WEBVTT 00:00:16.559 --> 00:00:21.960 So today uh my plan is to finish the 00:00:19.000 --> 00:00:24.120 open economy part of the course and uh 00:00:21.960 --> 00:00:27.200 we will talk about exchange regimes but 00:00:24.120 --> 00:00:28.240 but before I do that, I need to finish 00:00:27.199 --> 00:00:29.960 uh 00:00:28.239 --> 00:00:31.439 a few things that we didn't in the 00:00:29.960 --> 00:00:32.920 previous lecture 00:00:31.440 --> 00:00:34.120 and that will help us an introduction 00:00:32.920 --> 00:00:35.719 for the kind of things I want to talk 00:00:34.119 --> 00:00:37.559 about today. 00:00:35.719 --> 00:00:40.960 And uh 00:00:37.560 --> 00:00:43.640 let me start just reviewing that last uh 00:00:40.960 --> 00:00:45.280 slide with that we discussed 00:00:43.640 --> 00:00:46.480 uh which is the Mundell-Fleming model. 00:00:45.280 --> 00:00:49.799 And the Mundell-Fleming model 00:00:46.479 --> 00:00:51.439 essentially is our old IS-LM model in 00:00:49.799 --> 00:00:54.159 which the IS is a little different 00:00:51.439 --> 00:00:54.879 because now we have a net exports term 00:00:54.159 --> 00:00:57.119 uh 00:00:54.880 --> 00:01:01.280 which is a function of new things like 00:00:57.119 --> 00:01:03.159 uh foreign output foreign income and 00:01:01.280 --> 00:01:05.000 uh and most importantly the real 00:01:03.159 --> 00:01:08.159 exchange rate and the real exchange rate 00:01:05.000 --> 00:01:09.799 in itself because of the UIP uncovered 00:01:08.159 --> 00:01:11.879 interest parity condition is a function 00:01:09.799 --> 00:01:14.079 of expected exchange rate 00:01:11.879 --> 00:01:17.199 the the 00:01:14.079 --> 00:01:19.239 internal foreign in- interest rate 00:01:17.200 --> 00:01:20.799 and it also gives us yet another reason 00:01:19.239 --> 00:01:23.919 for why 00:01:20.799 --> 00:01:25.439 uh the interest rate affects uh domestic 00:01:23.920 --> 00:01:27.400 aggregate demand. Okay? There's a 00:01:25.439 --> 00:01:29.200 There's a There's a the traditional 00:01:27.400 --> 00:01:32.560 investment effect of a increase in 00:01:29.200 --> 00:01:34.200 interest rate but we also get um the 00:01:32.560 --> 00:01:35.680 appreciation effect of an increase in 00:01:34.200 --> 00:01:37.320 the interest rate which is 00:01:35.680 --> 00:01:39.760 contractionary from the point of view of 00:01:37.319 --> 00:01:42.839 aggregate demand. So but this is like 00:01:39.760 --> 00:01:45.080 that with uh this extra net export term 00:01:42.840 --> 00:01:47.320 and and in this diagram, you know, for 00:01:45.079 --> 00:01:50.879 this we have the same interest rate here 00:01:47.319 --> 00:01:52.319 uh from this diagram which which 00:01:50.879 --> 00:01:54.359 portrays the 00:01:52.319 --> 00:01:56.879 uh uncovered interest parity condition, 00:01:54.359 --> 00:01:59.480 we can get for any given international 00:01:56.879 --> 00:02:01.359 interest rate and expected exchange rate 00:01:59.480 --> 00:02:03.280 for next period uh 00:02:01.359 --> 00:02:04.879 we can get the current exchange rate. 00:02:03.280 --> 00:02:07.480 Okay? So 00:02:04.879 --> 00:02:10.118 that was our model and we did a few 00:02:07.480 --> 00:02:11.400 experiments here. The first one was 00:02:10.118 --> 00:02:13.120 well, what happens if the expected 00:02:11.400 --> 00:02:15.200 exchange rate goes up? 00:02:13.120 --> 00:02:16.960 The first thing is which curves move? 00:02:15.199 --> 00:02:20.199 Well, if the expected exchange rate goes 00:02:16.960 --> 00:02:21.560 up, then I know that for any given 00:02:20.199 --> 00:02:24.439 interest rate 00:02:21.560 --> 00:02:25.479 uh the current exchange rate will go up. 00:02:24.439 --> 00:02:27.039 Okay? 00:02:25.479 --> 00:02:29.039 I know that this curve, in other words, 00:02:27.039 --> 00:02:31.039 will shift to the right. 00:02:29.039 --> 00:02:32.400 Why do I know that? Well, because if the 00:02:31.039 --> 00:02:34.079 current exchange rate doesn't move by 00:02:32.400 --> 00:02:36.240 the same amount of expected exchange 00:02:34.080 --> 00:02:37.440 rate, now I'm on a expected 00:02:36.240 --> 00:02:39.840 I'm going to have a expected capital 00:02:37.439 --> 00:02:42.919 gain or loss which will be inconsistent 00:02:39.840 --> 00:02:45.520 with the previous uh parity of interest 00:02:42.919 --> 00:02:47.039 rate, you know? So we had agreed that 00:02:45.520 --> 00:02:48.960 uh you know, that we had certain 00:02:47.039 --> 00:02:50.479 expected appreciation. So let's make it 00:02:48.960 --> 00:02:51.640 very simple. Suppose that this interest 00:02:50.479 --> 00:02:53.759 rate happens to be equal to the 00:02:51.639 --> 00:02:55.319 international interest rate then we know 00:02:53.759 --> 00:02:56.679 that this exchange rate has to be equal 00:02:55.319 --> 00:02:57.919 to the expected exchange rate because 00:02:56.680 --> 00:02:59.080 you cannot expect an appreciation or 00:02:57.919 --> 00:03:00.719 depreciation of the currency if the 00:02:59.080 --> 00:03:02.320 interest rates are the same. 00:03:00.719 --> 00:03:04.599 But if now the expected exchange in the 00:03:02.319 --> 00:03:06.400 next period goes up and if the exchange 00:03:04.599 --> 00:03:08.519 rate today doesn't move, that would mean 00:03:06.400 --> 00:03:10.599 that you expect also capital uh uh 00:03:08.520 --> 00:03:12.520 an appreciation of the currency which 00:03:10.599 --> 00:03:13.879 means that investing in domestic bonds 00:03:12.520 --> 00:03:15.719 would give you a higher return because 00:03:13.879 --> 00:03:17.479 of the same interest rate plus expected 00:03:15.719 --> 00:03:19.000 appreciation. So we know that the 00:03:17.479 --> 00:03:21.599 uncovered interest parity condition will 00:03:19.000 --> 00:03:22.919 move to the right. You know, as a result 00:03:21.599 --> 00:03:24.840 of the increase in expected exchange 00:03:22.919 --> 00:03:27.399 rate. But it also means that at any 00:03:24.840 --> 00:03:29.599 given interest rate you get a higher an 00:03:27.400 --> 00:03:31.319 appreciated exchange rate relative to 00:03:29.599 --> 00:03:33.400 the previous one before the increase in 00:03:31.319 --> 00:03:35.680 expected exchange rate which means that 00:03:33.400 --> 00:03:36.640 the IS will shift to the left. 00:03:35.680 --> 00:03:38.760 Okay. 00:03:36.639 --> 00:03:40.199 So if the expected exchange rate goes 00:03:38.759 --> 00:03:41.599 up, that leads to an appreciation and 00:03:40.199 --> 00:03:44.000 that leads to 00:03:41.599 --> 00:03:44.919 contraction in aggregate demand. 00:03:44.000 --> 00:03:46.520 Okay. 00:03:44.919 --> 00:03:48.239 Good. 00:03:46.520 --> 00:03:50.320 Next experiment was well, what happens 00:03:48.240 --> 00:03:52.400 if foreign output comes down? Well, if 00:03:50.319 --> 00:03:53.759 foreign output comes down, then that has 00:03:52.400 --> 00:03:55.760 nothing to do with the interest parity 00:03:53.759 --> 00:03:57.879 condition. It's not 00:03:55.759 --> 00:03:59.519 doesn't show up in this expression. But 00:03:57.879 --> 00:04:01.719 it does shift this, you know, because it 00:03:59.520 --> 00:04:03.920 reduces our exports for any given level 00:04:01.719 --> 00:04:05.599 of interest rate and output and so the 00:04:03.919 --> 00:04:07.239 IS shifts to the left. So that's 00:04:05.599 --> 00:04:09.159 contractionary. That's a way you import 00:04:07.240 --> 00:04:12.040 a recession from the rest of the world. 00:04:09.159 --> 00:04:14.960 Okay? Uh as I said before 00:04:12.039 --> 00:04:16.560 people around Asia and and Latin America 00:04:14.960 --> 00:04:18.480 very very worried about the Chinese 00:04:16.560 --> 00:04:21.160 actually the Europeans as well because 00:04:18.480 --> 00:04:22.920 Germany exports a lot to China are very 00:04:21.160 --> 00:04:24.560 worried about contractions in China and 00:04:22.920 --> 00:04:27.040 so on because through that channel it's 00:04:24.560 --> 00:04:29.079 contractionary as well. Now we're in the 00:04:27.040 --> 00:04:31.840 other part of the 00:04:29.079 --> 00:04:33.919 of the cycle because China is reopening 00:04:31.839 --> 00:04:36.000 uh and and that sort of gives lots of 00:04:33.920 --> 00:04:37.640 hope to Europe and so on. 00:04:36.000 --> 00:04:39.920 And that's one of the reasons why the 00:04:37.639 --> 00:04:41.519 euro has appreciated vis-à-vis the the 00:04:39.920 --> 00:04:42.400 dollar recently. 00:04:41.519 --> 00:04:43.639 Okay. 00:04:42.399 --> 00:04:45.759 Um 00:04:43.639 --> 00:04:47.360 and then the the last experiment that I 00:04:45.759 --> 00:04:49.360 don't remember whether we finished or 00:04:47.360 --> 00:04:50.680 not, I think I said it very quickly is 00:04:49.360 --> 00:04:53.400 well, what happens if the international 00:04:50.680 --> 00:04:54.800 interest rate goes up? 00:04:53.399 --> 00:04:56.599 What moves? Well, the first thing that 00:04:54.800 --> 00:04:58.600 will move is this. This was a parameter, 00:04:56.600 --> 00:05:00.160 okay? So 00:04:58.600 --> 00:05:02.000 what do I know that if I keep the 00:05:00.160 --> 00:05:04.280 interest rate constant and the 00:05:02.000 --> 00:05:05.680 international interest rate went up what 00:05:04.279 --> 00:05:07.679 has to happen to the exchange and the 00:05:05.680 --> 00:05:09.160 expected exchange rate hasn't changed? 00:05:07.680 --> 00:05:10.959 What has to happen to the exchange rate 00:05:09.160 --> 00:05:11.920 today to be indifferent between the two 00:05:10.959 --> 00:05:14.879 things? 00:05:11.920 --> 00:05:16.319 The the two bonds. 00:05:14.879 --> 00:05:18.159 So this is experiment. Suppose that 00:05:16.319 --> 00:05:20.279 we're at any domestic interest rate, we 00:05:18.160 --> 00:05:22.760 don't touch that. Now I increase 00:05:20.279 --> 00:05:25.000 international interest rate 00:05:22.759 --> 00:05:27.199 and I say the expected exchange rate 00:05:25.000 --> 00:05:29.240 is the same as it used to be, what has 00:05:27.199 --> 00:05:30.759 to happen to the current exchange rate 00:05:29.240 --> 00:05:32.600 in order to be indifferent between 00:05:30.759 --> 00:05:35.159 investing in the US bond or the other 00:05:32.600 --> 00:05:35.160 foreign bond? 00:05:36.360 --> 00:05:40.000 Exactly, it has to depreciate. Why? 00:05:42.279 --> 00:05:45.479 That's correct but but why is it that 00:05:44.040 --> 00:05:47.680 you need an 00:05:45.480 --> 00:05:50.800 that the exchange rate falls today in 00:05:47.680 --> 00:05:52.720 order to restore to have the the 00:05:50.800 --> 00:05:55.120 interest parity condition 00:05:52.720 --> 00:05:55.120 holding? 00:05:55.279 --> 00:05:59.919 Okay. So remember what happened is that 00:05:58.040 --> 00:06:01.160 you had the same interest rate and now 00:05:59.920 --> 00:06:02.360 that the international interest rate 00:06:01.160 --> 00:06:04.400 went up. 00:06:02.360 --> 00:06:06.160 That means if nothing moves, now you 00:06:04.399 --> 00:06:07.919 preferred you were indifferent before. 