 --> 00:24:16,879
that period it's still the Argentinian

694
00:24:15,839 --> 00:24:18,199
peso.

695
00:24:16,880 --> 00:24:21,920
And uh,

696
00:24:18,200 --> 00:24:23,000
so I mean, look at the scale.

697
00:24:21,920 --> 00:24:25,840
So,

698
00:24:23,000 --> 00:24:28,359
you cannot see it, but but all these two

699
00:24:25,839 --> 00:24:30,000
countries are all the time fighting

700
00:24:28,359 --> 00:24:31,759
against the exchange rate. In fact,

701
00:24:30,000 --> 00:24:33,079
Argentina today has like five different

702
00:24:31,759 --> 00:24:34,720
exchange rates.

703
00:24:33,079 --> 00:24:36,359
There is the official exchange rate,

704
00:24:34,720 --> 00:24:37,720
there is the blue exchange rate, there

705
00:24:36,359 --> 00:24:39,199
is the purple exchange rate, there are

706
00:24:37,720 --> 00:24:40,759
all sorts of things.

707
00:24:39,200 --> 00:24:42,640
You should never pay with a credit card

708
00:24:40,759 --> 00:24:43,839
if you go to Argentina if you do tourism

709
00:24:42,640 --> 00:24:45,440
because you don't want to pay the

710
00:24:43,839 --> 00:24:47,639
official exchange rate. You can get

711
00:24:45,440 --> 00:24:48,840
three times that in the in the blue

712
00:24:47,640 --> 00:24:50,040
market.

713
00:24:48,839 --> 00:24:51,279
They don't call it the black market.

714
00:24:50,039 --> 00:24:53,920
It's Since everyone does it, I think

715
00:24:51,279 --> 00:24:55,519
it's blue is fine. But but so there are

716
00:24:53,920 --> 00:24:56,279
all sorts of exchange rates.

717
00:24:55,519 --> 00:24:58,200
Uh,

718
00:24:56,279 --> 00:25:00,200
and but it's still This is the official

719
00:24:58,200 --> 00:25:03,160
one. And even the official one you see

720
00:25:00,200 --> 00:25:05,240
sort of has completely exploded.

721
00:25:03,160 --> 00:25:06,840
The Turkish lira looks pretty good here

722
00:25:05,240 --> 00:25:08,519
just because I put it next to Argentina

723
00:25:06,839 --> 00:25:10,039
the Argentinian peso. Otherwise, it also

724
00:25:08,519 --> 00:25:12,000
would look pretty bad.

725
00:25:10,039 --> 00:25:13,519
Okay? But most of the these countries

726
00:25:12,000 --> 00:25:15,279
are all the time pegging the exchange

727
00:25:13,519 --> 00:25:17,599
rate because they use that to stabilize

728
00:25:15,279 --> 00:25:19,639
inflation, the whole thing breaks up,

729
00:25:17,599 --> 00:25:20,959
and then they boom, they go through big

730
00:25:19,640 --> 00:25:22,320
spikes. You see this one here. They're

731
00:25:20,960 --> 00:25:23,360
trying to stabilize. There you see that

732
00:25:22,319 --> 00:25:24,960
they're trying to stabilize the

733
00:25:23,359 --> 00:25:26,678
currency.

734
00:25:24,960 --> 00:25:28,039
They're not floating there in that

735
00:25:26,679 --> 00:25:31,480
range.

736
00:25:28,039 --> 00:25:33,200
And they were a little successful and

737
00:25:31,480 --> 00:25:35,559
And and and and that's happens all the

738
00:25:33,200 --> 00:25:35,559
time to them.

739
00:25:36,000 --> 00:25:40,839
And now obviously,

740
00:25:38,160 --> 00:25:42,120
I mean, look at this the size of this.

741
00:25:40,839 --> 00:25:43,480
This is an appreciation of the dollar

742
00:25:42,119 --> 00:25:45,000
relative So, it's a depreciation of the

743
00:25:43,480 --> 00:25:48,200
Argentinian peso.

744
00:25:45,000 --> 00:25:48,200
What do you think is happening here?

745
00:25:49,480 --> 00:25:52,679
Looks very smooth, by the way.

746
00:25:51,440 --> 00:25:55,160
It's not that it's moving around. It's

747
00:25:52,679 --> 00:25:55,160
just

748
00:25:55,559 --> 00:25:58,480
What do you think is happening?

749
00:26:01,519 --> 00:26:04,519
Very high inflation in the thousands,

750
00:26:03,640 --> 00:26:05,840
you know?

751
00:26:04,519 --> 00:26:08,200
And that's what that's what is happening

752
00:26:05,839 --> 00:26:10,159
here. But but again, this is a hybrid

753
00:26:08,200 --> 00:26:12,200
system. They They try to stabilize

754
00:26:10,160 --> 00:26:13,960
frequently the exchange rate. The thing

755
00:26:12,200 --> 00:26:15,600
goes and then they stabilize it again

756
00:26:13,960 --> 00:26:17,200
and and so on and so forth. But you

757
00:26:15,599 --> 00:26:18,599
can't fight

758
00:26:17,200 --> 00:26:19,679
just having much higher inflation than

759
00:26:18,599 --> 00:26:21,559
the rest of the world. You have higher

760
00:26:19,679 --> 00:26:22,440
inflation, then there's no way around

761
00:26:21,559 --> 00:26:24,440
that your currency is going to

762
00:26:22,440 --> 00:26:27,039
depreciate. They try to,

763
00:26:24,440 --> 00:26:27,039
but they can't.

764
00:26:27,200 --> 00:26:31,000
Anyways,

765
00:26:28,839 --> 00:26:31,000
uh,

766
00:26:31,160 --> 00:26:35,040
so let me let me go back to this model

767
00:26:32,960 --> 00:26:37,519
and and and and think a little bit more

768
00:26:35,039 --> 00:26:38,879
about the decision to

769
00:26:37,519 --> 00:26:40,720
have one kind of exchange rate or the

770
00:26:38,880 --> 00:26:42,440
other one and therefore everything that

771
00:26:40,720 --> 00:26:44,120
goes in between.

772
00:26:42,440 --> 00:26:46,200
So, remember I just to remind you that's

773
00:26:44,119 --> 00:26:48,079
that's the model we have.

774
00:26:46,200 --> 00:26:49,960
Um,

775
00:26:48,079 --> 00:26:51,720
so let me think about policy first and

776
00:26:49,960 --> 00:26:53,679
then then let's think how

777
00:26:51,720 --> 00:26:55,600
how how do you deal with policy in the

778
00:26:53,679 --> 00:26:56,840
different exchange rate regimes.

779
00:26:55,599 --> 00:26:59,480
And and then we'll see why would

780
00:26:56,839 --> 00:27:01,039
countries would want thing or the other.

781
00:26:59,480 --> 00:27:02,839
So, suppose a country's in a recession.

782
00:27:01,039 --> 00:27:04,159
We're in this model.

783
00:27:02,839 --> 00:27:06,199
Uh,

784
00:27:04,160 --> 00:27:08,080
and suppose that we are in the flexible

785
00:27:06,200 --> 00:27:10,279
exchange rate regime.

786
00:27:08,079 --> 00:27:11,079
So, what should the fis- fiscal policy

787
00:27:10,279 --> 00:27:13,240
do?

788
00:27:11,079 --> 00:27:15,119
Suppose you're in a recession.

789
00:27:13,240 --> 00:27:17,359
What what should fiscal fiscal policy

790
00:27:15,119 --> 00:27:17,359
do?

791
00:27:18,880 --> 00:27:21,960
There's nothing unique of closed economy

792
00:27:20,799 --> 00:27:22,799
here.

793
00:27:21,960 --> 00:27:24,360
You know,

794
00:27:22,799 --> 00:27:25,839
of open economy. In closed economy you

795
00:27:24,359 --> 00:27:27,240
would have given me the same answer.

