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Boston College (3,565)
BSLW 1021 (37)


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Business Law
BSLW 1021
Daniel Frost

LECTURE 6 TRILEMMA OF INTERNATIONAL MACROECONOMICS Policy makers have three desirable goals: 1. Stable exchange rate (promotes trade and foreign investment). 2. Independent monetary policy (provides tools to manage the business cycle). 3. Free capital movements (promotes integration, efficiency, and risk sharing). Trilemma impossible to achieve all three goals at the same time. CHOOSING TO FIX EXCHANGE RATE: PROS/CONS ∗ Peg domestic currency to foreign one. ∗ Promotes stability in trade and investment (limits foreign exchange risk) ∗ Strict limits on ability to conduct monetary policy. ∗ Unless it shuts down foreign exchange market. EXAMPLES OF TRILEMMA Countries next to the euro zone: ∗ Trade with eurozone important and they therefore need stable exchange rate. ∗ Can either peg, abandon monetary independence, float and keep independence. ∗ Allowing wider band around pegs create opportunity for some independence (temporarily). China ∗ Depend heavily on exports to US and need stable exchange rate with Dollar. ∗ Cannot accept US monetary policy (different economies). ∗ Their solution: strict capital controls. Past US exchange rate regimes ∗ Gold Standard (free capital mobility, no monetary independence 19-20 cent.) and Bretton Woods (post WWII-early 70s, no capital mobility, independent monetary policy) were also systems of pegs. ∗ Currently the US chooses capital mobility and monetary independence: volatility of exchange rate. WHY PRICES ARE HIGHER IN DEVELOPED COUNTRIES: BALASSA- SAMUELSON MODEL Countries: Home and Foreign. Goods: Traded and Non-traded Good T has the same price in both countries. Pt=1 Workers can produce either good but cannot move between Ep*t=1 countries. PRODUCTIVITY, WAGES, AND PRICES - A worker in Home country makes A units of T in an hour. His wage is $A. - Worker in Foreign country makes A* of I in an hour Ew*=A* - Productivity in making the non-traded good =1 - Worker in either country can produce one unit of good N in an hour. Price of N - Pn=A Ep*n=A* PREDICTIONS OF THE BALASSA-SAMUELSON MODEL Countries with more productive traded-goods industries have higher wages and
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