00:06:06.160 --> 00:06:09.520 Now you would prefer to invest in the 00:06:07.920 --> 00:06:11.759 international bond. 00:06:09.519 --> 00:06:13.919 If I don't change the the the US rate, 00:06:11.759 --> 00:06:15.399 then I have to compensate you by some 00:06:13.920 --> 00:06:16.879 other mean. 00:06:15.399 --> 00:06:17.759 The only way I can compensate you in 00:06:16.879 --> 00:06:20.639 this model, the only thing that's 00:06:17.759 --> 00:06:22.480 endogenous is by an expected 00:06:20.639 --> 00:06:23.599 appreciation of the exchange rate 00:06:22.480 --> 00:06:27.000 because that would give you a capital 00:06:23.600 --> 00:06:29.720 gain from holding the bond the US bond, 00:06:27.000 --> 00:06:31.000 a currency capital gain. Now 00:06:29.720 --> 00:06:32.560 since the expected exchange rate is 00:06:31.000 --> 00:06:34.600 given, the only way I can give you that 00:06:32.560 --> 00:06:36.000 is depreciating the currency today so 00:06:34.600 --> 00:06:36.840 then you can expect an appreciation 00:06:36.000 --> 00:06:38.319 tomorrow. 00:06:36.839 --> 00:06:39.759 From today to tomorrow. Okay, that's 00:06:38.319 --> 00:06:42.319 that's the mechanism. 00:06:39.759 --> 00:06:45.319 Okay, so that means that this 00:06:42.319 --> 00:06:46.680 uh curve here will shift to the right. 00:06:45.319 --> 00:06:49.000 Okay? For any given interest rate you 00:06:46.680 --> 00:06:50.199 need a sorry, to the left. For any given 00:06:49.000 --> 00:06:52.480 I made that mistake in the previous 00:06:50.199 --> 00:06:54.159 lecture as well. So for any given level 00:06:52.480 --> 00:06:55.960 of interest rate, this curve will have 00:06:54.160 --> 00:06:57.520 to move to the left. 00:06:55.959 --> 00:06:58.839 Okay? So if the interest rate doesn't 00:06:57.519 --> 00:07:00.839 change and international interest rate 00:06:58.839 --> 00:07:02.679 is up, you need an exchange rate today 00:07:00.839 --> 00:07:04.679 that is lower than it used to be so you 00:07:02.680 --> 00:07:05.879 can expect an appreciation from now to 00:07:04.680 --> 00:07:07.480 the next period. 00:07:05.879 --> 00:07:09.079 Okay? 00:07:07.480 --> 00:07:10.759 So that's what moves to the left. Now 00:07:09.079 --> 00:07:13.159 what happens? What else moves in that 00:07:10.759 --> 00:07:13.159 case? 00:07:15.480 --> 00:07:19.879 I remember when I'm I'm asking the 00:07:17.519 --> 00:07:22.079 question, what else moves? 00:07:19.879 --> 00:07:23.719 Uh I mean what other curve moves? What 00:07:22.079 --> 00:07:25.879 you need to do is just take something as 00:07:23.720 --> 00:07:27.400 given and then see what whether we get 00:07:25.879 --> 00:07:28.920 the same equilibrium output or not or 00:07:27.399 --> 00:07:30.879 not. So I'll take an interest rate as 00:07:28.920 --> 00:07:32.720 given as IS 00:07:30.879 --> 00:07:34.839 and then ask the question, well, will I 00:07:32.720 --> 00:07:36.040 get the same equilibrium output or not? 00:07:34.839 --> 00:07:38.399 If I get the same equilibrium output, 00:07:36.040 --> 00:07:39.480 that means the IS hasn't moved. 00:07:38.399 --> 00:07:40.839 But if I get a different equilibrium 00:07:39.480 --> 00:07:42.120 output, it means the IS has moved 00:07:40.839 --> 00:07:44.119 because for the same interest rate I'm 00:07:42.120 --> 00:07:47.439 getting a different equilibrium output. 00:07:44.120 --> 00:07:47.439 So what happens in this case? 00:07:48.480 --> 00:07:54.720 Does the IS move or not? 00:07:51.399 --> 00:07:54.719 When I star goes up? 00:08:05.000 --> 00:08:10.560 Going to simplify the question. Yes, it 00:08:07.120 --> 00:08:10.560 does. Which way? 00:08:15.920 --> 00:08:19.480 Will I get more or less output? 00:08:18.439 --> 00:08:20.920 When the international interest rate 00:08:19.480 --> 00:08:22.480 goes up? 00:08:20.920 --> 00:08:24.400 And I'm taking Look the kind of things 00:08:22.480 --> 00:08:26.439 I'm taking as given. I'm also taking as 00:08:24.399 --> 00:08:29.159 given international output. 00:08:26.439 --> 00:08:31.680 So I I'm not moving Y star. 00:08:29.160 --> 00:08:33.360 I'm not moving expected exchange rate. 00:08:31.680 --> 00:08:34.960 Uh 00:08:33.360 --> 00:08:36.560 and I'm asking the question 00:08:34.960 --> 00:08:38.519 is the domestic 00:08:36.559 --> 00:08:40.359 central bank, the Fed in the case of the 00:08:38.519 --> 00:08:41.960 US, does not change the interest rate, 00:08:40.360 --> 00:08:45.200 what happens to equilibrium output? Does 00:08:41.960 --> 00:08:46.600 it go down or up? 00:08:45.200 --> 00:08:48.640 If the other if the international 00:08:46.600 --> 00:08:50.399 interest rate goes up, the domestic 00:08:48.639 --> 00:08:53.840 interest does not 00:08:50.399 --> 00:08:53.840 what has to happen to exchange rate? 00:08:55.360 --> 00:08:58.480 You answered it before. 00:08:57.200 --> 00:09:01.120 Has to go down. That means it has to 00:08:58.480 --> 00:09:04.480 depreciate. What happens to net exports 00:09:01.120 --> 00:09:04.480 when the exchange rate depreciates? 00:09:06.759 --> 00:09:09.679 What does it mean that the exchange rate 00:09:07.879 --> 00:09:11.439 depreciates? Especially if you have the 00:09:09.679 --> 00:09:13.359 In this case we have the prices 00:09:11.440 --> 00:09:14.880 completely fixed. So now if the nominal 00:09:13.360 --> 00:09:16.919 exchange rate depreciates, means that 00:09:14.879 --> 00:09:19.840 the real exchange rate depreciates. 00:09:16.919 --> 00:09:19.839 What does that mean? 00:09:21.799 --> 00:09:24.679 What got cheaper? 00:09:26.639 --> 00:09:30.639 Okay, you need a lot of to study for the 00:09:28.320 --> 00:09:33.040 quiz. Uh 00:09:30.639 --> 00:09:34.360 domestic goods are cheaper. So so that 00:09:33.039 --> 00:09:35.480 means that the 00:09:34.360 --> 00:09:37.000 and 00:09:35.480 --> 00:09:38.320 equivalently foreign goods got more 00:09:37.000 --> 00:09:39.759 expensive. 00:09:38.320 --> 00:09:41.640 That means for any given level of 00:09:39.759 --> 00:09:43.960 domestic interest rate, now there will 00:09:41.639 --> 00:09:45.879 be less imports and more exports. That 00:09:43.960 --> 00:09:48.720 means net exports will be more which 00:09:45.879 --> 00:09:50.960 means the IS will shift to the right. 00:09:48.720 --> 00:09:50.960 Okay. 00:09:56.080 --> 00:10:00.280 Good. So these things you you need to 00:09:58.919 --> 00:10:02.079 control. I understand that this is a 00:10:00.279 --> 00:10:03.839 little confusing to think about exchange 00:10:02.080 --> 00:10:06.320 rate and so on, but 00:10:03.840 --> 00:10:06.320 but uh 00:10:08.240 --> 00:10:12.519 So, anything that happens here with 00:10:09.960 --> 00:10:15.360 exchange rate is just a relative price. 00:10:12.519 --> 00:10:18.079 The more expensive are your goods, 00:10:15.360 --> 00:10:19.759 the harder it will be to sell them, you 00:10:18.080 --> 00:10:21.720 And and the more tempted you will be to 00:10:19.759 --> 00:10:23.319 buy foreign goods. That's That's That's 00:10:21.720 --> 00:10:24.960 what it does. So, it's 00:10:23.320 --> 00:10:27.040 So, that's contraction. Appreciation of 00:10:24.960 --> 00:10:29.120 contraction here or not. Here, the story 00:10:27.039 --> 00:10:31.599 is a little different. It's all about 00:10:29.120 --> 00:10:32.960 equalizing expected returns. So, you 00:10:31.600 --> 00:10:34.759 need to have an equal movement in the 00:10:32.960 --> 00:10:36.320 exchange rate today so that you are 00:10:34.759 --> 00:10:38.000 always indifferent between investing in 00:10:36.320 --> 00:10:39.600 one side or the other. It's about the 00:10:38.000 --> 00:10:41.200 return, the expected exchange in the 00:10:39.600 --> 00:10:44.600 exchange rate. 00:10:41.200 --> 00:10:44.600 So, okay, good. 00:10:46.279 --> 00:10:49.600 Okay, I got it. It's a little unclear, 00:10:48.039 --> 00:10:52.279 but 00:10:49.600 --> 00:10:52.279 we'll keep trying. 00:10:54.000 --> 00:11:00.039 Is there anything particularly unclear? 00:10:56.759 --> 00:11:00.039 Or is all a blur here? 00:11:00.080 --> 00:11:05.800 Okay, got it. 00:11:03.080 --> 00:11:05.800 Um 00:11:06.159 --> 00:11:09.838 Well, let me So, all that is I describe 00:11:08.679 --> 00:11:13.079 here 00:11:09.839 --> 00:11:14.680 is is um 00:11:13.080 --> 00:11:17.160 is allowing the exchange rate to move. 00:11:14.679 --> 00:11:19.399 We're saying, "Look, if we move 00:11:17.159 --> 00:11:20.919 something or the foreign foreigners move 00:11:19.399 --> 00:11:22.799 something, then we ask the question, 00:11:20.919 --> 00:11:24.319 "Well, what does exchange rate has to do 00:11:22.799 --> 00:11:27.759 here?" 00:11:24.320 --> 00:11:29.320 Okay? And typically when when when 00:11:27.759 --> 00:11:31.960 that's done, 00:11:29.320 --> 00:11:34.000 we call those regimes floating exchange 00:11:31.960 --> 00:11:36.280 rate systems, meaning exchange rate can 00:11:34.000 --> 00:11:37.799 float, can move around. As interest 00:11:36.279 --> 00:11:40.279 rates in different parts of the world 00:11:37.799 --> 00:11:41.879 change, then the exchange rate moves 00:11:40.279 --> 00:11:43.559 around. Okay? 00:11:41.879 --> 00:11:44.919 Typically call that flexible exchange 00:11:43.559 --> 00:11:47.519 rate. I think the distinction is a lot 00:11:44.919 --> 00:11:50.279 harder to make in practice, but for 00:11:47.519 --> 00:11:52.360 reasons I'll explain later, but but 00:11:50.279 --> 00:11:54.319 that's what is meant as a as a floating 00:11:52.360 --> 00:11:56.759 exchange rate system, one in which 00:11:54.320 --> 00:11:58.320 really you're doing your Each country is 00:11:56.759 --> 00:11:59.679 doing its own policies and so on, and 00:11:58.320 --> 00:12:05.040 the exchange rate does what it needs to 00:11:59.679 --> 00:12:07.039 do so so so the financial markets clear. 00:12:05.039 --> 00:12:09.159 Many countries, however, do something 00:12:07.039 --> 00:12:11.000 which is a the polar opposite of that, 00:12:09.159 --> 00:12:12.838 which is called a fixed exchange rate 00:12:11.000 --> 00:12:15.279 regime. Okay? 00:12:12.839 --> 00:12:18.760 So, some countries really peg their 00:12:15.279 --> 00:12:21.279 currencies to a major currency. 00:12:18.759 --> 00:12:24.200 An extreme case is the Eurozone, where 00:12:21.279 --> 00:12:26.159 they gave up their individual currencies 00:12:24.200 --> 00:12:30.320 and they have a common currency. Okay? 00:12:26.159 --> 00:12:31.799 So, so Germany and and and and and and 00:12:30.320 --> 00:12:33.640 Italy have a 00:12:31.799 --> 00:12:35.519 ultra pegged exchange rate because they 00:12:33.639 --> 00:12:36.720 have the same currency. Okay? 00:12:35.519 --> 00:12:38.360 Now, 00:12:36.720 --> 00:12:39.320 most of the times fixed exchange rates 00:12:38.360 --> 00:12:41.279 are 00:12:39.320 --> 00:12:42.879 are a little weaker than that. 00:12:41.279 --> 00:12:44.279 For example, the Hong Kong dollar has 00:12:42.879 --> 00:12:46.559 been pegged to the dollar for a long 00:12:44.279 --> 00:12:48.720 time, for the US dollar for a long time. 00:12:46.559 --> 00:12:50.599 Okay? And we'll show you a few others. 00:12:48.720 --> 00:12:52.839 Many countries go through some phase 00:12:50.600 --> 00:12:54.560 where they try to peg the currency 00:12:52.839 --> 00:12:56.240 and it typically fails at some point, 00:12:54.559 --> 00:12:58.279 but but they have periods in which the 00:12:56.240 --> 00:12:59.879 currency is pegged. 