19.4 The Choice of International Policy Regime #Notebook

19.4 The Choice of International Policy Regime #Notebook

Problems are often exposed when the central bank runs out of reserves, like in Thailand did in 1997. 

The International Monetary Fund (IMF) often provides loans to countries attempting to defend the value of their currencies. 

However, the IMF often forces borrowers to undergo fiscal austerity programs and even created a major moral hazard problem, such as repeatedly lending to the same few countries.

In China’s defense, many developing countries find it advantageous to peg their exchange rates to the dollar, the yen, the euro, the pound sterling, or a basket of such important currencies. 

The peg, as a monetary policy target similar to an inflation or money supply target, allows the developing nation’s central bank to figure out whether to increase or decrease MB and by how much.

Fixed exchange rates not based on commodities like gold or silver are notoriously fragile. Relative macroeconomic changes in interest rates, trade, and productivity can create persistent imbalances over time between the developing and the anchor currencies. 

Reference

Wright, R.E. & Quadrini, V. (2009). Money and Banking. Saylor Foundation. Licensed under Creative Commons Attribution-NonCommercial-ShareAlike CC BY-NC-SA 3.0 license.