796
00:27:25,839 --> 00:27:29,759
You're in a recession, what will you do

797
00:27:27,240 --> 00:27:31,120
with fiscal policy?

798
00:27:29,759 --> 00:27:33,640
Have expansionary fiscal policy.

799
00:27:31,119 --> 00:27:35,359
Increase G. So, that means you move the

800
00:27:33,640 --> 00:27:36,960
IS to the right.

801
00:27:35,359 --> 00:27:38,719
Nothing changes in the open economy. You

802
00:27:36,960 --> 00:27:39,920
keep doing that.

803
00:27:38,720 --> 00:27:41,799
The only thing that you get is a little

804
00:27:39,920 --> 00:27:43,480
smaller multiplier because part of that

805
00:27:41,799 --> 00:27:45,440
will go to imports.

806
00:27:43,480 --> 00:27:47,240
But but it still it moves in the right

807
00:27:45,440 --> 00:27:49,279
direction. Okay?

808
00:27:47,240 --> 00:27:50,720
And and and yes, if countries rely on

809
00:27:49,279 --> 00:27:52,839
other countries doing also their own

810
00:27:50,720 --> 00:27:54,120
expansionary fiscal policy, but suppose

811
00:27:52,839 --> 00:27:55,919
we're talking about a recession that is

812
00:27:54,119 --> 00:27:57,479
unique to this country. Then you're

813
00:27:55,920 --> 00:27:59,080
going to do an expansionary fiscal

814
00:27:57,480 --> 00:28:02,400
policy.

815
00:27:59,079 --> 00:28:02,399
What would the central bank do?

816
00:28:02,960 --> 00:28:06,279
In closed economy.

817
00:28:04,839 --> 00:28:07,959
What?

818
00:28:06,279 --> 00:28:09,960
Drop interest rate. Well, in open

819
00:28:07,960 --> 00:28:12,200
economy does the same.

820
00:28:09,960 --> 00:28:13,720
You you just drop interest rate.

821
00:28:12,200 --> 00:28:15,240
It turns out that that will depreciate

822
00:28:13,720 --> 00:28:15,839
your currency,

823
00:28:15,240 --> 00:28:17,679
uh,

824
00:28:15,839 --> 00:28:19,199
which will help you

825
00:28:17,679 --> 00:28:20,720
as well. So, it's very expansionary

826
00:28:19,200 --> 00:28:22,480
because of that. You know, because it

827
00:28:20,720 --> 00:28:24,480
your currency depreciates, so net export

828
00:28:22,480 --> 00:28:26,960
goes up as a result of that. So, you get

829
00:28:24,480 --> 00:28:28,880
the investment kick. You lose a little

830
00:28:26,960 --> 00:28:31,120
bit because part of it goes to import,

831
00:28:28,880 --> 00:28:32,640
but then you also get the effect of net

832
00:28:31,119 --> 00:28:33,799
exports that come from the exchange

833
00:28:32,640 --> 00:28:36,200
rate. Okay?

834
00:28:33,799 --> 00:28:37,839
So, monetary policy is a great policy

835
00:28:36,200 --> 00:28:40,159
in open economy because it gets

836
00:28:37,839 --> 00:28:41,720
reinforced by the exchange rate.

837
00:28:40,159 --> 00:28:44,280
It's even better than fiscal other

838
00:28:41,720 --> 00:28:46,600
things equal when you compare the two.

839
00:28:44,279 --> 00:28:48,039
The two policies lose power relative to

840
00:28:46,599 --> 00:28:49,839
the closed economy because the

841
00:28:48,039 --> 00:28:51,839
multiplier is smaller.

842
00:28:49,839 --> 00:28:53,399
But the difference is that the interest

843
00:28:51,839 --> 00:28:54,480
rate policy gets the extra kick that

844
00:28:53,400 --> 00:28:55,600
comes from the depreciation of the

845
00:28:54,480 --> 00:28:59,159
currency.

846
00:28:55,599 --> 00:28:59,158
Okay? So, it's a very powerful tool.

847
00:29:00,039 --> 00:29:03,599
Okay.

848
00:29:02,359 --> 00:29:04,719
So, that's what you would do if you have

849
00:29:03,599 --> 00:29:07,279
a

850
00:29:04,720 --> 00:29:09,759
uh, flexible exchange rate.

851
00:29:07,279 --> 00:29:11,960
And that's what countries do in practice

852
00:29:09,759 --> 00:29:13,480
when they are free floaters.

853
00:29:11,960 --> 00:29:14,960
Suppose you have a fixed exchange rate

854
00:29:13,480 --> 00:29:16,360
regime.

855
00:29:14,960 --> 00:29:17,960
Okay?

856
00:29:16,359 --> 00:29:19,399
So, and it's a credible fixed exchange

857
00:29:17,960 --> 00:29:21,600
rate regime.

858
00:29:19,400 --> 00:29:23,240
Then I asked you again the question.

859
00:29:21,599 --> 00:29:24,879
What

860
00:29:23,240 --> 00:29:27,759
uh, what kind of fiscal policy would you

861
00:29:24,880 --> 00:29:27,760
run in that country?

862
00:29:29,279 --> 00:29:32,319
The same.

863
00:29:30,359 --> 00:29:34,719
Expansionary. That's what you would do.

864
00:29:32,319 --> 00:29:36,240
And it's effective as it was in closed

865
00:29:34,720 --> 00:29:38,679
economy. A little less because the

866
00:29:36,240 --> 00:29:41,000
multiplier is a little less. That's it.

867
00:29:38,679 --> 00:29:42,560
But no difference in the analysis.

868
00:29:41,000 --> 00:29:43,919
In fact,

869
00:29:42,559 --> 00:29:45,918
fiscal policy has exactly the same

870
00:29:43,919 --> 00:29:47,320
effect as as as fiscal policy in the

871
00:29:45,919 --> 00:29:48,520
flexible exchange rate in this case

872
00:29:47,319 --> 00:29:50,279
because I haven't moved the exchange

873
00:29:48,519 --> 00:29:52,400
rate in any event in either of the two

874
00:29:50,279 --> 00:29:55,920
cases. Okay?

875
00:29:52,400 --> 00:29:55,920
What should the central bank do?

876
00:29:58,200 --> 00:30:01,319
That's a tricky question.

877
00:30:05,440 --> 00:30:09,600
Hm? Yes, if the central bank knows. So,

878
00:30:07,519 --> 00:30:11,119
it would have to match. Yeah, exactly.

879
00:30:09,599 --> 00:30:12,559
Uh so, the central bank cannot do

880
00:30:11,119 --> 00:30:14,079
anything. I'm saying suppose this is a

881
00:30:12,559 --> 00:30:15,759
neo-Keynesian recession. This country's

882
00:30:14,079 --> 00:30:18,199
in recession.

883
00:30:15,759 --> 00:30:21,319
Now, now it wants to use its policy

884
00:30:18,200 --> 00:30:23,240
tools to deal with that. It has fiscal,

885
00:30:21,319 --> 00:30:24,359
but it doesn't have monetary policy.

886
00:30:23,240 --> 00:30:26,359
Unless

887
00:30:24,359 --> 00:30:27,919
the cycle of the other country coincides

888
00:30:26,359 --> 00:30:30,319
with your cycle. So, if it's a global

889
00:30:27,920 --> 00:30:31,279
recession or something like that, then

890
00:30:30,319 --> 00:30:32,599
then you're doomed because the other

891
00:30:31,279 --> 00:30:34,519
country's doing the monetary policy for

892
00:30:32,599 --> 00:30:36,519
what they're doing, what they need, not

893
00:30:34,519 --> 00:30:37,839
for what you need. And therefore, you

894
00:30:36,519 --> 00:30:40,319
don't have monetary policy. So, that's a

895
00:30:37,839 --> 00:30:42,000
costly thing of a fixed exchange rate.