00:12:58.279 --> 00:13:01.480 But so, let me 00:12:59.879 --> 00:13:02.960 Suppose that you have a pegged exchange 00:13:01.480 --> 00:13:05.600 rate, let me show you 00:13:02.960 --> 00:13:08.480 some features of it. Suppose you are in 00:13:05.600 --> 00:13:10.879 a peg in a peg or a fixed exchange rate 00:13:08.480 --> 00:13:12.639 regime pegged to another currency, and 00:13:10.879 --> 00:13:14.039 suppose it's credible. That's a big 00:13:12.639 --> 00:13:15.240 issue with fixed exchange rate, but 00:13:14.039 --> 00:13:16.759 suppose it's credible. There are some 00:13:15.240 --> 00:13:18.360 countries that have credible fixed 00:13:16.759 --> 00:13:20.799 exchange rate. 00:13:18.360 --> 00:13:23.360 Well, if if you have a fixed exchange 00:13:20.799 --> 00:13:25.399 rate with respect to some other currency 00:13:23.360 --> 00:13:26.960 and it's credible, then you know that 00:13:25.399 --> 00:13:28.480 the expected exchange rate is equal to 00:13:26.960 --> 00:13:29.600 exchange rate and equal to a constant. 00:13:28.480 --> 00:13:33.240 That's what it means to have a fixed 00:13:29.600 --> 00:13:35.399 exchange rate. Okay? It's constant. 00:13:33.240 --> 00:13:36.600 But if this is constant, means you never 00:13:35.399 --> 00:13:38.639 can expect an appreciation or 00:13:36.600 --> 00:13:41.399 depreciation 00:13:38.639 --> 00:13:43.000 because it's constant. It's fixed. 00:13:41.399 --> 00:13:45.159 And if you can't expect an appreciation 00:13:43.000 --> 00:13:48.200 or depreciation, the uncovered interest 00:13:45.159 --> 00:13:50.719 parity condition tells you that you 00:13:48.200 --> 00:13:51.879 know, what does it tell you? 00:13:50.720 --> 00:13:55.240 That your interest rate has to be the 00:13:51.879 --> 00:13:55.240 same as the foreign interest rate. 00:13:56.200 --> 00:14:01.120 Why? 00:13:58.320 --> 00:14:03.560 What would happen in a credible 00:14:01.120 --> 00:14:05.039 uh peg in a credible fixed exchange rate 00:14:03.559 --> 00:14:06.359 if the domestic interest rate is higher 00:14:05.039 --> 00:14:08.959 than the international 00:14:06.360 --> 00:14:12.240 than the currency the interest rate 00:14:08.960 --> 00:14:14.079 of the country you're pegging to? 00:14:12.240 --> 00:14:15.720 What would happen? Suppose that 00:14:14.078 --> 00:14:17.599 I'm in a fixed exchange rate and and we 00:14:15.720 --> 00:14:19.200 have the same interest rate and now I 00:14:17.600 --> 00:14:21.320 unilaterally decide to raise interest 00:14:19.200 --> 00:14:22.440 rates. 00:14:21.320 --> 00:14:24.079 What do you think would happen with 00:14:22.440 --> 00:14:25.200 capital flows? 00:14:24.078 --> 00:14:27.759 How would What would you do to your 00:14:25.200 --> 00:14:27.759 portfolio? 00:14:28.440 --> 00:14:31.280 If the currency is exchange rate is 00:14:29.919 --> 00:14:32.838 pegged 00:14:31.279 --> 00:14:35.000 and it's credible, 00:14:32.839 --> 00:14:36.880 it is as if they were issuing the same 00:14:35.000 --> 00:14:38.399 currency because it's the same It's a 00:14:36.879 --> 00:14:41.159 different currency, different name, but 00:14:38.399 --> 00:14:42.838 it has a constant in front of it. Okay? 00:14:41.159 --> 00:14:45.958 So, it's as if it was issuing the same 00:14:42.839 --> 00:14:47.400 currency. Two bonds that are identical 00:14:45.958 --> 00:14:48.519 and issued in the same currency cannot 00:14:47.399 --> 00:14:51.240 be paying different interest rate 00:14:48.519 --> 00:14:53.078 because you would go invest all your 00:14:51.240 --> 00:14:55.519 money, you know, in the in the bond that 00:14:53.078 --> 00:14:58.279 is paying a higher interest rate. 00:14:55.519 --> 00:15:00.039 And that's what happens here. So, it's 00:14:58.279 --> 00:15:01.759 Mechanically, what would happen is for 00:15:00.039 --> 00:15:03.078 some crazy reason a country has a fixed 00:15:01.759 --> 00:15:04.838 exchange rate, credible fixed exchange 00:15:03.078 --> 00:15:07.159 rate, decides to have an interest rate 00:15:04.839 --> 00:15:09.000 higher than the currency the the the 00:15:07.159 --> 00:15:10.879 interest rate in the currency it's it's 00:15:09.000 --> 00:15:12.839 being pegged to, 00:15:10.879 --> 00:15:14.039 then you would see massive capital flows 00:15:12.839 --> 00:15:16.240 to that country. So, there would be an 00:15:14.039 --> 00:15:18.120 enormous pressure for an appreciation of 00:15:16.240 --> 00:15:19.480 that currency. 00:15:18.120 --> 00:15:21.200 Okay? 00:15:19.480 --> 00:15:23.279 But but the And what the central bank 00:15:21.200 --> 00:15:25.759 would have to do is start buying massive 00:15:23.279 --> 00:15:27.799 amounts of the of the supplying massive 00:15:25.759 --> 00:15:29.200 amounts of this currency for those that 00:15:27.799 --> 00:15:31.159 want to buy it 00:15:29.200 --> 00:15:33.680 because there will be an infinite demand 00:15:31.159 --> 00:15:36.679 for that. Okay? 00:15:33.679 --> 00:15:38.199 So, in practice, what that means And And 00:15:36.679 --> 00:15:40.359 sometimes 00:15:38.200 --> 00:15:43.280 you can do that for a little while, but 00:15:40.360 --> 00:15:45.879 but but but not in in a sustained 00:15:43.279 --> 00:15:48.639 manner. So, what happens in practice is 00:15:45.879 --> 00:15:50.159 that if you really have a a a a pegged 00:15:48.639 --> 00:15:53.319 exchange rate and you have free capital 00:15:50.159 --> 00:15:55.879 mobility, which is people can move in 00:15:53.320 --> 00:15:58.000 and out of your bonds, China does them, 00:15:55.879 --> 00:16:00.240 for example, so it can allow itself to 00:15:58.000 --> 00:16:02.320 both control a little bit the currency 00:16:00.240 --> 00:16:03.000 and uh uh 00:16:02.320 --> 00:16:06.079 uh 00:16:03.000 --> 00:16:07.360 mean be semi semi pegged and it still 00:16:06.078 --> 00:16:09.159 can move its domestic interest rate 00:16:07.360 --> 00:16:10.639 because they have capital controls, but 00:16:09.159 --> 00:16:12.958 but if you don't have capital controls 00:16:10.639 --> 00:16:14.199 and people can move money in and out, it 00:16:12.958 --> 00:16:15.399 can do portfolio investment as it 00:16:14.200 --> 00:16:16.520 happened with most of the advanced 00:16:15.399 --> 00:16:19.600 economies, 00:16:16.519 --> 00:16:22.559 then effectively uh 00:16:19.600 --> 00:16:24.279 you give up domestic monetary policy. 00:16:22.559 --> 00:16:26.399 Okay? Because whatever the other country 00:16:24.279 --> 00:16:29.720 does, the country you're pegging to 00:16:26.399 --> 00:16:29.720 does, you have to follow. 00:16:29.799 --> 00:16:35.078 So, that's what it means. You peg, you 00:16:31.958 --> 00:16:37.879 give up your domestic monetary policy if 00:16:35.078 --> 00:16:39.000 you choose to peg to another country. 00:16:37.879 --> 00:16:40.600 I'll I'll a little later I'm going to 00:16:39.000 --> 00:16:43.120 tell you why countries may choose to do 00:16:40.600 --> 00:16:45.079 that, but that's what you do. 00:16:43.120 --> 00:16:47.440 Okay? And the the uncovered interest 00:16:45.078 --> 00:16:48.838 parity tells you that's what you do. 00:16:47.440 --> 00:16:50.800 You're not going to be able to deviate 00:16:48.839 --> 00:16:53.079 there significantly from the interest 00:16:50.799 --> 00:16:54.359 rate that the other country is setting 00:16:53.078 --> 00:16:56.479 if you want to maintain your fixed 00:16:54.360 --> 00:16:58.800 exchange rate. 00:16:56.480 --> 00:17:01.879 Now, in practice, there are many hybrid 00:16:58.799 --> 00:17:03.719 regimes. There There are very very few 00:17:01.879 --> 00:17:04.279 pure float regimes. 00:17:03.720 --> 00:17:06.679 Uh 00:17:04.279 --> 00:17:09.039 few. I mean, maybe five or something 00:17:06.679 --> 00:17:10.759 like that. But but but but so, there are 00:17:09.039 --> 00:17:13.480 all sorts of degrees 00:17:10.759 --> 00:17:15.640 of exchange rate regimes and and which 00:17:13.480 --> 00:17:19.000 are hybrids between fixed exchange rates 00:17:15.640 --> 00:17:21.720 and and fully flexible exchange rates. 00:17:19.000 --> 00:17:24.000 Let me show you just a few just 00:17:21.720 --> 00:17:26.799 randomly more or less randomly selected 00:17:24.000 --> 00:17:31.519 in Bloomberg. Uh so, there you have in 00:17:26.799 --> 00:17:33.119 in in in in white is the US euro. 00:17:31.519 --> 00:17:34.639 That's a float. That's a That's a 00:17:33.119 --> 00:17:36.799 cleanest float you can imagine. I mean, 00:17:34.640 --> 00:17:38.800 there's no 00:17:36.799 --> 00:17:41.879 Then, another which is a very clean 00:17:38.799 --> 00:17:43.799 float is the dollar yen, 00:17:41.880 --> 00:17:46.520 Japanese yen. 00:17:43.799 --> 00:17:48.799 Now, that's a currency that has that 00:17:46.519 --> 00:17:51.039 freely floats, but if there's a major 00:17:48.799 --> 00:17:52.519 dislocations, central banks do intervene 00:17:51.039 --> 00:17:53.799 to money So, 00:17:52.519 --> 00:17:56.480 it means 00:17:53.799 --> 00:17:57.599 in normal circumstances, they float. And 00:17:56.480 --> 00:17:59.759 the same is true with the euro. But if 00:17:57.599 --> 00:18:02.119 there's big dislocations, a major bank 00:17:59.759 --> 00:18:04.720 collapses or something like that, then 00:18:02.119 --> 00:18:06.119 there major dislocations in in financial 00:18:04.720 --> 00:18:08.079 markets. They become very segmented. 00:18:06.119 --> 00:18:10.199 Arbitrage is not that easy and so on. 00:18:08.079 --> 00:18:12.119 Then then then central banks intervene. 00:18:10.200 --> 00:18:14.519 But but for the normal business cycle 00:18:12.119 --> 00:18:16.000 and so on, they do not. 00:18:14.519 --> 00:18:17.920 They do not intervene in the currency 00:18:16.000 --> 00:18:20.759 market. They intervene in different ways 00:18:17.920 --> 00:18:22.840 and that's the reason I'll get there. 00:18:20.759 --> 00:18:25.400 And the other one is the the pound, not 00:18:22.839 --> 00:18:28.079 the US dollar versus the British pound. 00:18:25.400 --> 00:18:30.480 Uh then then it's also that's a pure 00:18:28.079 --> 00:18:33.199 float. 00:18:30.480 --> 00:18:36.519 This is also pure float. This is the 00:18:33.200 --> 00:18:39.480 US versus the Aussie dollar 00:18:36.519 --> 00:18:43.599 So, and against the Canadian dollar and 00:18:39.480 --> 00:18:47.079 against the the Swedish krona. 00:18:43.599 --> 00:18:48.839 Okay? Those are pretty floating 00:18:47.079 --> 00:18:51.000 regimes. They are a little different 00:18:48.839 --> 00:18:52.720 from the previous ones I showed you 00:18:51.000 --> 00:18:56.240 because these are currencies that are 00:18:52.720 --> 00:18:58.919 much more prone to sell off 00:18:56.240 --> 00:19:01.120 during risk-off environments. And that's 00:18:58.919 --> 00:19:03.480 the reason you see these spikes here. 00:19:01.119 --> 00:19:05.839 Okay? This was COVID. 00:19:03.480 --> 00:19:07.519 Biggest spike. You didn't see it in the 00:19:05.839 --> 00:19:08.759 in the dollar euro and so on and so 00:19:07.519 --> 00:19:10.879 forth. So, these are currencies that are 00:19:08.759 --> 00:19:14.039 free floaters, but they're very exposed 00:19:10.880 --> 00:19:15.240 to to risk the risk environment in the 00:19:14.039 --> 00:19:16.559 market. But they're still they're free 00:19:15.240 --> 00:19:18.919 floaters. 00:19:16.559 --> 00:19:20.200 Um 00:19:18.919 --> 00:19:22.280 The Swiss are a little bit more of 00:19:20.200 --> 00:19:23.679 independent minded than and but they do 00:19:22.279 --> 00:19:27.240 control a bit more the currency, but 00:19:23.679 --> 00:19:30.000 they're still I I consider those 00:19:27.240 --> 00:19:31.359 a free floaters. 