Money facilitates exchange and increases productivity. A monetary system uses fiat currency controlled by a central bank, which faces a trade-off between controlling inflation and responding to economic crises. The foreign exchange market determines currency exchange rates under different exchange rate regimes like free floating or fixed rates. Central banks intervene in currency markets to influence exchange rates by buying or selling their own currencies.
3. "The most powerful forces in the world are fictional realities."
"Money in fact is the most successful story, ever invented and told by humans, because it is
the only story everybody believes. Not everybody believes in God, not everybody believes in
human rights, not everybody believes in nationalism, but everybody believes in money."
- Yuval Harari
4. • The only purpose of money is EXCHANGE
• You can exchange in two dimensions
• Exchange with others
=> consumption
• Exchange with yourself in the other time
=> saving / borrowing
7. Adam Smith's "Pin Factory"
• Pin factory employing 10 men who produced 48,000 pins per day
• Each man could have produced only 10 or 20 pins per day individually
8. Thus, money is important because
• Exchange becomes more efficient
• Labor becomes divided, and productivity increases
10. Monetary System
• Fiat money ⇔ Gold standard
(e.g.) Bretton Woods System
• Fiat money
• Central bank has the authority to print/withdraw money
• Gold standard
• Money supply is fixed
11. Inflation
• Fiat money ⇒ the difference between nominal and real
values
• Nominal price: price of real goods in monetary unit
(money)
• Real value: price of real goods in other real goods
• Nominal value increases while real value is fixed
⇒ inflation
12. Hyperinflation in Zimbabwe
• Zimbabwe’s government runs huge budget deficits
• Its central bank prints tons of money to fund the deficits
(seignorage)
• The reckless creation of money led to hyperinflation in
2008–2009
• In 2015, eventually, the Reserve Bank of Zimbabwe
abandoned its own currency and switched to US dollar as
Zimbabwe’s official currency (dollarization)
19. Under Fiat-Money System,
• If inflation is high,
• Reduce money supply
• Control inflation
• If recession happens (low growth or high unemployment),
• Print money and reduce interest rate
• Stabilize the economic growth
21. Argentina. Oh, Argentina...
• Peronism: populism policy that started in 1946 in
Argentina.
• The government printed a lot of money to pay for social
welfare.
• It led to hyperinflation and the economy totally collapsed.
Argentina’s peso became worthless.
• Argentina initiated a new currency based on the currency
board system.
23. Wish it were a happy ending...
• Asian currency crisis and Russian Moratorium in 1998
• All emerging market currencies devalued and restored
competitiveness
• ... except Argentina
24.
25. Argentine Great Depression in 1998-2002
• Currency board is abandoned in 2002
• Argentine peso lost 80% of its value
• Inflation followed, and then the economic growth
26.
27. Trade-Off
• Fiat-money system can easily create inflation
• Gold-standard is not able to deal with business cycle or
economic crisis
28. Brief History of Monetary System
• 1821–1914: gold standard
• The purpose is to control the inflation after the
Napoleonic Wars
• 1914–1918: World War I, and the gold standard broke
down
• 1925–1931: gold standard was reinstated
29. Brief History of Monetary System
• 1929 until late 1930s: the Great Depression
• Gold standard broke down again due to the “beggar-
thy-neighbor” devaluations
• “Beggar-thy-neighbor” policy: countries devalue their
currencies to gain competitiveness and increase
exports
• 1939–1945: World War II
30. Brief History of Monetary System
• 1944–1971: Bretton Woods system
• USD was pegged to gold at $35/ounce
• Fixed exchange rates among currencies
• It also created IMF and World Bank
• Post 1971: floating exchange rate
31. Central Bank Independence
• Central bank's independence is critical to maintain the
fiat-money system
• Government can borrow money but they cannot print.
Only the central bank has the authority to print money.
• Without an independent central bank, it is extremely
tempting for a government to print money themselves
35. The Trilemma of Exchange Rate Systems
• Three goals of policy makers
• Stable exchange rate
• Independent monetary policy
• Capital market integration (free flow of capital)
• Impossible Trinity : one can achieve two of the three
goals, but it is impossible to achieve all three of them
36.
37. Impossible Trinity
• Monetary independence & capital market integration
• (e.g.) US, UK
• Monetary independence & exchange rate stability
• (e.g.) China, Bretton Woods agreement
• Exchange rate stability & capital market integration
• (e.g.) Hong Kong, countries within the European Union
38. How can central banks
make interventions in the
currency market?
39. To make it cheaper...
• If PBOC (People’s Bank of China), for example, wants to
make RMB cheap,
• Print RMB, sell RMB and buy USD
• RMB depreciates relative to USD
40.
41. To make it expensive...
• If PBOC wants to make RMB expensive,
• Sell foreign reserves (usually, US T-Bonds)
• Sell USD and receive RMB instead, withdraw the RMB
from circulation
• RMB appreciates relative to USD