896
00:30:40,319 --> 00:30:43,519
We already said it, but you now we're

897
00:30:42,000 --> 00:30:45,039
making it very concrete because we are

898
00:30:43,519 --> 00:30:46,680
in a recession,

899
00:30:45,039 --> 00:30:48,359
and you realize now that you don't have

900
00:30:46,680 --> 00:30:49,120
a tool that you had before.

901
00:30:48,359 --> 00:30:50,599
Okay?

902
00:30:49,119 --> 00:30:54,079
So, that's a cost

903
00:30:50,599 --> 00:30:54,079
of a fixed exchange rate.

904
00:30:54,400 --> 00:30:57,480
Here's an example. Uh here what I'm

905
00:30:56,319 --> 00:31:01,200
plotting

906
00:30:57,480 --> 00:31:02,920
is the the policy rate in the US.

907
00:31:01,200 --> 00:31:04,720
That's the blue one.

908
00:31:02,920 --> 00:31:05,880
And that's the policy rate in Hong Kong.

909
00:31:04,720 --> 00:31:06,880
There's a small difference, but you can

910
00:31:05,880 --> 00:31:08,640
see that the

911
00:31:06,880 --> 00:31:10,120
These are technical things. But you can

912
00:31:08,640 --> 00:31:12,640
see that that Hong Kong has to follow

913
00:31:10,119 --> 00:31:14,319
the US essentially. It's exactly the

914
00:31:12,640 --> 00:31:16,800
same shape.

915
00:31:14,319 --> 00:31:18,119
So, Hong Kong doesn't have independent

916
00:31:16,799 --> 00:31:19,000
policy.

917
00:31:18,119 --> 00:31:20,639
Okay?

918
00:31:19,000 --> 00:31:22,319
It Again, those are technical gaps.

919
00:31:20,640 --> 00:31:24,080
They're not really

920
00:31:22,319 --> 00:31:26,480
But just look at the shape. It's exactly

921
00:31:24,079 --> 00:31:28,480
the same, moving around. So, Hong Kong

922
00:31:26,480 --> 00:31:30,200
doesn't have monetary policy.

923
00:31:28,480 --> 00:31:31,480
Period.

924
00:31:30,200 --> 00:31:32,759
Not something they have. So, if they get

925
00:31:31,480 --> 00:31:33,960
a recession that has to do with their

926
00:31:32,759 --> 00:31:35,599
own cycle,

927
00:31:33,960 --> 00:31:37,400
and that is not a result of something

928
00:31:35,599 --> 00:31:39,000
that's happening in the US,

929
00:31:37,400 --> 00:31:41,360
they don't have that that tool to deal

930
00:31:39,000 --> 00:31:41,359
with that.

931
00:31:41,680 --> 00:31:45,920
Of course, during COVID and and during

932
00:31:43,759 --> 00:31:47,599
the global financial crisis, they were

933
00:31:45,920 --> 00:31:48,600
aligned. So, they you know,

934
00:31:47,599 --> 00:31:50,319
they would have moved it in the same

935
00:31:48,599 --> 00:31:51,959
direction. That worked.

936
00:31:50,319 --> 00:31:53,879
But if there's a shock that is

937
00:31:51,960 --> 00:31:55,120
Chinese-centric, that is affecting Hong

938
00:31:53,880 --> 00:31:56,560
Kong,

939
00:31:55,119 --> 00:31:58,319
the US monetary policy is not going to

940
00:31:56,559 --> 00:32:00,559
react to that.

941
00:31:58,319 --> 00:32:01,839
And that that's a problem for Hong Kong

942
00:32:00,559 --> 00:32:03,519
Hong Kong.

943
00:32:01,839 --> 00:32:06,159
And still, they choose to do it. And the

944
00:32:03,519 --> 00:32:07,960
good question is why?

945
00:32:06,160 --> 00:32:09,279
Always there's politics that is more

946
00:32:07,960 --> 00:32:11,120
than than the kind of thing, but there

947
00:32:09,279 --> 00:32:13,839
are also economic arguments for why you

948
00:32:11,119 --> 00:32:16,599
may want to do these things.

949
00:32:13,839 --> 00:32:18,559
Another situation that I mentioned

950
00:32:16,599 --> 00:32:20,359
happens all the time every other day in

951
00:32:18,559 --> 00:32:22,039
Argentina, for example,

952
00:32:20,359 --> 00:32:23,519
is speculative attacks on the currency.

953
00:32:22,039 --> 00:32:25,480
So, you want to have a fixed exchange

954
00:32:23,519 --> 00:32:26,679
rate, but the markets don't believe you

955
00:32:25,480 --> 00:32:27,880
that you're going to be able to keep it

956
00:32:26,679 --> 00:32:29,720
there.

957
00:32:27,880 --> 00:32:31,200
And uh

958
00:32:29,720 --> 00:32:33,799
And so, what happens? So, look at this

959
00:32:31,200 --> 00:32:36,120
equation here. Suppose that that

960
00:32:33,799 --> 00:32:37,319
that you have a fixed exchange rate, but

961
00:32:36,119 --> 00:32:39,359
now the markets think you're not going

962
00:32:37,319 --> 00:32:40,319
to be able to sustain it.

963
00:32:39,359 --> 00:32:42,479
Okay?

964
00:32:40,319 --> 00:32:44,079
So, that means suppose that this guy is

965
00:32:42,480 --> 00:32:45,519
just going down.

966
00:32:44,079 --> 00:32:47,319
That happens again in Argentina every

967
00:32:45,519 --> 00:32:49,440
other day.

968
00:32:47,319 --> 00:32:50,759
Probably today, every single day. No?

969
00:32:49,440 --> 00:32:52,200
They want to say that they want to sign

970
00:32:50,759 --> 00:32:53,359
the exchange rate, but the markets don't

971
00:32:52,200 --> 00:32:56,120
believe you, and they expect your

972
00:32:53,359 --> 00:32:58,599
currency to lose value in the next few

973
00:32:56,119 --> 00:33:01,799
hours in the case of Argentina.

974
00:32:58,599 --> 00:33:01,799
So, this guy is going down.

975
00:33:03,000 --> 00:33:06,359
What happens to the current to the to

976
00:33:04,679 --> 00:33:08,560
the current exchange rate? So, expected

977
00:33:06,359 --> 00:33:10,240
exchange rate goes down. Big

978
00:33:08,559 --> 00:33:12,839
The The everyone expects your currency

979
00:33:10,240 --> 00:33:12,839
to drop.

980
00:33:13,640 --> 00:33:17,200
What What will tend to happen to

981
00:33:16,039 --> 00:33:18,678
the

982
00:33:17,200 --> 00:33:21,799
currency today?

983
00:33:18,679 --> 00:33:21,800
To the Argentinian peso today?

984
00:33:23,519 --> 00:33:28,679
It drops, but you have a fixed exchange

985
00:33:25,319 --> 00:33:30,359
rate, you can't let it drop.

986
00:33:28,679 --> 00:33:32,120
I I'm So, if you're going to maintain an

987
00:33:30,359 --> 00:33:33,439
exchange a fixed exchange rate, and now

988
00:33:32,119 --> 00:33:35,319
you have a speculative attack, people

989
00:33:33,440 --> 00:33:36,960
think your currency is going to drop,

990
00:33:35,319 --> 00:33:39,079
and you want to maintain your peg,

991
00:33:36,960 --> 00:33:41,160
that's called defending the peg. If you

992
00:33:39,079 --> 00:33:42,879
want to defend the peg, then the only

993
00:33:41,160 --> 00:33:44,440
option you have if this guy is dropping

994
00:33:42,880 --> 00:33:46,440
to keep the exchange rate is to raise

995
00:33:44,440 --> 00:33:47,920
interest rates a lot.