00:19:30.000 --> 00:19:34.679 These are currencies that are a little 00:19:31.359 --> 00:19:35.599 different. This is the Brazilian real. 00:19:34.679 --> 00:19:38.600 Uh 00:19:35.599 --> 00:19:40.480 the zar is the South African rand. 00:19:38.599 --> 00:19:42.240 And this is the 00:19:40.480 --> 00:19:43.679 Colombian peso. 00:19:42.240 --> 00:19:45.679 And you see several things here. They 00:19:43.679 --> 00:19:48.120 They do move. So, so they have a big 00:19:45.679 --> 00:19:49.720 component of flexible exchange rate. 00:19:48.119 --> 00:19:52.879 Uh 00:19:49.720 --> 00:19:54.880 They do intervene a lot more, though. Uh 00:19:52.880 --> 00:19:56.880 because they're exposed to much more 00:19:54.880 --> 00:19:59.200 risk off type environment and so on and 00:19:56.880 --> 00:20:00.800 they need to intervene fairly frequently 00:19:59.200 --> 00:20:01.720 to control movements in the exchange 00:20:00.799 --> 00:20:04.720 rate. 00:20:01.720 --> 00:20:05.880 But but you also see a trend 00:20:04.720 --> 00:20:07.960 in these things. 00:20:05.880 --> 00:20:09.880 So, their currencies are becoming 00:20:07.960 --> 00:20:12.160 chronically weaker relative to the 00:20:09.880 --> 00:20:13.920 dollar. 00:20:12.160 --> 00:20:15.800 And the reason for that 00:20:13.920 --> 00:20:17.400 is because they're countries that have 00:20:15.799 --> 00:20:18.639 higher inflation. 00:20:17.400 --> 00:20:20.080 So, if you want to maintain the real 00:20:18.640 --> 00:20:22.080 exchange rate constant and you have high 00:20:20.079 --> 00:20:23.480 inflation than the other country, then 00:20:22.079 --> 00:20:24.879 your nominal exchange rate has to be 00:20:23.480 --> 00:20:25.839 depreciating. 00:20:24.880 --> 00:20:27.040 Okay? 00:20:25.839 --> 00:20:29.079 Because your prices are rising at a 00:20:27.039 --> 00:20:30.000 faster pace than the other one, 00:20:29.079 --> 00:20:31.879 well, 00:20:30.000 --> 00:20:33.920 if the exchange rate was not 00:20:31.880 --> 00:20:35.080 appreciating on average depreciating on 00:20:33.920 --> 00:20:36.800 average, then it would mean that you 00:20:35.079 --> 00:20:38.519 would be coming more and more expensive. 00:20:36.799 --> 00:20:40.599 Okay? So, that's the reason. Countries 00:20:38.519 --> 00:20:42.680 that have higher inflation, they tend to 00:20:40.599 --> 00:20:43.639 have these trends as well. 00:20:42.680 --> 00:20:45.799 Okay? 00:20:43.640 --> 00:20:47.800 But they're still fairly floating. 00:20:45.799 --> 00:20:49.759 Here, these are all 00:20:47.799 --> 00:20:52.200 currencies that are 00:20:49.759 --> 00:20:53.279 uh, to a different degree 00:20:52.200 --> 00:20:54.519 uh, 00:20:53.279 --> 00:20:56.000 um, 00:20:54.519 --> 00:20:58.160 targeted in the sense that they're 00:20:56.000 --> 00:21:00.640 contained in in terms of they're not 00:20:58.160 --> 00:21:03.000 free to float at will. 00:21:00.640 --> 00:21:05.320 Uh, the scale here will mislead you. If 00:21:03.000 --> 00:21:07.680 I had put it in the same scale as the 00:21:05.319 --> 00:21:09.759 the euro dollar or the the euro yen and 00:21:07.680 --> 00:21:10.799 the the dollar yen or the euro yen as 00:21:09.759 --> 00:21:12.759 well, 00:21:10.799 --> 00:21:15.200 then these things would have been looked 00:21:12.759 --> 00:21:16.839 very small. Okay? So, so I should have 00:21:15.200 --> 00:21:18.000 put a a real floater there so you would 00:21:16.839 --> 00:21:19.399 have seen that these guys are moving a 00:21:18.000 --> 00:21:20.160 lot less. 00:21:19.400 --> 00:21:22.840 And these are different kind of 00:21:20.160 --> 00:21:25.720 countries. This is the Hong Kong dollar 00:21:22.839 --> 00:21:27.519 that for all practical purposes pegged. 00:21:25.720 --> 00:21:29.120 Okay? These little wiggles is just 00:21:27.519 --> 00:21:30.559 technical things that happen overnight 00:21:29.119 --> 00:21:32.639 and stuff like that. 00:21:30.559 --> 00:21:34.279 But they're pegged to the dollar. 00:21:32.640 --> 00:21:35.840 Okay? So, the Hong Kong dollar is pegged 00:21:34.279 --> 00:21:37.000 to the dollar. 00:21:35.839 --> 00:21:38.839 Uh, 00:21:37.000 --> 00:21:40.400 that means they really don't have 00:21:38.839 --> 00:21:43.480 independent monetary policy relative to 00:21:40.400 --> 00:21:47.040 the US vis-a-vis the US. 00:21:43.480 --> 00:21:48.079 The This is the CNH. This is the the the 00:21:47.039 --> 00:21:49.639 um, 00:21:48.079 --> 00:21:50.879 the Chinese 00:21:49.640 --> 00:21:52.880 renminbi 00:21:50.880 --> 00:21:54.600 and and and it's a currency again. I 00:21:52.880 --> 00:21:56.360 should have put it with a floated real 00:21:54.599 --> 00:21:59.480 floater there. It's a lot more 00:21:56.359 --> 00:22:02.759 controlled. Okay? So, it moves around 00:21:59.480 --> 00:22:04.319 but but in a much tighter range and and 00:22:02.759 --> 00:22:06.480 and they're thinking about exchange rate 00:22:04.319 --> 00:22:08.159 when part of their policy program and so 00:22:06.480 --> 00:22:11.079 on, the exchange rate is something 00:22:08.160 --> 00:22:11.080 they're thinking about. 00:22:11.240 --> 00:22:14.559 This one here, the blue one is is an 00:22:13.119 --> 00:22:16.159 interesting one. 00:22:14.559 --> 00:22:18.159 Uh, 00:22:16.160 --> 00:22:21.519 um, 00:22:18.160 --> 00:22:22.400 that's the the the the Singaporean 00:22:21.519 --> 00:22:24.160 Okay? 00:22:22.400 --> 00:22:26.040 And the Singaporean dollar, they have a 00:22:24.160 --> 00:22:28.960 very interesting regime. 00:22:26.039 --> 00:22:30.759 They have a a a um, 00:22:28.960 --> 00:22:34.600 a target zone, meaning they let the 00:22:30.759 --> 00:22:36.720 exchange rate move within a range only. 00:22:34.599 --> 00:22:38.480 But it's not pegged against a 00:22:36.720 --> 00:22:39.679 single currency, it's pegged against a 00:22:38.480 --> 00:22:41.160 basket 00:22:39.679 --> 00:22:44.480 of of currencies. 00:22:41.160 --> 00:22:46.600 Okay? And the the recipe is secret. 00:22:44.480 --> 00:22:48.559 So, everyone is always guessing what 00:22:46.599 --> 00:22:49.759 they're doing and so on. They do change 00:22:48.559 --> 00:22:51.919 the weights a little bit to keep the 00:22:49.759 --> 00:22:54.279 markets confused. But but their currency 00:22:51.920 --> 00:22:55.679 is very stable. It's well understood. 00:22:54.279 --> 00:22:57.920 It's a It's a weighted average of the 00:22:55.679 --> 00:23:00.160 euro, the renminbi and the and the 00:22:57.920 --> 00:23:02.480 dollar. But but they they don't disclose 00:23:00.160 --> 00:23:04.200 exactly the thing, but you know, you can 00:23:02.480 --> 00:23:06.319 filter out what they're doing and and 00:23:04.200 --> 00:23:07.880 they they keep things in a range 00:23:06.319 --> 00:23:10.599 uh, and they occasionally change the 00:23:07.880 --> 00:23:12.760 slope of that range, but but it's very 00:23:10.599 --> 00:23:15.159 regulated in that country. And they in 00:23:12.759 --> 00:23:17.079 fact they state their monetary policy in 00:23:15.160 --> 00:23:18.560 terms of the effects. They say, "That's 00:23:17.079 --> 00:23:20.359 our policy." 00:23:18.559 --> 00:23:21.839 Interest rate is what everything needs 00:23:20.359 --> 00:23:23.839 to be so the exchange rate remains in 00:23:21.839 --> 00:23:24.959 that range. That's that's that's the way 00:23:23.839 --> 00:23:26.559 they state the monetary policy. They 00:23:24.960 --> 00:23:28.120 don't even think about 00:23:26.559 --> 00:23:30.240 So, I let the markets determine the 00:23:28.119 --> 00:23:31.799 interest rate, we determine the exchange 00:23:30.240 --> 00:23:34.519 rate here in that range. And it's a 00:23:31.799 --> 00:23:34.519 narrow range. 00:23:35.279 --> 00:23:38.799 Again, 00:23:36.440 --> 00:23:40.120 I should have put 00:23:38.799 --> 00:23:41.480 um, 00:23:40.119 --> 00:23:43.319 a real floater there so you would have 00:23:41.480 --> 00:23:45.559 seen that. Okay? So, 00:23:43.319 --> 00:23:47.240 so the the point is that 00:23:45.559 --> 00:23:50.720 everything goes. They're all sort of 00:23:47.240 --> 00:23:51.880 arrangements happening around the world. 00:23:50.720 --> 00:23:53.759 This is These are different kind of 00:23:51.880 --> 00:23:55.880 currencies, you know? 00:23:53.759 --> 00:23:58.160 Uh, this is the the 00:23:55.880 --> 00:24:00.040 the 00:23:58.160 --> 00:24:00.960 the Turkish lira 00:24:00.039 --> 00:24:04.079 Okay? 00:24:00.960 --> 00:24:05.400 and the Argentinian peso. 00:24:04.079 --> 00:24:07.000 I think through this sample it's been 00:24:05.400 --> 00:24:08.679 called peso since since they have this 00:24:07.000 --> 00:24:10.759 very high inflation, they keep changing 00:24:08.679 --> 00:24:12.480 the name of the currency and so on 00:24:10.759 --> 00:24:14.279 because they have to remove zeros from 00:24:12.480 --> 00:24:15.839 things. So, but but I think through all 00:24:14.279 --> 00:24:16.879 that period it's still the Argentinian 00:24:15.839 --> 00:24:18.199 peso. 00:24:16.880 --> 00:24:21.920 And uh, 00:24:18.200 --> 00:24:23.000 so I mean, look at the scale. 00:24:21.920 --> 00:24:25.840 So, 00:24:23.000 --> 00:24:28.359 you cannot see it, but but all these two 00:24:25.839 --> 00:24:30.000 countries are all the time fighting 00:24:28.359 --> 00:24:31.759 against the exchange rate. In fact, 00:24:30.000 --> 00:24:33.079 Argentina today has like five different 00:24:31.759 --> 00:24:34.720 exchange rates. 00:24:33.079 --> 00:24:36.359 There is the official exchange rate, 00:24:34.720 --> 00:24:37.720 there is the blue exchange rate, there 00:24:36.359 --> 00:24:39.199 is the purple exchange rate, there are 00:24:37.720 --> 00:24:40.759 all sorts of things. 00:24:39.200 --> 00:24:42.640 You should never pay with a credit card 00:24:40.759 --> 00:24:43.839 if you go to Argentina if you do tourism 00:24:42.640 --> 00:24:45.440 because you don't want to pay the 00:24:43.839 --> 00:24:47.639 official exchange rate. You can get 00:24:45.440 --> 00:24:48.840 three times that in the in the blue 00:24:47.640 --> 00:24:50.040 market. 00:24:48.839 --> 00:24:51.279 They don't call it the black market. 00:24:50.039 --> 00:24:53.920 It's Since everyone does it, I think 00:24:51.279 --> 00:24:55.519 it's blue is fine. But but so there are 00:24:53.920 --> 00:24:56.279 all sorts of exchange rates. 00:24:55.519 --> 00:24:58.200 Uh, 00:24:56.279 --> 00:25:00.200 and but it's still This is the official 00:24:58.200 --> 00:25:03.160 one. And even the official one you see 00:25:00.200 --> 00:25:05.240 sort of has completely exploded. 00:25:03.160 --> 00:25:06.840 The Turkish lira looks pretty good here 00:25:05.240 --> 00:25:08.519 just because I put it next to Argentina 00:25:06.839 --> 00:25:10.039 the Argentinian peso. Otherwise, it also 00:25:08.519 --> 00:25:12.000 would look pretty bad. 00:25:10.039 --> 00:25:13.519 Okay? But most of the these countries 00:25:12.000 --> 00:25:15.279 are all the time pegging the exchange 00:25:13.519 --> 00:25:17.599 rate because they use that to stabilize 00:25:15.279 --> 00:25:19.639 inflation, the whole thing breaks up, 00:25:17.599 --> 00:25:20.959 and then they boom, they go through big 00:25:19.640 --> 00:25:22.320 spikes. You see this one here. They're 00:25:20.960 --> 00:25:23.360 trying to stabilize. There you see that 00:25:22.319 --> 00:25:24.960 they're trying to stabilize the 00:25:23.359 --> 00:25:26.678 currency. 00:25:24.960 --> 00:25:28.039 They're not floating there in that 00:25:26.679 --> 00:25:31.480 range. 