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AFTER ARGENTINA -WHAT NEXT FOR EXCHANGE RATES AND MONETARY POLICY IN THE AMERICAS

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					  AFTER ARGENTINA:WHAT NEXT FOR
EXCHANGE RATES AND MONETARY POLICY
         IN THE AMERICAS?

                                    Vivek Dehejia
                      Carleton University & CESifo
    Concepts



         What does economic theory have to say on choice
         of exchange rate/monetary policy regimes?
         Comparing different “monetary orders” (D.
         Laidler) -- monetary / exchange rate regimes,
         plus institutions/perceptions underlying
         Arguments for/against “fixed” vs. “flexible”
         exchange rates




2
    “Impossible Trinity”




            Open capital markets
            Achieving domestic macroeconomic goals (e.g.,
            price stability)
            Choice of exchange rate regime




3
    “Classic” Argument for Flexible Rates
    (Milton Friedman)



            By freeing monetary policy to pursue
            domestic policy goals (e.g., full
            employment, price stability), a flexible
            exchange rate can “insulate” or “buffer” the
            economy from external shocks
            Modern version: Inflation targeting is best
            for macro. stabilization (e.g., Dehejia/Rowe)




4
    Optimum Currency Areas (Robert Mundell)



           “Optimum currency area” is an economic
           region in which external shocks are largely
           synchronized.
           Flexible rates cannot insulate an economy
           composed of different regions
           Fiscal federalism can mitigate costs of
           adjustment




5
    Transaction Cost Argument



            R. Harris/T. Courchene suggest that
            exchange rate volatility can impede
            trade/investment flows
            Firms need to “hedge” against exchange rate
            risk
            Fixing exchange rate may thereby stimulate
            trade, investment, and economic growth




6
    Monetary/Trade areas facets of
    Economic Union


             EU example: customs union and common
             currency as part of large politico-economic
             integration
             NAMU to complement NAFTA?
             (Harris/Courchene)
             But: EU has common institutions, fiscal
             federalism, lacking in the Americas




7
    Political Economy Argument for Fixing



           In economies with poor monetary
           management, hyperinflation can result
           Fixing the exchange rate is a politico-
           economic mechanism for tying monetary
           policy (credibility, commitment)
           E.g., Dollarized Panama has US inflation
           rate




8
    Political Economy Argument against Fixing



           “All money is political” (R. Mundell)
           Fixing, esp. dollarization, perceived as loss of
           monetary “sovereignty”
           Dollarization implies also lack of political
           accountability (policy set in Washington) (D.
           Laidler)




9
 Fixing vs. Currency Board



        Fixed exchange rate prone to speculative
        attack (financial crisis), e.g., ERM in early
        1990s
        Currency board can be prone bank runs (e.g.,
        Argentina in 2000), loss of lender of last resort
        for central bank




10
 Dollarization vs. Currency Board



        Full dollarization has added
        credibility/commitment over fixing (e.g.,
        currency board)
        But, with dollarization you lose seigniorage,
        important for many developing countries




11
 A Second Best World



       In a world with 3 big currency zones ($, EUR,
       YEN), fixing against one means floating
       against the others
       Fixing/dollarization works best for a small
       open economy heavily tied to the country it
       fixes to (e.g., Panama)




12
 Two Different Utopias



        “A global economy requires a global
        currency.” (P. Volcker/R. Mundell)
        Flexible exchange rates linking economies
        each of which pursues inflation targeting (D.
        Laidler)




13

				
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