996
00:33:46,440 --> 00:33:49,759
That's the way you fight the main way

997
00:33:47,920 --> 00:33:52,240
you fight it. I mean, you fight it by

998
00:33:49,759 --> 00:33:54,160
closing capital accounts and so on, but

999
00:33:52,240 --> 00:33:56,519
that's the last resort. You first try to

1000
00:33:54,160 --> 00:33:58,360
fight it with monetary policy. So, if

1001
00:33:56,519 --> 00:34:00,599
this thing is dropping, you fight it by

1002
00:33:58,359 --> 00:34:01,839
increasing interest rate a lot.

1003
00:34:00,599 --> 00:34:03,199
And that's the way you stabilize the

1004
00:34:01,839 --> 00:34:04,559
currency.

1005
00:34:03,200 --> 00:34:06,559
But what happens when you raise interest

1006
00:34:04,559 --> 00:34:08,559
rate a lot to defend the parity, the

1007
00:34:06,559 --> 00:34:11,519
peg?

1008
00:34:08,559 --> 00:34:11,519
What is the problem of that?

1009
00:34:17,878 --> 00:34:21,839
Yeah, you generate a domestic recession.

1010
00:34:19,960 --> 00:34:23,480
Okay? Because just to defend your

1011
00:34:21,840 --> 00:34:25,760
currency, your peg,

1012
00:34:23,480 --> 00:34:26,480
you had to raise interest rate a lot.

1013
00:34:25,760 --> 00:34:27,240
No?

1014
00:34:26,480 --> 00:34:29,480
So, it means you're going to have a

1015
00:34:27,239 --> 00:34:31,559
recession at home.

1016
00:34:29,480 --> 00:34:31,559
Okay?

1017
00:34:31,639 --> 00:34:34,319
So, that's another problem of fixed

1018
00:34:32,960 --> 00:34:37,159
exchange. It's a problem That's not a

1019
00:34:34,320 --> 00:34:38,480
problem for Hong Kong. It was in 1997.

1020
00:34:37,159 --> 00:34:40,480
They did have a speculative attack

1021
00:34:38,480 --> 00:34:42,480
despite the fact that they had

1022
00:34:40,480 --> 00:34:44,800
twice the number of reserves relative to

1023
00:34:42,480 --> 00:34:46,159
their money base, but still they had

1024
00:34:44,800 --> 00:34:47,960
speculative problem there. But it rarely

1025
00:34:46,159 --> 00:34:51,119
happens in Hong Kong. In Argentina,

1026
00:34:47,960 --> 00:34:52,840
again, every other day, but but in

1027
00:34:51,119 --> 00:34:55,358
same in Turkey.

1028
00:34:52,840 --> 00:34:56,960
In Turkey, it's every 15 days, but but

1029
00:34:55,358 --> 00:34:59,960
but

1030
00:34:56,960 --> 00:35:01,800
but it's happening all the time.

1031
00:34:59,960 --> 00:35:02,679
So, that's a problem as well, because if

1032
00:35:01,800 --> 00:35:04,800
you have

1033
00:35:02,679 --> 00:35:06,119
to spend a lot of energy defending your

1034
00:35:04,800 --> 00:35:08,800
peg, then you're going to be causing

1035
00:35:06,119 --> 00:35:12,599
lots of recessions at home just to

1036
00:35:08,800 --> 00:35:12,600
stabilize the currency. Okay?

1037
00:35:13,400 --> 00:35:16,840
That's That's bigger economies. They

1038
00:35:15,079 --> 00:35:19,400
were okay. Well, Argentina, Turkey, and

1039
00:35:16,840 --> 00:35:21,920
so on, no? But these are

1040
00:35:19,400 --> 00:35:23,000
bigger boys, no? Here we have a

1041
00:35:21,920 --> 00:35:25,119
a

1042
00:35:23,000 --> 00:35:26,480
This is the ERM crisis. So, before the

1043
00:35:25,119 --> 00:35:27,279
euro,

1044
00:35:26,480 --> 00:35:30,039
uh

1045
00:35:27,280 --> 00:35:30,760
more or less the Eurozone plus the UK

1046
00:35:30,039 --> 00:35:33,559
uh

1047
00:35:30,760 --> 00:35:37,080
had a system called the ERM.

1048
00:35:33,559 --> 00:35:40,239
The EM EMS ERM ERM is the Well, anyway.

1049
00:35:37,079 --> 00:35:42,719
EMS is European Monetary System. ERM is

1050
00:35:40,239 --> 00:35:45,399
Exchange Rate Mechanism or something

1051
00:35:42,719 --> 00:35:46,879
like that. And they're both linked. But

1052
00:35:45,400 --> 00:35:49,160
let's call it the

1053
00:35:46,880 --> 00:35:52,240
European Monetary System. And the basic

1054
00:35:49,159 --> 00:35:54,839
idea of the European Monetary System

1055
00:35:52,239 --> 00:35:56,439
was that that

1056
00:35:54,840 --> 00:35:58,519
they behave very much like Singapore

1057
00:35:56,440 --> 00:36:00,440
with respect to each other. Meaning,

1058
00:35:58,519 --> 00:36:03,639
they allow themselves to

1059
00:36:00,440 --> 00:36:05,960
move around, but only in narrow bands.

1060
00:36:03,639 --> 00:36:08,960
The The countries that had the more

1061
00:36:05,960 --> 00:36:08,960
stable

1062
00:36:09,079 --> 00:36:12,719
domestic monetary position, like France

1063
00:36:11,559 --> 00:36:15,119
vis-à-vis the

1064
00:36:12,719 --> 00:36:18,239
Germany, the Deutschmark, and the French

1065
00:36:15,119 --> 00:36:20,719
franc, but they had these bands of 2 and

1066
00:36:18,239 --> 00:36:22,319
1/2% up and down, and they moved within

1067
00:36:20,719 --> 00:36:24,358
those those ranges. They didn't have a

1068
00:36:22,320 --> 00:36:26,359
full peg, but they allowed themselves to

1069
00:36:24,358 --> 00:36:27,960
move a little bit. Portugal, which it

1070
00:36:26,358 --> 00:36:30,000
was a little bit had a little bit less

1071
00:36:27,960 --> 00:36:32,400
discipline, they had 5% for each side

1072
00:36:30,000 --> 00:36:34,800
and stuff like that. But the point is,

1073
00:36:32,400 --> 00:36:36,599
they would have narrow bands. Okay? And

1074
00:36:34,800 --> 00:36:38,160
they moved around in those narrow bands,

1075
00:36:36,599 --> 00:36:39,279
and they kept their

1076
00:36:38,159 --> 00:36:41,119
uh

1077
00:36:39,280 --> 00:36:43,720
kept it for quite a while

1078
00:36:41,119 --> 00:36:46,480
before the euro.

1079
00:36:43,719 --> 00:36:49,439
Now, here the whole system came under a

1080
00:36:46,480 --> 00:36:49,440
speculative attack.

1081
00:36:50,199 --> 00:36:56,199
What happened around there?

1082
00:36:52,280 --> 00:36:56,200
You You probably have no idea.

1083
00:36:58,280 --> 00:37:04,720
Well, it's really linked to that, yes.

1084
00:37:02,199 --> 00:37:06,159
Yeah. It's the German re- reunification.

1085
00:37:04,719 --> 00:37:07,679
So, what happened is

1086
00:37:06,159 --> 00:37:10,679
when

1087
00:37:07,679 --> 00:37:12,039
East Germany and and West Germany unify,

1088
00:37:10,679 --> 00:37:13,919
they had to have a massive fiscal

1089
00:37:12,039 --> 00:37:15,039
policy, massive expansionary fiscal

1090
00:37:13,920 --> 00:37:17,680
policy.

1091
00:37:15,039 --> 00:37:20,800
And that big expansion put lots of

1092
00:37:17,679 --> 00:37:22,679
upward pressure on the on on on

1093
00:37:20,800 --> 00:37:25,640
on German interest rates.

1094
00:37:22,679 --> 00:37:27,519
And And that led to big appreciations

1095
00:37:25,639 --> 00:37:28,920
uh of the Deutschmark.