00:25:28.039 --> 00:25:33.200 And they were a little successful and 00:25:31.480 --> 00:25:35.559 And and and and that's happens all the 00:25:33.200 --> 00:25:35.559 time to them. 00:25:36.000 --> 00:25:40.839 And now obviously, 00:25:38.160 --> 00:25:42.120 I mean, look at this the size of this. 00:25:40.839 --> 00:25:43.480 This is an appreciation of the dollar 00:25:42.119 --> 00:25:45.000 relative So, it's a depreciation of the 00:25:43.480 --> 00:25:48.200 Argentinian peso. 00:25:45.000 --> 00:25:48.200 What do you think is happening here? 00:25:49.480 --> 00:25:52.679 Looks very smooth, by the way. 00:25:51.440 --> 00:25:55.160 It's not that it's moving around. It's 00:25:52.679 --> 00:25:55.160 just 00:25:55.559 --> 00:25:58.480 What do you think is happening? 00:26:01.519 --> 00:26:04.519 Very high inflation in the thousands, 00:26:03.640 --> 00:26:05.840 you know? 00:26:04.519 --> 00:26:08.200 And that's what that's what is happening 00:26:05.839 --> 00:26:10.159 here. But but again, this is a hybrid 00:26:08.200 --> 00:26:12.200 system. They They try to stabilize 00:26:10.160 --> 00:26:13.960 frequently the exchange rate. The thing 00:26:12.200 --> 00:26:15.600 goes and then they stabilize it again 00:26:13.960 --> 00:26:17.200 and and so on and so forth. But you 00:26:15.599 --> 00:26:18.599 can't fight 00:26:17.200 --> 00:26:19.679 just having much higher inflation than 00:26:18.599 --> 00:26:21.559 the rest of the world. You have higher 00:26:19.679 --> 00:26:22.440 inflation, then there's no way around 00:26:21.559 --> 00:26:24.440 that your currency is going to 00:26:22.440 --> 00:26:27.039 depreciate. They try to, 00:26:24.440 --> 00:26:27.039 but they can't. 00:26:27.200 --> 00:26:31.000 Anyways, 00:26:28.839 --> 00:26:31.000 uh, 00:26:31.160 --> 00:26:35.040 so let me let me go back to this model 00:26:32.960 --> 00:26:37.519 and and and and think a little bit more 00:26:35.039 --> 00:26:38.879 about the decision to 00:26:37.519 --> 00:26:40.720 have one kind of exchange rate or the 00:26:38.880 --> 00:26:42.440 other one and therefore everything that 00:26:40.720 --> 00:26:44.120 goes in between. 00:26:42.440 --> 00:26:46.200 So, remember I just to remind you that's 00:26:44.119 --> 00:26:48.079 that's the model we have. 00:26:46.200 --> 00:26:49.960 Um, 00:26:48.079 --> 00:26:51.720 so let me think about policy first and 00:26:49.960 --> 00:26:53.679 then then let's think how 00:26:51.720 --> 00:26:55.600 how how do you deal with policy in the 00:26:53.679 --> 00:26:56.840 different exchange rate regimes. 00:26:55.599 --> 00:26:59.480 And and then we'll see why would 00:26:56.839 --> 00:27:01.039 countries would want thing or the other. 00:26:59.480 --> 00:27:02.839 So, suppose a country's in a recession. 00:27:01.039 --> 00:27:04.159 We're in this model. 00:27:02.839 --> 00:27:06.199 Uh, 00:27:04.160 --> 00:27:08.080 and suppose that we are in the flexible 00:27:06.200 --> 00:27:10.279 exchange rate regime. 00:27:08.079 --> 00:27:11.079 So, what should the fis- fiscal policy 00:27:10.279 --> 00:27:13.240 do? 00:27:11.079 --> 00:27:15.119 Suppose you're in a recession. 00:27:13.240 --> 00:27:17.359 What what should fiscal fiscal policy 00:27:15.119 --> 00:27:17.359 do? 00:27:18.880 --> 00:27:21.960 There's nothing unique of closed economy 00:27:20.799 --> 00:27:22.799 here. 00:27:21.960 --> 00:27:24.360 You know, 00:27:22.799 --> 00:27:25.839 of open economy. In closed economy you 00:27:24.359 --> 00:27:27.240 would have given me the same answer. 00:27:25.839 --> 00:27:29.759 You're in a recession, what will you do 00:27:27.240 --> 00:27:31.120 with fiscal policy? 00:27:29.759 --> 00:27:33.640 Have expansionary fiscal policy. 00:27:31.119 --> 00:27:35.359 Increase G. So, that means you move the 00:27:33.640 --> 00:27:36.960 IS to the right. 00:27:35.359 --> 00:27:38.719 Nothing changes in the open economy. You 00:27:36.960 --> 00:27:39.920 keep doing that. 00:27:38.720 --> 00:27:41.799 The only thing that you get is a little 00:27:39.920 --> 00:27:43.480 smaller multiplier because part of that 00:27:41.799 --> 00:27:45.440 will go to imports. 00:27:43.480 --> 00:27:47.240 But but it still it moves in the right 00:27:45.440 --> 00:27:49.279 direction. Okay? 00:27:47.240 --> 00:27:50.720 And and and yes, if countries rely on 00:27:49.279 --> 00:27:52.839 other countries doing also their own 00:27:50.720 --> 00:27:54.120 expansionary fiscal policy, but suppose 00:27:52.839 --> 00:27:55.919 we're talking about a recession that is 00:27:54.119 --> 00:27:57.479 unique to this country. Then you're 00:27:55.920 --> 00:27:59.080 going to do an expansionary fiscal 00:27:57.480 --> 00:28:02.400 policy. 00:27:59.079 --> 00:28:02.399 What would the central bank do? 00:28:02.960 --> 00:28:06.279 In closed economy. 00:28:04.839 --> 00:28:07.959 What? 00:28:06.279 --> 00:28:09.960 Drop interest rate. Well, in open 00:28:07.960 --> 00:28:12.200 economy does the same. 00:28:09.960 --> 00:28:13.720 You you just drop interest rate. 00:28:12.200 --> 00:28:15.240 It turns out that that will depreciate 00:28:13.720 --> 00:28:15.839 your currency, 00:28:15.240 --> 00:28:17.679 uh, 00:28:15.839 --> 00:28:19.199 which will help you 00:28:17.679 --> 00:28:20.720 as well. So, it's very expansionary 00:28:19.200 --> 00:28:22.480 because of that. You know, because it 00:28:20.720 --> 00:28:24.480 your currency depreciates, so net export 00:28:22.480 --> 00:28:26.960 goes up as a result of that. So, you get 00:28:24.480 --> 00:28:28.880 the investment kick. You lose a little 00:28:26.960 --> 00:28:31.120 bit because part of it goes to import, 00:28:28.880 --> 00:28:32.640 but then you also get the effect of net 00:28:31.119 --> 00:28:33.799 exports that come from the exchange 00:28:32.640 --> 00:28:36.200 rate. Okay? 00:28:33.799 --> 00:28:37.839 So, monetary policy is a great policy 00:28:36.200 --> 00:28:40.159 in open economy because it gets 00:28:37.839 --> 00:28:41.720 reinforced by the exchange rate. 00:28:40.159 --> 00:28:44.280 It's even better than fiscal other 00:28:41.720 --> 00:28:46.600 things equal when you compare the two. 00:28:44.279 --> 00:28:48.039 The two policies lose power relative to 00:28:46.599 --> 00:28:49.839 the closed economy because the 00:28:48.039 --> 00:28:51.839 multiplier is smaller. 00:28:49.839 --> 00:28:53.399 But the difference is that the interest 00:28:51.839 --> 00:28:54.480 rate policy gets the extra kick that 00:28:53.400 --> 00:28:55.600 comes from the depreciation of the 00:28:54.480 --> 00:28:59.159 currency. 00:28:55.599 --> 00:28:59.158 Okay? So, it's a very powerful tool. 00:29:00.039 --> 00:29:03.599 Okay. 00:29:02.359 --> 00:29:04.719 So, that's what you would do if you have 00:29:03.599 --> 00:29:07.279 a 00:29:04.720 --> 00:29:09.759 uh, flexible exchange rate. 00:29:07.279 --> 00:29:11.960 And that's what countries do in practice 00:29:09.759 --> 00:29:13.480 when they are free floaters. 00:29:11.960 --> 00:29:14.960 Suppose you have a fixed exchange rate 00:29:13.480 --> 00:29:16.360 regime. 00:29:14.960 --> 00:29:17.960 Okay? 00:29:16.359 --> 00:29:19.399 So, and it's a credible fixed exchange 00:29:17.960 --> 00:29:21.600 rate regime. 00:29:19.400 --> 00:29:23.240 Then I asked you again the question. 00:29:21.599 --> 00:29:24.879 What 00:29:23.240 --> 00:29:27.759 uh, what kind of fiscal policy would you 00:29:24.880 --> 00:29:27.760 run in that country? 00:29:29.279 --> 00:29:32.319 The same. 00:29:30.359 --> 00:29:34.719 Expansionary. That's what you would do. 00:29:32.319 --> 00:29:36.240 And it's effective as it was in closed 00:29:34.720 --> 00:29:38.679 economy. A little less because the 00:29:36.240 --> 00:29:41.000 multiplier is a little less. That's it. 00:29:38.679 --> 00:29:42.560 But no difference in the analysis. 00:29:41.000 --> 00:29:43.919 In fact, 00:29:42.559 --> 00:29:45.918 fiscal policy has exactly the same 00:29:43.919 --> 00:29:47.320 effect as as as fiscal policy in the 00:29:45.919 --> 00:29:48.520 flexible exchange rate in this case 00:29:47.319 --> 00:29:50.279 because I haven't moved the exchange 00:29:48.519 --> 00:29:52.400 rate in any event in either of the two 00:29:50.279 --> 00:29:55.920 cases. Okay? 00:29:52.400 --> 00:29:55.920 What should the central bank do? 00:29:58.200 --> 00:30:01.319 That's a tricky question. 00:30:05.440 --> 00:30:09.600 Hm? Yes, if the central bank knows. So, 00:30:07.519 --> 00:30:11.119 it would have to match. Yeah, exactly. 00:30:09.599 --> 00:30:12.559 Uh so, the central bank cannot do 00:30:11.119 --> 00:30:14.079 anything. I'm saying suppose this is a 00:30:12.559 --> 00:30:15.759 neo-Keynesian recession. This country's 00:30:14.079 --> 00:30:18.199 in recession. 00:30:15.759 --> 00:30:21.319 Now, now it wants to use its policy 00:30:18.200 --> 00:30:23.240 tools to deal with that. It has fiscal, 00:30:21.319 --> 00:30:24.359 but it doesn't have monetary policy. 00:30:23.240 --> 00:30:26.359 Unless 00:30:24.359 --> 00:30:27.919 the cycle of the other country coincides 00:30:26.359 --> 00:30:30.319 with your cycle. So, if it's a global 00:30:27.920 --> 00:30:31.279 recession or something like that, then 00:30:30.319 --> 00:30:32.599 then you're doomed because the other 00:30:31.279 --> 00:30:34.519 country's doing the monetary policy for 00:30:32.599 --> 00:30:36.519 what they're doing, what they need, not 00:30:34.519 --> 00:30:37.839 for what you need. And therefore, you 00:30:36.519 --> 00:30:40.319 don't have monetary policy. So, that's a 00:30:37.839 --> 00:30:42.000 costly thing of a fixed exchange rate. 00:30:40.319 --> 00:30:43.519 We already said it, but you now we're 00:30:42.000 --> 00:30:45.039 making it very concrete because we are 00:30:43.519 --> 00:30:46.680 in a recession, 00:30:45.039 --> 00:30:48.359 and you realize now that you don't have 00:30:46.680 --> 00:30:49.120 a tool that you had before. 00:30:48.359 --> 00:30:50.599 Okay? 00:30:49.119 --> 00:30:54.079 So, that's a cost 00:30:50.599 --> 00:30:54.079 of a fixed exchange rate. 00:30:54.400 --> 00:30:57.480 Here's an example. Uh here what I'm 00:30:56.319 --> 00:31:01.200 plotting 00:30:57.480 --> 00:31:02.920 is the the policy rate in the US. 00:31:01.200 --> 00:31:04.720 That's the blue one. 00:31:02.920 --> 00:31:05.880 And that's the policy rate in Hong Kong. 00:31:04.720 --> 00:31:06.880 There's a small difference, but you can 00:31:05.880 --> 00:31:08.640 see that the 00:31:06.880 --> 00:31:10.120 These are technical things. But you can 00:31:08.640 --> 00:31:12.640 see that that Hong Kong has to follow 00:31:10.119 --> 00:31:14.319 the US essentially. It's exactly the 00:31:12.640 --> 00:31:16.800 same shape. 00:31:14.319 --> 00:31:18.119 So, Hong Kong doesn't have independent 00:31:16.799 --> 00:31:19.000 policy. 00:31:18.119 --> 00:31:20.639 Okay? 00:31:19.000 --> 00:31:22.319 It Again, those are technical gaps. 00:31:20.640 --> 00:31:24.080 They're not really 00:31:22.319 --> 00:31:26.480 But just look at the shape. It's exactly 00:31:24.079 --> 00:31:28.480 the same, moving around. So, Hong Kong 00:31:26.480 --> 00:31:30.200 doesn't have monetary policy. 00:31:28.480 --> 00:31:31.480 Period. 