POLI 243 Lecture Notes - Trilemma, Moral Hazard, Fixed Exchange-Rate System

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4 Apr 2012
The Politics of International Monetary Relations
International Media of Exchange 4/3/12 10:59 PM
The Functions of Money
Why money helps markets work better
It allows specialization even at the domestic level
Money is a medium of exchange
o the in between step in a transaction
Money serves as
o a unit of measure
o a medium of exchange
o a store of value
How is money provided?
Influx of gold and silver from America to Europe brought more
trade to Europe because metal was a good everyone wanted
Government action: Legal Tender
Managing Money
o Confidence
o Liquidity
The Central Bank’s Role
Balancing confidence and liquidity
inflation is the result of too much liquidity
Two prices for money
o the interest rate
! raising interest rates" lowering liquidity
o the exchange rate: the international price of money
Mundell-Fleming noted the tension (aka the “trilemma”)
o Fixed exchange rate: creates certainty for international
o Open capital controls: to invest and borrow abroad
o domestic monetary policy autonomy " government wants
complete control over interest rates
o governments want those three things, but it is a dilemma
because of the two different prices for money
Providing stability to the international financial system
Lender of last resort (LLR)
The LLR function and “moral hazard”
Regulatory role as the trade off
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