1096
00:37:27,519 --> 00:37:30,519
And And the other countries tried to

1097
00:37:28,920 --> 00:37:32,240
fight it because they had to be in this

1098
00:37:30,519 --> 00:37:33,320
very narrow band.

1099
00:37:32,239 --> 00:37:35,239
But they were experiencing these big

1100
00:37:33,320 --> 00:37:36,760
speculative attacks.

1101
00:37:35,239 --> 00:37:38,358
And so, they had to raise their interest

1102
00:37:36,760 --> 00:37:39,120
rate enormously.

1103
00:37:38,358 --> 00:37:40,639
Uh

1104
00:37:39,119 --> 00:37:42,079
the UK tried to do it for a while, and

1105
00:37:40,639 --> 00:37:44,199
they essentially said, "I we give up."

1106
00:37:42,079 --> 00:37:45,480
And then they they they they abandoned

1107
00:37:44,199 --> 00:37:47,279
the the system.

1108
00:37:45,480 --> 00:37:49,199
The French tried to stay in there for

1109
00:37:47,280 --> 00:37:50,280
quite a bit. Okay? You can see the

1110
00:37:49,199 --> 00:37:51,559
French franc. They didn't move. They

1111
00:37:50,280 --> 00:37:53,280
didn't move.

1112
00:37:51,559 --> 00:37:54,759
But it was extremely costly for them

1113
00:37:53,280 --> 00:37:56,680
because the interest rate has to go up a

1114
00:37:54,760 --> 00:37:58,440
lot, and sort of like got into a big

1115
00:37:56,679 --> 00:38:00,319
recession and so on. Eventually, the

1116
00:37:58,440 --> 00:38:02,760
whole system broke up broke down. I

1117
00:38:00,320 --> 00:38:05,200
mean, everyone left. And eventually,

1118
00:38:02,760 --> 00:38:06,640
they rejoined, but now in the euro. And

1119
00:38:05,199 --> 00:38:08,839
the euro is a little different because

1120
00:38:06,639 --> 00:38:11,000
in the euro, you give up There's no

1121
00:38:08,840 --> 00:38:13,559
space for the speculative attacks

1122
00:38:11,000 --> 00:38:14,400
because there's a single currency.

1123
00:38:13,559 --> 00:38:15,880
Okay?

1124
00:38:14,400 --> 00:38:17,000
So, that's the that's the most extreme

1125
00:38:15,880 --> 00:38:18,880
form.

1126
00:38:17,000 --> 00:38:20,960
Speculative attacks nowadays in Europe

1127
00:38:18,880 --> 00:38:22,640
happen through different means. It's

1128
00:38:20,960 --> 00:38:24,000
It's It's the

1129
00:38:22,639 --> 00:38:24,839
Well, anyways, let me not get into that

1130
00:38:24,000 --> 00:38:26,358
for

1131
00:38:24,840 --> 00:38:28,240
But but

1132
00:38:26,358 --> 00:38:29,519
But here you have So, what I'm saying,

1133
00:38:28,239 --> 00:38:31,479
having a fixed exchange rate is not

1134
00:38:29,519 --> 00:38:33,159
easy, even for countries that have sort

1135
00:38:31,480 --> 00:38:37,240
of very well-developed financial

1136
00:38:33,159 --> 00:38:37,239
markets, and so on and so forth.

1137
00:38:37,679 --> 00:38:41,480
Now, it would seem,

1138
00:38:39,519 --> 00:38:42,519
given all that I said,

1139
00:38:41,480 --> 00:38:43,599
that

1140
00:38:42,519 --> 00:38:45,039
I mean, there's no reason to have a

1141
00:38:43,599 --> 00:38:48,159
fixed exchange rate. It's something you

1142
00:38:45,039 --> 00:38:49,320
you give up an an instrument, and on top

1143
00:38:48,159 --> 00:38:50,719
of that,

1144
00:38:49,320 --> 00:38:53,039
you're subject to speculative attacks

1145
00:38:50,719 --> 00:38:55,159
all the time. Okay? Not all the time.

1146
00:38:53,039 --> 00:38:57,199
Well, it depends on how bad you are. But

1147
00:38:55,159 --> 00:38:59,358
but you know, you have to be very

1148
00:38:57,199 --> 00:39:00,879
well-behaved because otherwise, you're

1149
00:38:59,358 --> 00:39:01,799
subject to speculative attacks all the

1150
00:39:00,880 --> 00:39:03,200
time.

1151
00:39:01,800 --> 00:39:05,359
So,

1152
00:39:03,199 --> 00:39:07,119
So, why not do flexible exchange rate?

1153
00:39:05,358 --> 00:39:08,358
Why Why What is wrong with flexible

1154
00:39:07,119 --> 00:39:10,039
exchange rate?

1155
00:39:08,358 --> 00:39:11,920
Well, I think the main problem of

1156
00:39:10,039 --> 00:39:13,759
flexible exchange rate

1157
00:39:11,920 --> 00:39:15,240
is that it tends to move a lot.

1158
00:39:13,760 --> 00:39:17,040
I mean, we know that it moves a lot more

1159
00:39:15,239 --> 00:39:18,919
than fundamentals, meaning

1160
00:39:17,039 --> 00:39:20,639
you know, productivity is a little

1161
00:39:18,920 --> 00:39:21,920
higher in one country than the other,

1162
00:39:20,639 --> 00:39:23,319
demand is a little higher in the other

1163
00:39:21,920 --> 00:39:25,519
in the other country, but the exchange

1164
00:39:23,320 --> 00:39:28,000
rate moves a lot more than those little

1165
00:39:25,519 --> 00:39:29,800
differences justify.

1166
00:39:28,000 --> 00:39:31,519
And the reason one way of understanding

1167
00:39:29,800 --> 00:39:32,720
this is the following.

1168
00:39:31,519 --> 00:39:34,358
And this it will serve as an

1169
00:39:32,719 --> 00:39:36,199
introduction to the next topic of the

1170
00:39:34,358 --> 00:39:37,719
course, which will be asset pricing and

1171
00:39:36,199 --> 00:39:39,439
things like that.

1172
00:39:37,719 --> 00:39:41,439
So, let's look at revisit our interest

1173
00:39:39,440 --> 00:39:42,679
parity condition, but now let's not

1174
00:39:41,440 --> 00:39:46,200
assume

1175
00:39:42,679 --> 00:39:48,279
that that that the next the the the

1176
00:39:46,199 --> 00:39:49,639
expected exchange rate is fixed.

1177
00:39:48,280 --> 00:39:51,720
I mean, that was an assumption just to

1178
00:39:49,639 --> 00:39:53,839
make our life simple, but but it it's

1179
00:39:51,719 --> 00:39:56,399
not be. So, that's a that's a then

1180
00:39:53,840 --> 00:39:58,720
covered interest rate condition is this.

1181
00:39:56,400 --> 00:40:00,920
Well, you see, I can replace this guy

1182
00:39:58,719 --> 00:40:02,719
here for what will happen next period.

1183
00:40:00,920 --> 00:40:04,360
It's the same thing shifted by a period

1184
00:40:02,719 --> 00:40:07,519
with an expectation there.

1185
00:40:04,360 --> 00:40:09,559
So, ET + 1 expected, this guy here is

1186
00:40:07,519 --> 00:40:12,239
equal to 1 +

1187
00:40:09,559 --> 00:40:13,480
expected domestic interest rate 1 period

1188
00:40:12,239 --> 00:40:15,639
from now

1189
00:40:13,480 --> 00:40:17,480
divided by 1 + international interest

1190
00:40:15,639 --> 00:40:20,039
rate expected 1 period from now

1191
00:40:17,480 --> 00:40:20,880
times the expected exchange rate for T +

1192
00:40:20,039 --> 00:40:22,320
2

1193
00:40:20,880 --> 00:40:23,840
2 years from now.