00:31:30.200 --> 00:31:32.759 Not something they have. So, if they get 00:31:31.480 --> 00:31:33.960 a recession that has to do with their 00:31:32.759 --> 00:31:35.599 own cycle, 00:31:33.960 --> 00:31:37.400 and that is not a result of something 00:31:35.599 --> 00:31:39.000 that's happening in the US, 00:31:37.400 --> 00:31:41.360 they don't have that that tool to deal 00:31:39.000 --> 00:31:41.359 with that. 00:31:41.680 --> 00:31:45.920 Of course, during COVID and and during 00:31:43.759 --> 00:31:47.599 the global financial crisis, they were 00:31:45.920 --> 00:31:48.600 aligned. So, they you know, 00:31:47.599 --> 00:31:50.319 they would have moved it in the same 00:31:48.599 --> 00:31:51.959 direction. That worked. 00:31:50.319 --> 00:31:53.879 But if there's a shock that is 00:31:51.960 --> 00:31:55.120 Chinese-centric, that is affecting Hong 00:31:53.880 --> 00:31:56.560 Kong, 00:31:55.119 --> 00:31:58.319 the US monetary policy is not going to 00:31:56.559 --> 00:32:00.559 react to that. 00:31:58.319 --> 00:32:01.839 And that that's a problem for Hong Kong 00:32:00.559 --> 00:32:03.519 Hong Kong. 00:32:01.839 --> 00:32:06.159 And still, they choose to do it. And the 00:32:03.519 --> 00:32:07.960 good question is why? 00:32:06.160 --> 00:32:09.279 Always there's politics that is more 00:32:07.960 --> 00:32:11.120 than than the kind of thing, but there 00:32:09.279 --> 00:32:13.839 are also economic arguments for why you 00:32:11.119 --> 00:32:16.599 may want to do these things. 00:32:13.839 --> 00:32:18.559 Another situation that I mentioned 00:32:16.599 --> 00:32:20.359 happens all the time every other day in 00:32:18.559 --> 00:32:22.039 Argentina, for example, 00:32:20.359 --> 00:32:23.519 is speculative attacks on the currency. 00:32:22.039 --> 00:32:25.480 So, you want to have a fixed exchange 00:32:23.519 --> 00:32:26.679 rate, but the markets don't believe you 00:32:25.480 --> 00:32:27.880 that you're going to be able to keep it 00:32:26.679 --> 00:32:29.720 there. 00:32:27.880 --> 00:32:31.200 And uh 00:32:29.720 --> 00:32:33.799 And so, what happens? So, look at this 00:32:31.200 --> 00:32:36.120 equation here. Suppose that that 00:32:33.799 --> 00:32:37.319 that you have a fixed exchange rate, but 00:32:36.119 --> 00:32:39.359 now the markets think you're not going 00:32:37.319 --> 00:32:40.319 to be able to sustain it. 00:32:39.359 --> 00:32:42.479 Okay? 00:32:40.319 --> 00:32:44.079 So, that means suppose that this guy is 00:32:42.480 --> 00:32:45.519 just going down. 00:32:44.079 --> 00:32:47.319 That happens again in Argentina every 00:32:45.519 --> 00:32:49.440 other day. 00:32:47.319 --> 00:32:50.759 Probably today, every single day. No? 00:32:49.440 --> 00:32:52.200 They want to say that they want to sign 00:32:50.759 --> 00:32:53.359 the exchange rate, but the markets don't 00:32:52.200 --> 00:32:56.120 believe you, and they expect your 00:32:53.359 --> 00:32:58.599 currency to lose value in the next few 00:32:56.119 --> 00:33:01.799 hours in the case of Argentina. 00:32:58.599 --> 00:33:01.799 So, this guy is going down. 00:33:03.000 --> 00:33:06.359 What happens to the current to the to 00:33:04.679 --> 00:33:08.560 the current exchange rate? So, expected 00:33:06.359 --> 00:33:10.240 exchange rate goes down. Big 00:33:08.559 --> 00:33:12.839 The The everyone expects your currency 00:33:10.240 --> 00:33:12.839 to drop. 00:33:13.640 --> 00:33:17.200 What What will tend to happen to 00:33:16.039 --> 00:33:18.678 the 00:33:17.200 --> 00:33:21.799 currency today? 00:33:18.679 --> 00:33:21.800 To the Argentinian peso today? 00:33:23.519 --> 00:33:28.679 It drops, but you have a fixed exchange 00:33:25.319 --> 00:33:30.359 rate, you can't let it drop. 00:33:28.679 --> 00:33:32.120 I I'm So, if you're going to maintain an 00:33:30.359 --> 00:33:33.439 exchange a fixed exchange rate, and now 00:33:32.119 --> 00:33:35.319 you have a speculative attack, people 00:33:33.440 --> 00:33:36.960 think your currency is going to drop, 00:33:35.319 --> 00:33:39.079 and you want to maintain your peg, 00:33:36.960 --> 00:33:41.160 that's called defending the peg. If you 00:33:39.079 --> 00:33:42.879 want to defend the peg, then the only 00:33:41.160 --> 00:33:44.440 option you have if this guy is dropping 00:33:42.880 --> 00:33:46.440 to keep the exchange rate is to raise 00:33:44.440 --> 00:33:47.920 interest rates a lot. 00:33:46.440 --> 00:33:49.759 That's the way you fight the main way 00:33:47.920 --> 00:33:52.240 you fight it. I mean, you fight it by 00:33:49.759 --> 00:33:54.160 closing capital accounts and so on, but 00:33:52.240 --> 00:33:56.519 that's the last resort. You first try to 00:33:54.160 --> 00:33:58.360 fight it with monetary policy. So, if 00:33:56.519 --> 00:34:00.599 this thing is dropping, you fight it by 00:33:58.359 --> 00:34:01.839 increasing interest rate a lot. 00:34:00.599 --> 00:34:03.199 And that's the way you stabilize the 00:34:01.839 --> 00:34:04.559 currency. 00:34:03.200 --> 00:34:06.559 But what happens when you raise interest 00:34:04.559 --> 00:34:08.559 rate a lot to defend the parity, the 00:34:06.559 --> 00:34:11.519 peg? 00:34:08.559 --> 00:34:11.519 What is the problem of that? 00:34:17.878 --> 00:34:21.839 Yeah, you generate a domestic recession. 00:34:19.960 --> 00:34:23.480 Okay? Because just to defend your 00:34:21.840 --> 00:34:25.760 currency, your peg, 00:34:23.480 --> 00:34:26.480 you had to raise interest rate a lot. 00:34:25.760 --> 00:34:27.240 No? 00:34:26.480 --> 00:34:29.480 So, it means you're going to have a 00:34:27.239 --> 00:34:31.559 recession at home. 00:34:29.480 --> 00:34:31.559 Okay? 00:34:31.639 --> 00:34:34.319 So, that's another problem of fixed 00:34:32.960 --> 00:34:37.159 exchange. It's a problem That's not a 00:34:34.320 --> 00:34:38.480 problem for Hong Kong. It was in 1997. 00:34:37.159 --> 00:34:40.480 They did have a speculative attack 00:34:38.480 --> 00:34:42.480 despite the fact that they had 00:34:40.480 --> 00:34:44.800 twice the number of reserves relative to 00:34:42.480 --> 00:34:46.159 their money base, but still they had 00:34:44.800 --> 00:34:47.960 speculative problem there. But it rarely 00:34:46.159 --> 00:34:51.119 happens in Hong Kong. In Argentina, 00:34:47.960 --> 00:34:52.840 again, every other day, but but in 00:34:51.119 --> 00:34:55.358 same in Turkey. 00:34:52.840 --> 00:34:56.960 In Turkey, it's every 15 days, but but 00:34:55.358 --> 00:34:59.960 but 00:34:56.960 --> 00:35:01.800 but it's happening all the time. 00:34:59.960 --> 00:35:02.679 So, that's a problem as well, because if 00:35:01.800 --> 00:35:04.800 you have 00:35:02.679 --> 00:35:06.119 to spend a lot of energy defending your 00:35:04.800 --> 00:35:08.800 peg, then you're going to be causing 00:35:06.119 --> 00:35:12.599 lots of recessions at home just to 00:35:08.800 --> 00:35:12.600 stabilize the currency. Okay? 00:35:13.400 --> 00:35:16.840 That's That's bigger economies. They 00:35:15.079 --> 00:35:19.400 were okay. Well, Argentina, Turkey, and 00:35:16.840 --> 00:35:21.920 so on, no? But these are 00:35:19.400 --> 00:35:23.000 bigger boys, no? Here we have a 00:35:21.920 --> 00:35:25.119 a 00:35:23.000 --> 00:35:26.480 This is the ERM crisis. So, before the 00:35:25.119 --> 00:35:27.279 euro, 00:35:26.480 --> 00:35:30.039 uh 00:35:27.280 --> 00:35:30.760 more or less the Eurozone plus the UK 00:35:30.039 --> 00:35:33.559 uh 00:35:30.760 --> 00:35:37.080 had a system called the ERM. 00:35:33.559 --> 00:35:40.239 The EM EMS ERM ERM is the Well, anyway. 00:35:37.079 --> 00:35:42.719 EMS is European Monetary System. ERM is 00:35:40.239 --> 00:35:45.399 Exchange Rate Mechanism or something 00:35:42.719 --> 00:35:46.879 like that. And they're both linked. But 00:35:45.400 --> 00:35:49.160 let's call it the 00:35:46.880 --> 00:35:52.240 European Monetary System. And the basic 00:35:49.159 --> 00:35:54.839 idea of the European Monetary System 00:35:52.239 --> 00:35:56.439 was that that 00:35:54.840 --> 00:35:58.519 they behave very much like Singapore 00:35:56.440 --> 00:36:00.440 with respect to each other. Meaning, 00:35:58.519 --> 00:36:03.639 they allow themselves to 00:36:00.440 --> 00:36:05.960 move around, but only in narrow bands. 00:36:03.639 --> 00:36:08.960 The The countries that had the more 00:36:05.960 --> 00:36:08.960 stable 00:36:09.079 --> 00:36:12.719 domestic monetary position, like France 00:36:11.559 --> 00:36:15.119 vis-à-vis the 00:36:12.719 --> 00:36:18.239 Germany, the Deutschmark, and the French 00:36:15.119 --> 00:36:20.719 franc, but they had these bands of 2 and 00:36:18.239 --> 00:36:22.319 1/2% up and down, and they moved within 00:36:20.719 --> 00:36:24.358 those those ranges. They didn't have a 00:36:22.320 --> 00:36:26.359 full peg, but they allowed themselves to 00:36:24.358 --> 00:36:27.960 move a little bit. Portugal, which it 00:36:26.358 --> 00:36:30.000 was a little bit had a little bit less 00:36:27.960 --> 00:36:32.400 discipline, they had 5% for each side 00:36:30.000 --> 00:36:34.800 and stuff like that. But the point is, 00:36:32.400 --> 00:36:36.599 they would have narrow bands. Okay? And 00:36:34.800 --> 00:36:38.160 they moved around in those narrow bands, 00:36:36.599 --> 00:36:39.279 and they kept their 00:36:38.159 --> 00:36:41.119 uh 00:36:39.280 --> 00:36:43.720 kept it for quite a while 00:36:41.119 --> 00:36:46.480 before the euro. 00:36:43.719 --> 00:36:49.439 Now, here the whole system came under a 00:36:46.480 --> 00:36:49.440 speculative attack. 00:36:50.199 --> 00:36:56.199 What happened around there? 00:36:52.280 --> 00:36:56.200 You You probably have no idea. 00:36:58.280 --> 00:37:04.720 Well, it's really linked to that, yes. 00:37:02.199 --> 00:37:06.159 Yeah. It's the German re- reunification. 00:37:04.719 --> 00:37:07.679 So, what happened is 00:37:06.159 --> 00:37:10.679 when 00:37:07.679 --> 00:37:12.039 East Germany and and West Germany unify, 00:37:10.679 --> 00:37:13.919 they had to have a massive fiscal 00:37:12.039 --> 00:37:15.039 policy, massive expansionary fiscal 00:37:13.920 --> 00:37:17.680 policy. 00:37:15.039 --> 00:37:20.800 And that big expansion put lots of 00:37:17.679 --> 00:37:22.679 upward pressure on the on on on 00:37:20.800 --> 00:37:25.640 on German interest rates. 00:37:22.679 --> 00:37:27.519 And And that led to big appreciations 00:37:25.639 --> 00:37:28.920 uh of the Deutschmark. 00:37:27.519 --> 00:37:30.519 And And the other countries tried to 00:37:28.920 --> 00:37:32.240 fight it because they had to be in this 00:37:30.519 --> 00:37:33.320 very narrow band. 00:37:32.239 --> 00:37:35.239 But they were experiencing these big 00:37:33.320 --> 00:37:36.760 speculative attacks. 00:37:35.239 --> 00:37:38.358 And so, they had to raise their interest 00:37:36.760 --> 00:37:39.120 rate enormously. 00:37:38.358 --> 00:37:40.639 Uh 00:37:39.119 --> 00:37:42.079 the UK tried to do it for a while, and 00:37:40.639 --> 00:37:44.199 they essentially said, "I we give up." 00:37:42.079 --> 00:37:45.480 And then they they they they abandoned 00:37:44.199 --> 00:37:47.279 the the system. 