Fixed Exchange Rate and the Effective Monetary Policies

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Question Cluster for Fixed Exchange Rate Discussion David Benjamin March 24, 2013 I. What does it mean for a country to fix its exchange rate? A. Explain the nature of the bands the Bretton Woods system set up to allow exchange rates to fluctuate. B. How would you define a ”crawling peg?” Why can this be thought of as a type of fixed exchange rate? II. Why do the authors argue for the impotence of monetary policy under a fixed exchange rate? A. Why might fiscal policy not be a good substitute for monetary policy? B. How does capital mobility contribute to the impotence of monetary policy? C. What is meant by sterilized monetary policy? Why do the authors called sterilized money interventions smoke and mirror? III. What are the traditional advantages of fixed exchange rates? A. What are some of the effects of variability of exchange rates? Why did the European Union believe they would be detrimental to the establishment of a common market? B. Describe the benefits of a low inflation regime. How do fixed rates achieve these? 1 C. How do fixed exchange rates help countries with a persistent history of inflation? IV. What is the relationship between the size of capital markets and the ability to defend a peg? A. Why do the authors believe it is misleading to believe that large capital markets make it impossible to defend a peg? B. How much reserves does a country need to defend a peg? Why? How does Table 1 make this point? C. Explain the relationship between speculative attacks and bank runs. V. Why do the authors believe that other objectives of government make it difficult to defend the peg? A. Why is it both necessary and difficult for countries to raise interest rates to defend a peg? How do the examples of Sweden and England show those difficulties? B. Why did Mexico have such a difficult time defending its peg? 1. How and why did Mexico choose to peg in the first place? 2. How did the behavior of tesebonos show the difficulty in defending the peg? 3. What factors lead to Mexico abandoning the peg? C. Why does the author consider the timing of sudden stops a puzzle? 1. What is true about the relationship between interest rates over time and speculative attacks in the data? How does this compare to the model? VI. Why do the authors consider fixed exchange rates to be an endangered species? A. How does Table 2 boost this claim? How was Table 2 constructed? B. What factor lead to successful pegs? How do larger confidence intervals change this result? 2 VII. What alternatives to a fixed exchange rate exist for countries concerned about their reputation for inflation? A. Which policy do the authors highlight as potentially successful? B. Explain the author’s opinion about real exchange rate targeting. What about targeting deviations from PPP? C. Which policy conclusions should be made about large and sustained current account deficits? 3