1194
00:40:22,320 --> 00:40:25,600
And I can keep doing this. I can replace

1195
00:40:23,840 --> 00:40:27,680
this by something equivalent to that

1196
00:40:25,599 --> 00:40:29,679
with all the sub index shifted by 1

1197
00:40:27,679 --> 00:40:30,879
year, blah blah blah blah blah blah.

1198
00:40:29,679 --> 00:40:32,399
And so, I can end up writing this

1199
00:40:30,880 --> 00:40:33,599
exchange rate

1200
00:40:32,400 --> 00:40:35,639
as

1201
00:40:33,599 --> 00:40:37,400
this product of lots of things that can

1202
00:40:35,639 --> 00:40:38,839
happen in the future. The the monetary

1203
00:40:37,400 --> 00:40:41,119
policy path

1204
00:40:38,840 --> 00:40:43,280
at home, the monetary policy path, not

1205
00:40:41,119 --> 00:40:44,279
the next period, the path for years to

1206
00:40:43,280 --> 00:40:45,920
come

1207
00:40:44,280 --> 00:40:47,880
of

1208
00:40:45,920 --> 00:40:49,440
monetary policy in the other country,

1209
00:40:47,880 --> 00:40:51,599
and there's always an expected exchange

1210
00:40:49,440 --> 00:40:55,360
rate at the end there

1211
00:40:51,599 --> 00:40:57,159
that is free. It can move around.

1212
00:40:55,360 --> 00:41:00,120
So, the problem of this exchange is that

1213
00:40:57,159 --> 00:41:02,000
the future matters too much

1214
00:41:00,119 --> 00:41:03,799
in a sense. And you know, people have

1215
00:41:02,000 --> 00:41:05,400
lots of imagination, so

1216
00:41:03,800 --> 00:41:07,039
all sorts of weird things they imagine.

1217
00:41:05,400 --> 00:41:08,880
And and when you people have lots of

1218
00:41:07,039 --> 00:41:10,759
imagination, then these things are

1219
00:41:08,880 --> 00:41:12,640
moving a lot. And that's the reason do

1220
00:41:10,760 --> 00:41:13,880
you see enormous fluctuations in nominal

1221
00:41:12,639 --> 00:41:15,519
exchange rate.

1222
00:41:13,880 --> 00:41:17,079
Now,

1223
00:41:15,519 --> 00:41:18,800
uh

1224
00:41:17,079 --> 00:41:20,239
And that's the problem. It's a problem

1225
00:41:18,800 --> 00:41:22,800
to have a very volatile exchange rate

1226
00:41:20,239 --> 00:41:24,719
because it it makes transactions more

1227
00:41:22,800 --> 00:41:26,039
difficult. I mean, you know, if you the

1228
00:41:24,719 --> 00:41:27,279
price of things are ready price of

1229
00:41:26,039 --> 00:41:29,400
things are changing all the time, it's a

1230
00:41:27,280 --> 00:41:30,240
little bit more difficult to plan.

1231
00:41:29,400 --> 00:41:31,840
Uh

1232
00:41:30,239 --> 00:41:33,279
financial investments become more

1233
00:41:31,840 --> 00:41:35,640
because you get all this exchange rate

1234
00:41:33,280 --> 00:41:37,160
volatility in between. So, that's one of

1235
00:41:35,639 --> 00:41:38,079
the main reasons

1236
00:41:37,159 --> 00:41:41,119
uh

1237
00:41:38,079 --> 00:41:42,679
you would prefer, if you could to have a

1238
00:41:41,119 --> 00:41:44,239
more

1239
00:41:42,679 --> 00:41:46,239
managed exchange rate. It's because you

1240
00:41:44,239 --> 00:41:48,559
don't want this all this artificial

1241
00:41:46,239 --> 00:41:50,959
volatility that comes from behavioral

1242
00:41:48,559 --> 00:41:53,279
traits and things of that kind. Okay?

1243
00:41:50,960 --> 00:41:54,960
That's the main reason.

1244
00:41:53,280 --> 00:41:57,080
Uh

1245
00:41:54,960 --> 00:41:58,480
Look at this example, for example.

1246
00:41:57,079 --> 00:41:59,599
Example, for example, sorry about that.

1247
00:41:58,480 --> 00:42:03,559
But

1248
00:41:59,599 --> 00:42:06,360
this is Russia during the the the war.

1249
00:42:03,559 --> 00:42:09,599
This was the the the the ruble, the the

1250
00:42:06,360 --> 00:42:10,920
the the Russian currency.

1251
00:42:09,599 --> 00:42:12,360
And

1252
00:42:10,920 --> 00:42:13,559
when they invaded, of course, this thing

1253
00:42:12,360 --> 00:42:16,120
collapsed.

1254
00:42:13,559 --> 00:42:16,799
The currency collapsed. Okay?

1255
00:42:16,119 --> 00:42:18,359
Uh

1256
00:42:16,800 --> 00:42:20,519
this period is a is a little longer than

1257
00:42:18,360 --> 00:42:21,840
you think, but but it collapsed for for

1258
00:42:20,519 --> 00:42:23,239
quite a while.

1259
00:42:21,840 --> 00:42:25,280
And then it recovered a lot, actually

1260
00:42:23,239 --> 00:42:27,759
overshot and came down.

1261
00:42:25,280 --> 00:42:29,560
So, this is not because the Central Bank

1262
00:42:27,760 --> 00:42:31,920
said, you know,

1263
00:42:29,559 --> 00:42:34,199
we're going to

1264
00:42:31,920 --> 00:42:35,880
devalue the currency. It's just people

1265
00:42:34,199 --> 00:42:37,399
said, "Wow, this a country going into

1266
00:42:35,880 --> 00:42:38,440
war. It's going to be a mess, blah blah

1267
00:42:37,400 --> 00:42:40,920
blah blah."

1268
00:42:38,440 --> 00:42:43,079
So, all that future I talk about

1269
00:42:40,920 --> 00:42:45,360
uh

1270
00:42:43,079 --> 00:42:46,679
essentially destroyed the currency.

1271
00:42:45,360 --> 00:42:48,720
Okay?

1272
00:42:46,679 --> 00:42:50,639
Now, a lot of that recovery happened

1273
00:42:48,719 --> 00:42:52,119
there not because people now

1274
00:42:50,639 --> 00:42:53,719
began to see the future as a better

1275
00:42:52,119 --> 00:42:54,960
future or anything like that.

1276
00:42:53,719 --> 00:42:56,119
It's because

1277
00:42:54,960 --> 00:42:58,320
they had to hike interest rate

1278
00:42:56,119 --> 00:43:00,799
massively. They were around 4 or 5% and

1279
00:42:58,320 --> 00:43:01,960
they had to go to 20% interest rate to

1280
00:43:00,800 --> 00:43:03,920
defend the exchange rate. Remember I

1281
00:43:01,960 --> 00:43:04,960
told you have a speculative attack and

1282
00:43:03,920 --> 00:43:06,960
you have enormous pressure on your

1283
00:43:04,960 --> 00:43:08,480
currency. Well, the main tool you have

1284
00:43:06,960 --> 00:43:09,599
to offset that is to raise interest

1285
00:43:08,480 --> 00:43:11,000
rate.

1286
00:43:09,599 --> 00:43:12,519
They had they had interest rate

1287
00:43:11,000 --> 00:43:14,320
massively. They did a lot of other

1288
00:43:12,519 --> 00:43:16,039
things as well. They

1289
00:43:14,320 --> 00:43:17,760
put capital controls and lots of things.

1290
00:43:16,039 --> 00:43:19,559
But but but this was the main thing they

1291
00:43:17,760 --> 00:43:21,440
did. And so, they dragged the recession

1292
00:43:19,559 --> 00:43:23,360
the economy into recession for war

1293
00:43:21,440 --> 00:43:25,200
related reasons and because of the

1294
00:43:23,360 --> 00:43:25,960
monetary policy response they had to do

1295
00:43:25,199 --> 00:43:28,119
with that.