00:37:45.480 --> 00:37:49.199 The French tried to stay in there for 00:37:47.280 --> 00:37:50.280 quite a bit. Okay? You can see the 00:37:49.199 --> 00:37:51.559 French franc. They didn't move. They 00:37:50.280 --> 00:37:53.280 didn't move. 00:37:51.559 --> 00:37:54.759 But it was extremely costly for them 00:37:53.280 --> 00:37:56.680 because the interest rate has to go up a 00:37:54.760 --> 00:37:58.440 lot, and sort of like got into a big 00:37:56.679 --> 00:38:00.319 recession and so on. Eventually, the 00:37:58.440 --> 00:38:02.760 whole system broke up broke down. I 00:38:00.320 --> 00:38:05.200 mean, everyone left. And eventually, 00:38:02.760 --> 00:38:06.640 they rejoined, but now in the euro. And 00:38:05.199 --> 00:38:08.839 the euro is a little different because 00:38:06.639 --> 00:38:11.000 in the euro, you give up There's no 00:38:08.840 --> 00:38:13.559 space for the speculative attacks 00:38:11.000 --> 00:38:14.400 because there's a single currency. 00:38:13.559 --> 00:38:15.880 Okay? 00:38:14.400 --> 00:38:17.000 So, that's the that's the most extreme 00:38:15.880 --> 00:38:18.880 form. 00:38:17.000 --> 00:38:20.960 Speculative attacks nowadays in Europe 00:38:18.880 --> 00:38:22.640 happen through different means. It's 00:38:20.960 --> 00:38:24.000 It's It's the 00:38:22.639 --> 00:38:24.839 Well, anyways, let me not get into that 00:38:24.000 --> 00:38:26.358 for 00:38:24.840 --> 00:38:28.240 But but 00:38:26.358 --> 00:38:29.519 But here you have So, what I'm saying, 00:38:28.239 --> 00:38:31.479 having a fixed exchange rate is not 00:38:29.519 --> 00:38:33.159 easy, even for countries that have sort 00:38:31.480 --> 00:38:37.240 of very well-developed financial 00:38:33.159 --> 00:38:37.239 markets, and so on and so forth. 00:38:37.679 --> 00:38:41.480 Now, it would seem, 00:38:39.519 --> 00:38:42.519 given all that I said, 00:38:41.480 --> 00:38:43.599 that 00:38:42.519 --> 00:38:45.039 I mean, there's no reason to have a 00:38:43.599 --> 00:38:48.159 fixed exchange rate. It's something you 00:38:45.039 --> 00:38:49.320 you give up an an instrument, and on top 00:38:48.159 --> 00:38:50.719 of that, 00:38:49.320 --> 00:38:53.039 you're subject to speculative attacks 00:38:50.719 --> 00:38:55.159 all the time. Okay? Not all the time. 00:38:53.039 --> 00:38:57.199 Well, it depends on how bad you are. But 00:38:55.159 --> 00:38:59.358 but you know, you have to be very 00:38:57.199 --> 00:39:00.879 well-behaved because otherwise, you're 00:38:59.358 --> 00:39:01.799 subject to speculative attacks all the 00:39:00.880 --> 00:39:03.200 time. 00:39:01.800 --> 00:39:05.359 So, 00:39:03.199 --> 00:39:07.119 So, why not do flexible exchange rate? 00:39:05.358 --> 00:39:08.358 Why Why What is wrong with flexible 00:39:07.119 --> 00:39:10.039 exchange rate? 00:39:08.358 --> 00:39:11.920 Well, I think the main problem of 00:39:10.039 --> 00:39:13.759 flexible exchange rate 00:39:11.920 --> 00:39:15.240 is that it tends to move a lot. 00:39:13.760 --> 00:39:17.040 I mean, we know that it moves a lot more 00:39:15.239 --> 00:39:18.919 than fundamentals, meaning 00:39:17.039 --> 00:39:20.639 you know, productivity is a little 00:39:18.920 --> 00:39:21.920 higher in one country than the other, 00:39:20.639 --> 00:39:23.319 demand is a little higher in the other 00:39:21.920 --> 00:39:25.519 in the other country, but the exchange 00:39:23.320 --> 00:39:28.000 rate moves a lot more than those little 00:39:25.519 --> 00:39:29.800 differences justify. 00:39:28.000 --> 00:39:31.519 And the reason one way of understanding 00:39:29.800 --> 00:39:32.720 this is the following. 00:39:31.519 --> 00:39:34.358 And this it will serve as an 00:39:32.719 --> 00:39:36.199 introduction to the next topic of the 00:39:34.358 --> 00:39:37.719 course, which will be asset pricing and 00:39:36.199 --> 00:39:39.439 things like that. 00:39:37.719 --> 00:39:41.439 So, let's look at revisit our interest 00:39:39.440 --> 00:39:42.679 parity condition, but now let's not 00:39:41.440 --> 00:39:46.200 assume 00:39:42.679 --> 00:39:48.279 that that that the next the the the 00:39:46.199 --> 00:39:49.639 expected exchange rate is fixed. 00:39:48.280 --> 00:39:51.720 I mean, that was an assumption just to 00:39:49.639 --> 00:39:53.839 make our life simple, but but it it's 00:39:51.719 --> 00:39:56.399 not be. So, that's a that's a then 00:39:53.840 --> 00:39:58.720 covered interest rate condition is this. 00:39:56.400 --> 00:40:00.920 Well, you see, I can replace this guy 00:39:58.719 --> 00:40:02.719 here for what will happen next period. 00:40:00.920 --> 00:40:04.360 It's the same thing shifted by a period 00:40:02.719 --> 00:40:07.519 with an expectation there. 00:40:04.360 --> 00:40:09.559 So, ET + 1 expected, this guy here is 00:40:07.519 --> 00:40:12.239 equal to 1 + 00:40:09.559 --> 00:40:13.480 expected domestic interest rate 1 period 00:40:12.239 --> 00:40:15.639 from now 00:40:13.480 --> 00:40:17.480 divided by 1 + international interest 00:40:15.639 --> 00:40:20.039 rate expected 1 period from now 00:40:17.480 --> 00:40:20.880 times the expected exchange rate for T + 00:40:20.039 --> 00:40:22.320 2 00:40:20.880 --> 00:40:23.840 2 years from now. 00:40:22.320 --> 00:40:25.600 And I can keep doing this. I can replace 00:40:23.840 --> 00:40:27.680 this by something equivalent to that 00:40:25.599 --> 00:40:29.679 with all the sub index shifted by 1 00:40:27.679 --> 00:40:30.879 year, blah blah blah blah blah blah. 00:40:29.679 --> 00:40:32.399 And so, I can end up writing this 00:40:30.880 --> 00:40:33.599 exchange rate 00:40:32.400 --> 00:40:35.639 as 00:40:33.599 --> 00:40:37.400 this product of lots of things that can 00:40:35.639 --> 00:40:38.839 happen in the future. The the monetary 00:40:37.400 --> 00:40:41.119 policy path 00:40:38.840 --> 00:40:43.280 at home, the monetary policy path, not 00:40:41.119 --> 00:40:44.279 the next period, the path for years to 00:40:43.280 --> 00:40:45.920 come 00:40:44.280 --> 00:40:47.880 of 00:40:45.920 --> 00:40:49.440 monetary policy in the other country, 00:40:47.880 --> 00:40:51.599 and there's always an expected exchange 00:40:49.440 --> 00:40:55.360 rate at the end there 00:40:51.599 --> 00:40:57.159 that is free. It can move around. 00:40:55.360 --> 00:41:00.120 So, the problem of this exchange is that 00:40:57.159 --> 00:41:02.000 the future matters too much 00:41:00.119 --> 00:41:03.799 in a sense. And you know, people have 00:41:02.000 --> 00:41:05.400 lots of imagination, so 00:41:03.800 --> 00:41:07.039 all sorts of weird things they imagine. 00:41:05.400 --> 00:41:08.880 And and when you people have lots of 00:41:07.039 --> 00:41:10.759 imagination, then these things are 00:41:08.880 --> 00:41:12.640 moving a lot. And that's the reason do 00:41:10.760 --> 00:41:13.880 you see enormous fluctuations in nominal 00:41:12.639 --> 00:41:15.519 exchange rate. 00:41:13.880 --> 00:41:17.079 Now, 00:41:15.519 --> 00:41:18.800 uh 00:41:17.079 --> 00:41:20.239 And that's the problem. It's a problem 00:41:18.800 --> 00:41:22.800 to have a very volatile exchange rate 00:41:20.239 --> 00:41:24.719 because it it makes transactions more 00:41:22.800 --> 00:41:26.039 difficult. I mean, you know, if you the 00:41:24.719 --> 00:41:27.279 price of things are ready price of 00:41:26.039 --> 00:41:29.400 things are changing all the time, it's a 00:41:27.280 --> 00:41:30.240 little bit more difficult to plan. 00:41:29.400 --> 00:41:31.840 Uh 00:41:30.239 --> 00:41:33.279 financial investments become more 00:41:31.840 --> 00:41:35.640 because you get all this exchange rate 00:41:33.280 --> 00:41:37.160 volatility in between. So, that's one of 00:41:35.639 --> 00:41:38.079 the main reasons 00:41:37.159 --> 00:41:41.119 uh 00:41:38.079 --> 00:41:42.679 you would prefer, if you could to have a 00:41:41.119 --> 00:41:44.239 more 00:41:42.679 --> 00:41:46.239 managed exchange rate. It's because you 00:41:44.239 --> 00:41:48.559 don't want this all this artificial 00:41:46.239 --> 00:41:50.959 volatility that comes from behavioral 00:41:48.559 --> 00:41:53.279 traits and things of that kind. Okay? 00:41:50.960 --> 00:41:54.960 That's the main reason. 00:41:53.280 --> 00:41:57.080 Uh 00:41:54.960 --> 00:41:58.480 Look at this example, for example. 00:41:57.079 --> 00:41:59.599 Example, for example, sorry about that. 00:41:58.480 --> 00:42:03.559 But 00:41:59.599 --> 00:42:06.360 this is Russia during the the the war. 00:42:03.559 --> 00:42:09.599 This was the the the the ruble, the the 00:42:06.360 --> 00:42:10.920 the the Russian currency. 00:42:09.599 --> 00:42:12.360 And 00:42:10.920 --> 00:42:13.559 when they invaded, of course, this thing 00:42:12.360 --> 00:42:16.120 collapsed. 00:42:13.559 --> 00:42:16.799 The currency collapsed. Okay? 00:42:16.119 --> 00:42:18.359 Uh 00:42:16.800 --> 00:42:20.519 this period is a is a little longer than 00:42:18.360 --> 00:42:21.840 you think, but but it collapsed for for 00:42:20.519 --> 00:42:23.239 quite a while. 00:42:21.840 --> 00:42:25.280 And then it recovered a lot, actually 00:42:23.239 --> 00:42:27.759 overshot and came down. 00:42:25.280 --> 00:42:29.560 So, this is not because the Central Bank 00:42:27.760 --> 00:42:31.920 said, you know, 00:42:29.559 --> 00:42:34.199 we're going to 00:42:31.920 --> 00:42:35.880 devalue the currency. It's just people 00:42:34.199 --> 00:42:37.399 said, "Wow, this a country going into 00:42:35.880 --> 00:42:38.440 war. It's going to be a mess, blah blah 00:42:37.400 --> 00:42:40.920 blah blah." 00:42:38.440 --> 00:42:43.079 So, all that future I talk about 00:42:40.920 --> 00:42:45.360 uh 00:42:43.079 --> 00:42:46.679 essentially destroyed the currency. 00:42:45.360 --> 00:42:48.720 Okay? 00:42:46.679 --> 00:42:50.639 Now, a lot of that recovery happened 00:42:48.719 --> 00:42:52.119 there not because people now 00:42:50.639 --> 00:42:53.719 began to see the future as a better 00:42:52.119 --> 00:42:54.960 future or anything like that. 00:42:53.719 --> 00:42:56.119 It's because 00:42:54.960 --> 00:42:58.320 they had to hike interest rate 00:42:56.119 --> 00:43:00.799 massively. They were around 4 or 5% and 00:42:58.320 --> 00:43:01.960 they had to go to 20% interest rate to 00:43:00.800 --> 00:43:03.920 defend the exchange rate. Remember I 00:43:01.960 --> 00:43:04.960 told you have a speculative attack and 00:43:03.920 --> 00:43:06.960 you have enormous pressure on your 00:43:04.960 --> 00:43:08.480 currency. Well, the main tool you have 00:43:06.960 --> 00:43:09.599 to offset that is to raise interest 00:43:08.480 --> 00:43:11.000 rate. 00:43:09.599 --> 00:43:12.519 They had they had interest rate 00:43:11.000 --> 00:43:14.320 massively. They did a lot of other 00:43:12.519 --> 00:43:16.039 things as well. They 00:43:14.320 --> 00:43:17.760 put capital controls and lots of things. 