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Fixed v Floating (Chap. 8) (key points (benefits for the home county from…
Fixed v Floating (Chap. 8)
base currency: countries in the ERM unilaterally pegging to the DM
asymmetric shock: country specific shock that is not shared by other countries, leads to policy conflicts
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, then the economic stabilization costs to home of fixing its exchange rate to the base are smaller. As economic similarity rises, the stability costs of having a fixed exchange rate decrease.)
fixed exchanged rates are not necessary to ensure good inflation, this can only be achieved with an exchange rate peg
in countries that can't borrow their own currency, fixed exchange rates are preferable to floating exchange rates
fear of floating: countries with lack of central bank independence, high liability with dollarization, etc are more likely to peg their currency
fixed exchange rate systems: complex arrangements that involve multiple countries
reserve currency system: system in which fixed exchange rates are based on
cooperative arrangements
1) based on mutual agreement between center and concenter countries in settling interest rates
2) based on mutual agreements about adjustments to the fixed exchange rate levels themselves
devaluation/revaluation: used in terms of pegs being adjusted
beggar-thy-neighbor policy: home can improve its position at the expense of and without the permission of the foreign country
gold standard: gold and money were interchangeable, value of gold and money was used as the measure of the money supply
relied on the principle of free convertibility: central banks on both counters bought and sold gold in exchange for paper money, and there was unrestricted global trade on gold
four relevant observations
arbitrage was not costless; if the exchange rate deviated slightly, there might be a loss
arbitrage works in opposite directions if E is above par, and if there is a depreciation relative to parity
interest arbitrage between two money markets equalizes the interest rates in each country, which brings in the trilemma
inherent symmetry of the gold standard when operated properly
key points
benefits for the home county from a fixed exchange rate: lower transaction costs, increased trade, investments, and migration with base/center country
costs to the home country from a fixed exchange rate: arise from different economic shocks, different monetary policies
symmetry-integration diagram: high levels above the FIX line means good to fix; low levels below the FIX line means good to float
may have extra benefits if fixed rates are the only nominal anchor in a high-inflation country