1296
00:43:25,960 --> 00:43:29,800
Okay? So, that's an extreme case of a

1297
00:43:28,119 --> 00:43:32,839
war. But but that's the kind of things

1298
00:43:29,800 --> 00:43:35,400
that can happen. Uh

1299
00:43:32,840 --> 00:43:36,559
in in in in an in a floating exchange

1300
00:43:35,400 --> 00:43:38,920
rate.

1301
00:43:36,559 --> 00:43:41,079
Even when

1302
00:43:38,920 --> 00:43:41,079
uh

1303
00:43:41,679 --> 00:43:44,879
I mean, the main constraint in Argentina

1304
00:43:43,519 --> 00:43:46,159
and Turkey and so on is reserves. They

1305
00:43:44,880 --> 00:43:48,039
don't have enough reserves. So, if you

1306
00:43:46,159 --> 00:43:50,319
have to defend your currency

1307
00:43:48,039 --> 00:43:52,000
by intervening in the in the in the

1308
00:43:50,320 --> 00:43:53,200
FX market

1309
00:43:52,000 --> 00:43:54,880
if you don't have enough, then you're

1310
00:43:53,199 --> 00:43:56,879
not credible. I mean,

1311
00:43:54,880 --> 00:43:59,519
if you have massive capital outflows and

1312
00:43:56,880 --> 00:44:01,079
you have a few billion dollars there,

1313
00:43:59,519 --> 00:44:02,440
it's not going to work.

1314
00:44:01,079 --> 00:44:04,119
That's not the case of Russia. They had

1315
00:44:02,440 --> 00:44:05,880
massive amount of reserves. So, that

1316
00:44:04,119 --> 00:44:07,319
that was not the issue. It was all about

1317
00:44:05,880 --> 00:44:09,519
expectations of things that happen in

1318
00:44:07,320 --> 00:44:13,519
the future. It was all about

1319
00:44:09,519 --> 00:44:13,519
this kind of terms. Okay?

1320
00:44:14,000 --> 00:44:18,199
Anyway, so so that added to the cost

1321
00:44:16,679 --> 00:44:20,239
they had.

1322
00:44:18,199 --> 00:44:22,159
So,

1323
00:44:20,239 --> 00:44:23,399
so how do we choose these things then in

1324
00:44:22,159 --> 00:44:24,759
practice?

1325
00:44:23,400 --> 00:44:27,320
Again, there are lots of things and

1326
00:44:24,760 --> 00:44:28,040
politics plays play role and so on.

1327
00:44:27,320 --> 00:44:32,240
Uh

1328
00:44:28,039 --> 00:44:33,759
but this this a case to so so again

1329
00:44:32,239 --> 00:44:35,759
I would put it even the other way

1330
00:44:33,760 --> 00:44:37,040
around. I think that if you could, you

1331
00:44:35,760 --> 00:44:38,960
would like to have a fixed exchange

1332
00:44:37,039 --> 00:44:40,320
rate.

1333
00:44:38,960 --> 00:44:41,440
If you could,

1334
00:44:40,320 --> 00:44:42,600
you would like to have a fixed exchange

1335
00:44:41,440 --> 00:44:44,840
rate because then you remove all this

1336
00:44:42,599 --> 00:44:46,639
spurious noise that happens every single

1337
00:44:44,840 --> 00:44:49,440
day because of exchange rate volatility

1338
00:44:46,639 --> 00:44:51,000
that complicates your life.

1339
00:44:49,440 --> 00:44:53,358
Uh

1340
00:44:51,000 --> 00:44:54,880
But so, when can you do that?

1341
00:44:53,358 --> 00:44:56,480
Well, first, you can do it with respect

1342
00:44:54,880 --> 00:44:59,119
to some other country

1343
00:44:56,480 --> 00:45:00,480
where the shocks are very similar.

1344
00:44:59,119 --> 00:45:03,159
You know, because

1345
00:45:00,480 --> 00:45:05,480
you you know, if you know that that that

1346
00:45:03,159 --> 00:45:06,920
say you're Mexico, but

1347
00:45:05,480 --> 00:45:08,559
or the north of Mexico, something like

1348
00:45:06,920 --> 00:45:10,480
that, and you know that all your shocks

1349
00:45:08,559 --> 00:45:11,960
are really shocks to the US.

1350
00:45:10,480 --> 00:45:13,039
Then the US can do the monetary policy

1351
00:45:11,960 --> 00:45:14,240
for you.

1352
00:45:13,039 --> 00:45:15,519
You know, because you have the same

1353
00:45:14,239 --> 00:45:17,599
shocks.

1354
00:45:15,519 --> 00:45:19,239
I'm exaggerating. So, if you're very

1355
00:45:17,599 --> 00:45:20,880
similar

1356
00:45:19,239 --> 00:45:22,399
then it makes sense to have a fixed

1357
00:45:20,880 --> 00:45:23,680
exchange rate because why pay for all

1358
00:45:22,400 --> 00:45:25,358
that volatility when you're going to be

1359
00:45:23,679 --> 00:45:26,639
doing the same policies

1360
00:45:25,358 --> 00:45:27,960
in both countries more or less at the

1361
00:45:26,639 --> 00:45:29,199
same time because you're exposed to the

1362
00:45:27,960 --> 00:45:30,880
same shocks.

1363
00:45:29,199 --> 00:45:33,960
So, that's one thing. That's one reason

1364
00:45:30,880 --> 00:45:35,280
why the Eurozone is a Eurozone because

1365
00:45:33,960 --> 00:45:37,280
they're European countries that have

1366
00:45:35,280 --> 00:45:38,519
very similar business cycles and so on.

1367
00:45:37,280 --> 00:45:39,400
Germany is a little different. That's

1368
00:45:38,519 --> 00:45:41,280
the reason they always have some

1369
00:45:39,400 --> 00:45:43,358
problem. I mean, the north and the

1370
00:45:41,280 --> 00:45:46,040
south, they're a little different. But

1371
00:45:43,358 --> 00:45:50,039
but but they're much more similar

1372
00:45:46,039 --> 00:45:50,039
than than other countries. Uh

1373
00:45:50,639 --> 00:45:55,519
Uh so so that's that's what they have

1374
00:45:53,320 --> 00:45:59,120
want.

1375
00:45:55,519 --> 00:46:01,800
Another option is is is when you have

1376
00:45:59,119 --> 00:46:02,960
lots of fiscal capacity.

1377
00:46:01,800 --> 00:46:04,440
Because if you have lots of fiscal

1378
00:46:02,960 --> 00:46:05,720
capacity, then the cost of not having

1379
00:46:04,440 --> 00:46:06,920
monetary policy is not that large

1380
00:46:05,719 --> 00:46:09,159
because you can fight your business

1381
00:46:06,920 --> 00:46:10,358
cycle with fiscal policy.

1382
00:46:09,159 --> 00:46:12,079
That's the case of Hong Kong, for

1383
00:46:10,358 --> 00:46:13,639
example. Hong Kong

1384
00:46:12,079 --> 00:46:14,920
Hong Kong, first of all, is not subject

1385
00:46:13,639 --> 00:46:16,759
to speculative attack because they have

1386
00:46:14,920 --> 00:46:18,480
massive amount of reserves. So, anyone

1387
00:46:16,760 --> 00:46:21,359
that dares attacking them is going to

1388
00:46:18,480 --> 00:46:22,480
lose their shirt. So, so they're safe.

1389
00:46:21,358 --> 00:46:23,519
Uh

1390
00:46:22,480 --> 00:46:25,119
uh

1391
00:46:23,519 --> 00:46:26,880
Soros tried many years back and he

1392
00:46:25,119 --> 00:46:28,279
didn't do as well as he did attacking

1393
00:46:26,880 --> 00:46:29,000
the British pound.