00:43:16.039 --> 00:43:19.559 But but but this was the main thing they 00:43:17.760 --> 00:43:21.440 did. And so, they dragged the recession 00:43:19.559 --> 00:43:23.360 the economy into recession for war 00:43:21.440 --> 00:43:25.200 related reasons and because of the 00:43:23.360 --> 00:43:25.960 monetary policy response they had to do 00:43:25.199 --> 00:43:28.119 with that. 00:43:25.960 --> 00:43:29.800 Okay? So, that's an extreme case of a 00:43:28.119 --> 00:43:32.839 war. But but that's the kind of things 00:43:29.800 --> 00:43:35.400 that can happen. Uh 00:43:32.840 --> 00:43:36.559 in in in in an in a floating exchange 00:43:35.400 --> 00:43:38.920 rate. 00:43:36.559 --> 00:43:41.079 Even when 00:43:38.920 --> 00:43:41.079 uh 00:43:41.679 --> 00:43:44.879 I mean, the main constraint in Argentina 00:43:43.519 --> 00:43:46.159 and Turkey and so on is reserves. They 00:43:44.880 --> 00:43:48.039 don't have enough reserves. So, if you 00:43:46.159 --> 00:43:50.319 have to defend your currency 00:43:48.039 --> 00:43:52.000 by intervening in the in the in the 00:43:50.320 --> 00:43:53.200 FX market 00:43:52.000 --> 00:43:54.880 if you don't have enough, then you're 00:43:53.199 --> 00:43:56.879 not credible. I mean, 00:43:54.880 --> 00:43:59.519 if you have massive capital outflows and 00:43:56.880 --> 00:44:01.079 you have a few billion dollars there, 00:43:59.519 --> 00:44:02.440 it's not going to work. 00:44:01.079 --> 00:44:04.119 That's not the case of Russia. They had 00:44:02.440 --> 00:44:05.880 massive amount of reserves. So, that 00:44:04.119 --> 00:44:07.319 that was not the issue. It was all about 00:44:05.880 --> 00:44:09.519 expectations of things that happen in 00:44:07.320 --> 00:44:13.519 the future. It was all about 00:44:09.519 --> 00:44:13.519 this kind of terms. Okay? 00:44:14.000 --> 00:44:18.199 Anyway, so so that added to the cost 00:44:16.679 --> 00:44:20.239 they had. 00:44:18.199 --> 00:44:22.159 So, 00:44:20.239 --> 00:44:23.399 so how do we choose these things then in 00:44:22.159 --> 00:44:24.759 practice? 00:44:23.400 --> 00:44:27.320 Again, there are lots of things and 00:44:24.760 --> 00:44:28.040 politics plays play role and so on. 00:44:27.320 --> 00:44:32.240 Uh 00:44:28.039 --> 00:44:33.759 but this this a case to so so again 00:44:32.239 --> 00:44:35.759 I would put it even the other way 00:44:33.760 --> 00:44:37.040 around. I think that if you could, you 00:44:35.760 --> 00:44:38.960 would like to have a fixed exchange 00:44:37.039 --> 00:44:40.320 rate. 00:44:38.960 --> 00:44:41.440 If you could, 00:44:40.320 --> 00:44:42.600 you would like to have a fixed exchange 00:44:41.440 --> 00:44:44.840 rate because then you remove all this 00:44:42.599 --> 00:44:46.639 spurious noise that happens every single 00:44:44.840 --> 00:44:49.440 day because of exchange rate volatility 00:44:46.639 --> 00:44:51.000 that complicates your life. 00:44:49.440 --> 00:44:53.358 Uh 00:44:51.000 --> 00:44:54.880 But so, when can you do that? 00:44:53.358 --> 00:44:56.480 Well, first, you can do it with respect 00:44:54.880 --> 00:44:59.119 to some other country 00:44:56.480 --> 00:45:00.480 where the shocks are very similar. 00:44:59.119 --> 00:45:03.159 You know, because 00:45:00.480 --> 00:45:05.480 you you know, if you know that that that 00:45:03.159 --> 00:45:06.920 say you're Mexico, but 00:45:05.480 --> 00:45:08.559 or the north of Mexico, something like 00:45:06.920 --> 00:45:10.480 that, and you know that all your shocks 00:45:08.559 --> 00:45:11.960 are really shocks to the US. 00:45:10.480 --> 00:45:13.039 Then the US can do the monetary policy 00:45:11.960 --> 00:45:14.240 for you. 00:45:13.039 --> 00:45:15.519 You know, because you have the same 00:45:14.239 --> 00:45:17.599 shocks. 00:45:15.519 --> 00:45:19.239 I'm exaggerating. So, if you're very 00:45:17.599 --> 00:45:20.880 similar 00:45:19.239 --> 00:45:22.399 then it makes sense to have a fixed 00:45:20.880 --> 00:45:23.680 exchange rate because why pay for all 00:45:22.400 --> 00:45:25.358 that volatility when you're going to be 00:45:23.679 --> 00:45:26.639 doing the same policies 00:45:25.358 --> 00:45:27.960 in both countries more or less at the 00:45:26.639 --> 00:45:29.199 same time because you're exposed to the 00:45:27.960 --> 00:45:30.880 same shocks. 00:45:29.199 --> 00:45:33.960 So, that's one thing. That's one reason 00:45:30.880 --> 00:45:35.280 why the Eurozone is a Eurozone because 00:45:33.960 --> 00:45:37.280 they're European countries that have 00:45:35.280 --> 00:45:38.519 very similar business cycles and so on. 00:45:37.280 --> 00:45:39.400 Germany is a little different. That's 00:45:38.519 --> 00:45:41.280 the reason they always have some 00:45:39.400 --> 00:45:43.358 problem. I mean, the north and the 00:45:41.280 --> 00:45:46.040 south, they're a little different. But 00:45:43.358 --> 00:45:50.039 but but they're much more similar 00:45:46.039 --> 00:45:50.039 than than other countries. Uh 00:45:50.639 --> 00:45:55.519 Uh so so that's that's what they have 00:45:53.320 --> 00:45:59.120 want. 00:45:55.519 --> 00:46:01.800 Another option is is is when you have 00:45:59.119 --> 00:46:02.960 lots of fiscal capacity. 00:46:01.800 --> 00:46:04.440 Because if you have lots of fiscal 00:46:02.960 --> 00:46:05.720 capacity, then the cost of not having 00:46:04.440 --> 00:46:06.920 monetary policy is not that large 00:46:05.719 --> 00:46:09.159 because you can fight your business 00:46:06.920 --> 00:46:10.358 cycle with fiscal policy. 00:46:09.159 --> 00:46:12.079 That's the case of Hong Kong, for 00:46:10.358 --> 00:46:13.639 example. Hong Kong 00:46:12.079 --> 00:46:14.920 Hong Kong, first of all, is not subject 00:46:13.639 --> 00:46:16.759 to speculative attack because they have 00:46:14.920 --> 00:46:18.480 massive amount of reserves. So, anyone 00:46:16.760 --> 00:46:21.359 that dares attacking them is going to 00:46:18.480 --> 00:46:22.480 lose their shirt. So, so they're safe. 00:46:21.358 --> 00:46:23.519 Uh 00:46:22.480 --> 00:46:25.119 uh 00:46:23.519 --> 00:46:26.880 Soros tried many years back and he 00:46:25.119 --> 00:46:28.279 didn't do as well as he did attacking 00:46:26.880 --> 00:46:29.000 the British pound. 00:46:28.280 --> 00:46:29.680 Uh 00:46:29.000 --> 00:46:32.039 um 00:46:29.679 --> 00:46:33.919 then then but they also have lots of 00:46:32.039 --> 00:46:35.519 fiscal resources, so they can 00:46:33.920 --> 00:46:37.440 fight their domestic recessions and so 00:46:35.519 --> 00:46:39.960 on with fiscal policy. 00:46:37.440 --> 00:46:41.119 The other factor, which also applies to 00:46:39.960 --> 00:46:43.440 Hong Kong 00:46:41.119 --> 00:46:45.319 if you have very flexible factor 00:46:43.440 --> 00:46:48.079 markets. So, if wages move very easily, 00:46:45.320 --> 00:46:50.000 if prices move very easily domestically 00:46:48.079 --> 00:46:51.840 then you don't care about 00:46:50.000 --> 00:46:53.358 having a fixed nominal exchange rate 00:46:51.840 --> 00:46:55.120 because a fixed nominal exchange rate is 00:46:53.358 --> 00:46:56.239 not the same as a fixed real exchange 00:46:55.119 --> 00:46:57.400 rate, which is what you really need to 00:46:56.239 --> 00:46:59.319 move around. 00:46:57.400 --> 00:47:00.519 If your prices are flexible 00:46:59.320 --> 00:47:01.640 doesn't matter that nominal exchange 00:47:00.519 --> 00:47:02.759 doesn't move because the prices are 00:47:01.639 --> 00:47:04.039 moving around. 00:47:02.760 --> 00:47:06.240 And so, you you still have lots of 00:47:04.039 --> 00:47:08.119 flexibility in the real exchange rate. 00:47:06.239 --> 00:47:09.639 And that's the reason I would say is one 00:47:08.119 --> 00:47:11.319 of the reasons uh political reasons as 00:47:09.639 --> 00:47:12.799 well, but but why they can afford it. 00:47:11.320 --> 00:47:13.920 Why I think in the case of Hong Kong 00:47:12.800 --> 00:47:15.560 it's the other way around. It was some 00:47:13.920 --> 00:47:18.280 political reasons 00:47:15.559 --> 00:47:20.039 uh and and and the and then they build a 00:47:18.280 --> 00:47:22.120 system so that 00:47:20.039 --> 00:47:24.400 is is a is a coherent system because 00:47:22.119 --> 00:47:26.358 they have lots of fiscal capacity, can 00:47:24.400 --> 00:47:29.680 defend the currency well 00:47:26.358 --> 00:47:29.679 and they have very flexible markets. 00:47:30.599 --> 00:47:32.759 Uh 00:47:33.519 --> 00:47:36.199 This is 00:47:34.480 --> 00:47:38.559 Well, this again, this is what I said 00:47:36.199 --> 00:47:40.519 before. If you if you 00:47:38.559 --> 00:47:42.000 if this is what I said before. If you if 00:47:40.519 --> 00:47:42.960 you have you don't like that noise. If 00:47:42.000 --> 00:47:45.239 you especially you're going to be 00:47:42.960 --> 00:47:46.639 trading a lot with people and so on. 00:47:45.239 --> 00:47:48.358 You know, 00:47:46.639 --> 00:47:50.400 in Europe, many people cross the border 00:47:48.358 --> 00:47:52.719 many times a day and then you want to go 00:47:50.400 --> 00:47:54.079 shopping one way or the other. It's a 00:47:52.719 --> 00:47:55.839 it's a pain if the exchange rate is 00:47:54.079 --> 00:47:57.639 moving all the time. You know? It's much 00:47:55.840 --> 00:47:59.079 easier if things are stable. And the 00:47:57.639 --> 00:48:00.839 same apply to financial transactions. 00:47:59.079 --> 00:48:02.239 People have deposits in different banks 00:48:00.840 --> 00:48:04.720 and stuff like that. 00:48:02.239 --> 00:48:06.399 It's it's better if you don't have all 00:48:04.719 --> 00:48:08.719 that fluctuation. And the case of the 00:48:06.400 --> 00:48:10.000 Euro area, they decided that 00:48:08.719 --> 00:48:11.399 uh 00:48:10.000 --> 00:48:13.079 that the advantage of having a very 00:48:11.400 --> 00:48:14.039 fixed exchange rate 00:48:13.079 --> 00:48:16.159 uh 00:48:14.039 --> 00:48:17.599 uh were more than the cost for 00:48:16.159 --> 00:48:20.239 individual countries of not having 00:48:17.599 --> 00:48:21.639 independent monetary policy. 00:48:20.239 --> 00:48:24.199 It's still a work in progress. They're 00:48:21.639 --> 00:48:26.559 building that is not finished. 00:48:24.199 --> 00:48:28.159 But but but they're working at it. 00:48:26.559 --> 00:48:30.440 The other reason why 00:48:28.159 --> 00:48:32.199 uh countries fix exchange rate 00:48:30.440 --> 00:48:33.159 uh and that's the Argentinian reason and 00:48:32.199 --> 00:48:35.919 so on 00:48:33.159 --> 00:48:37.199 is is when when they have no control in 00:48:35.920 --> 00:48:38.920 inflation. 00:48:37.199 --> 00:48:40.559 They have no credibility. 00:48:38.920 --> 00:48:42.840 And so, if you peg to another currency 00:48:40.559 --> 00:48:45.599 that has credibility, then the idea, the 00:48:42.840 --> 00:48:47.720 hope at least, is that you will inherit 00:48:45.599 --> 00:48:49.519 the credibility of the other currency. 00:48:47.719 --> 00:48:51.799 And that's what they tried to 00:48:49.519 --> 00:48:53.840 uh Ar- Argentina had a currency board 00:48:51.800 --> 00:48:56.400 like Hong Kong for a while. The whole 00:48:53.840 --> 00:48:58.240 idea was to control inflation. Well, 00:48:56.400 --> 00:49:00.920 let's peg to someone. 00:48:58.239 --> 00:49:02.439 Uh and and and if they if the markets 00:49:00.920 --> 00:49:04.200 believe you, then it will work because 00:49:02.440 --> 00:49:06.320 then you inherit the the credibility of 00:49:04.199 --> 00:49:07.439 the You're saying, when you take a fixed 00:49:06.320 --> 00:49:08.680 exchange rate, I'm not going to run 00:49:07.440 --> 00:49:10.119 monetary policy, which is the main 00:49:08.679 --> 00:49:11.079 source of inflation. 00:49:10.119 --> 00:49:13.319 So, I'm going to let the credible 00:49:11.079 --> 00:49:15.239 country run the monetary policy for me. 00:49:13.320 --> 00:49:16.960 That's what gives you credibility. 00:49:15.239 --> 00:49:18.559 As long as somebody believes that you're 00:49:16.960 --> 00:49:19.920 not going to 00:49:18.559 --> 00:49:21.679 quit the thing. 00:49:19.920 --> 00:49:24.039 But but but that's the reason countries 00:49:21.679 --> 00:49:25.000 do it, often to stabilize inflation as 00:49:24.039 --> 00:49:27.119 well. 00:49:25.000 --> 00:49:27.119 Okay.