1394
00:46:28,280 --> 00:46:29,680
Uh

1395
00:46:29,000 --> 00:46:32,039
um

1396
00:46:29,679 --> 00:46:33,919
then then but they also have lots of

1397
00:46:32,039 --> 00:46:35,519
fiscal resources, so they can

1398
00:46:33,920 --> 00:46:37,440
fight their domestic recessions and so

1399
00:46:35,519 --> 00:46:39,960
on with fiscal policy.

1400
00:46:37,440 --> 00:46:41,119
The other factor, which also applies to

1401
00:46:39,960 --> 00:46:43,440
Hong Kong

1402
00:46:41,119 --> 00:46:45,319
if you have very flexible factor

1403
00:46:43,440 --> 00:46:48,079
markets. So, if wages move very easily,

1404
00:46:45,320 --> 00:46:50,000
if prices move very easily domestically

1405
00:46:48,079 --> 00:46:51,840
then you don't care about

1406
00:46:50,000 --> 00:46:53,358
having a fixed nominal exchange rate

1407
00:46:51,840 --> 00:46:55,120
because a fixed nominal exchange rate is

1408
00:46:53,358 --> 00:46:56,239
not the same as a fixed real exchange

1409
00:46:55,119 --> 00:46:57,400
rate, which is what you really need to

1410
00:46:56,239 --> 00:46:59,319
move around.

1411
00:46:57,400 --> 00:47:00,519
If your prices are flexible

1412
00:46:59,320 --> 00:47:01,640
doesn't matter that nominal exchange

1413
00:47:00,519 --> 00:47:02,759
doesn't move because the prices are

1414
00:47:01,639 --> 00:47:04,039
moving around.

1415
00:47:02,760 --> 00:47:06,240
And so, you you still have lots of

1416
00:47:04,039 --> 00:47:08,119
flexibility in the real exchange rate.

1417
00:47:06,239 --> 00:47:09,639
And that's the reason I would say is one

1418
00:47:08,119 --> 00:47:11,319
of the reasons uh political reasons as

1419
00:47:09,639 --> 00:47:12,799
well, but but why they can afford it.

1420
00:47:11,320 --> 00:47:13,920
Why I think in the case of Hong Kong

1421
00:47:12,800 --> 00:47:15,560
it's the other way around. It was some

1422
00:47:13,920 --> 00:47:18,280
political reasons

1423
00:47:15,559 --> 00:47:20,039
uh and and and the and then they build a

1424
00:47:18,280 --> 00:47:22,120
system so that

1425
00:47:20,039 --> 00:47:24,400
is is a is a coherent system because

1426
00:47:22,119 --> 00:47:26,358
they have lots of fiscal capacity, can

1427
00:47:24,400 --> 00:47:29,680
defend the currency well

1428
00:47:26,358 --> 00:47:29,679
and they have very flexible markets.

1429
00:47:30,599 --> 00:47:32,759
Uh

1430
00:47:33,519 --> 00:47:36,199
This is

1431
00:47:34,480 --> 00:47:38,559
Well, this again, this is what I said

1432
00:47:36,199 --> 00:47:40,519
before. If you if you

1433
00:47:38,559 --> 00:47:42,000
if this is what I said before. If you if

1434
00:47:40,519 --> 00:47:42,960
you have you don't like that noise. If

1435
00:47:42,000 --> 00:47:45,239
you especially you're going to be

1436
00:47:42,960 --> 00:47:46,639
trading a lot with people and so on.

1437
00:47:45,239 --> 00:47:48,358
You know,

1438
00:47:46,639 --> 00:47:50,400
in Europe, many people cross the border

1439
00:47:48,358 --> 00:47:52,719
many times a day and then you want to go

1440
00:47:50,400 --> 00:47:54,079
shopping one way or the other. It's a

1441
00:47:52,719 --> 00:47:55,839
it's a pain if the exchange rate is

1442
00:47:54,079 --> 00:47:57,639
moving all the time. You know? It's much

1443
00:47:55,840 --> 00:47:59,079
easier if things are stable. And the

1444
00:47:57,639 --> 00:48:00,839
same apply to financial transactions.

1445
00:47:59,079 --> 00:48:02,239
People have deposits in different banks

1446
00:48:00,840 --> 00:48:04,720
and stuff like that.

1447
00:48:02,239 --> 00:48:06,399
It's it's better if you don't have all

1448
00:48:04,719 --> 00:48:08,719
that fluctuation. And the case of the

1449
00:48:06,400 --> 00:48:10,000
Euro area, they decided that

1450
00:48:08,719 --> 00:48:11,399
uh

1451
00:48:10,000 --> 00:48:13,079
that the advantage of having a very

1452
00:48:11,400 --> 00:48:14,039
fixed exchange rate

1453
00:48:13,079 --> 00:48:16,159
uh

1454
00:48:14,039 --> 00:48:17,599
uh were more than the cost for

1455
00:48:16,159 --> 00:48:20,239
individual countries of not having

1456
00:48:17,599 --> 00:48:21,639
independent monetary policy.

1457
00:48:20,239 --> 00:48:24,199
It's still a work in progress. They're

1458
00:48:21,639 --> 00:48:26,559
building that is not finished.

1459
00:48:24,199 --> 00:48:28,159
But but but they're working at it.

1460
00:48:26,559 --> 00:48:30,440
The other reason why

1461
00:48:28,159 --> 00:48:32,199
uh countries fix exchange rate

1462
00:48:30,440 --> 00:48:33,159
uh and that's the Argentinian reason and

1463
00:48:32,199 --> 00:48:35,919
so on

1464
00:48:33,159 --> 00:48:37,199
is is when when they have no control in

1465
00:48:35,920 --> 00:48:38,920
inflation.

1466
00:48:37,199 --> 00:48:40,559
They have no credibility.

1467
00:48:38,920 --> 00:48:42,840
And so, if you peg to another currency

1468
00:48:40,559 --> 00:48:45,599
that has credibility, then the idea, the

1469
00:48:42,840 --> 00:48:47,720
hope at least, is that you will inherit

1470
00:48:45,599 --> 00:48:49,519
the credibility of the other currency.

1471
00:48:47,719 --> 00:48:51,799
And that's what they tried to

1472
00:48:49,519 --> 00:48:53,840
uh Ar- Argentina had a currency board

1473
00:48:51,800 --> 00:48:56,400
like Hong Kong for a while. The whole

1474
00:48:53,840 --> 00:48:58,240
idea was to control inflation. Well,

1475
00:48:56,400 --> 00:49:00,920
let's peg to someone.

1476
00:48:58,239 --> 00:49:02,439
Uh and and and if they if the markets

1477
00:49:00,920 --> 00:49:04,200
believe you, then it will work because

1478
00:49:02,440 --> 00:49:06,320
then you inherit the the credibility of

1479
00:49:04,199 --> 00:49:07,439
the You're saying, when you take a fixed

1480
00:49:06,320 --> 00:49:08,680
exchange rate, I'm not going to run

1481
00:49:07,440 --> 00:49:10,119
monetary policy, which is the main

1482
00:49:08,679 --> 00:49:11,079
source of inflation.

1483
00:49:10,119 --> 00:49:13,319
So, I'm going to let the credible

1484
00:49:11,079 --> 00:49:15,239
country run the monetary policy for me.

1485
00:49:13,320 --> 00:49:16,960
That's what gives you credibility.

1486
00:49:15,239 --> 00:49:18,559
As long as somebody believes that you're

1487
00:49:16,960 --> 00:49:19,920
not going to

1488
00:49:18,559 --> 00:49:21,679
quit the thing.

1489
00:49:19,920 --> 00:49:24,039
But but but that's the reason countries

1490
00:49:21,679 --> 00:49:25,000
do it, often to stabilize inflation as

1491
00:49:24,039 --> 00:49:27,119
well.

1492
00:49:25,000 --> 00:49:27,119
Okay.