MMT18 Int Fin

Global Financial Architecture -- the rise and fall of the Gold Standard

World War 1 depleted treasuries of the European states and caused temporary abandonment of the Gold Standard. One could say that difficulties with the gold standard was part of the reasons fro WW1, and even more so, WW2. The first lecture (part 1) explains the difficulties with the gold standard that created serious problems and eventually led to world war 2. The second lecture (part 2) discusses the Bretton Woods conference which created the Gold-Exchange Standard -- instead of being backed by gold, currencies would be backed by dollars, which could be exchanged for gold. This standard also broke down with the Nixon Shock, when in 1971 Nixon abandoned the convertibility of dollars into gold. This created a new world where there is no backing for any currency, and floating exchange rates are common. One of the MAIN ideas of Modern Monetary Theory is that people still have not gotten used to the idea of floating currencies and policies are made as if we had a gold standard and fixed exchange rates. All of macro theory is based on wrong theories about money and exchange rates. MMT is designed to provide an alternative

This 7th Lecture of Advanced Macro is meant to be an inverted classroom. Students should come to class after watching the two video lectures linked below on the Global Financial Architecture. Before doing this, you might want to review "The Battle for the Control of Money" which was covered in Adv Macro I in lecture MAC19

In the next two lectures, we will discuss the contents of the two video lectures on Global Financial Architecture. The Monday class will be about the first lecture (AND also about the assignment given below. The Wednesday Class will be about the second lecture - from Bretton Woods to Nixon Shock. (and we will discuss issues from the assignment given below

QUESTIONS FOR FINAL:

1. Explain the classical Quantity Theory of Money, and explain how Keynesian theory shows that money is not neutral.

Quantity Theory of Money states that money supply and price level in the economy are in direct proportion to each other. Algebraically, MV=PT.

Where M= Money supply

V=Velocity of Money

P= Price level

T= Volume of transactions (total output)

Assuming the V and T to be constant, change in M causes a proportionate change in P. Thus, in classical system, money is just a veil whose main function is to determine the general price level inthe economy.

According to Keynes, money is not neutral in the short run. Money plays a key role in the economy. In Keynesian view, economy does not always operate at full employment level. He believed in the existence of unemployment in the economy. When there is unemployment in the economy and the economy is operating below its full capacity, changes in money supply can have strong influence on the level of output and employment. When money supply increases in the economy, its first impact is on the rate of interest which tends to fall. Investment will increase in response to decline in interest rate. The increased investment will raise affective demand through the multiplier effect thus increasing the level of output and employment. Thus, changes in money supply have significant effect on the real variables such as interest rate, level of output, employment and income.

2. Explain the historical context of emergence of the Gold Standard, as a way of trading between different colonial empires. Why did the need for this inter-empire trade arise, and how did this require a gold standard?

Industrial revolution created the possibility of massive over production led to the emergence of market societies. These market societies values production, consumption, and wealth above all traditional human pursuit. There was no demand for the European products in the traditional self-sufficient societies. Europeans conquered and colonized these traditional socities through military power to create demand for their surplus and destroyed indigenous economies, and political and social institutions. European economies grew immensely rich by utilizing global resources for production, and through exploitation of their colonies, they started to trade with each other. Trade within an empire can be done using a fiat currency which acquires value merely because the sovereign state decrees that this note will be legal tender for all commercial transactions and taxes. However, international trade cannot be done in this way because sovereign fiat does not extend across state boundaries.

To resolve this issue, a trading system was designed according to some set of rules using a gold standard. Under the Gold Standard, a country’s money supply was linked to gold. International balance of payments differences were settled in gold. Countries with a balance of payments surplus would receive gold inflows, while countries in deficit would experience an outflow of gold.

3. Explain the breakdown of the Gold Standard due to World War 1. In particular, explain the conflict between monetary needs of domestic economy and the monetary requirements for international trade, and how this conflict became impossible to resolve in the post WW1 period.

Due to World war 1, European countries suspended the gold standard so they could print enough money to pay for their military involvement. Massive war expenses put a lot of countries into debt and they were unable to maintain gold reserves which led to the breakdown of gold standard. After World War 1, there was a massive effort to re-create the Gold Standard but this effort failed because of various reason. One of the reasons was the need to rebuild the domestic economies destroyed by the war. This required investment, using loans and deficit spending. However, expansion in fiat money was not compatible with maintaining a stable exchange rate in the international markets. The needs of the domestic economy were in very severe conflict with the needs for global trade. This time, the importance of rebuilding domestic economy was prioritized, leading to failure in the attempts to stabilize currencies against gold, needed to create stable exchange rates required for international trade.

HOMEWORK TO BE DONE BEFORE MONDAY MORNING - EMAIL ASSIGNMENTS TO ME with copy to Nisa.

Dear Students

Next week, I would like to cover two existing video-lectures on the rise and fall of the gold standard. Both lectures are linked on the newly created page AM06 linked below:

https://sites.google.com/site/az4macro/am07-int-fin

Here is a set of assignments for you to do before coming to class on Monday morning 11th Feb 2019:

A: -- I would like for you to review lecture MAC19 from last semester, regarding the Battle for the Control of Money, which would be very useful background for these two lectures.

B; -- Watch the first of the two videos which covers the rise and fall of the Gold Standard, going from before the World War 1 period to the Bretton Woods Conference in 1944, which was held while World War II was still going on, but nearing its end. The need for creating a new financial system for trading after the WW2 was obvious to all, and it was urgent to put a system in place, since gold standard was clearly dead.

C: Read the article linked below -- this is a debate between Paul Krugman and Stephanie Kelton -- Krugman asked four question about MMT to Kelton - the article contains her answers.

https://www.bloomberg.com/opinion/articles/2019-03-01/paul-krugman-s-four-questions-about-mmt

D: (OPTIONAL) You may want to watch this video (in order to do the assignment): Stephanie Kelton: On What you Know about Money is Wrong

MOST IMPORTANT -- Assignment to be done and sent to my be email by Monday morning

TAKE ONE ISSUE on which MMT and Standard Orthodox Policy DISAGREE, and CLEARLY articulate the position of both sides. NOTE that you are NOT BEING asked to provide the ANSWER -- which position is correct -- You are just being asked to state both sides of the argument as clearly as you can. The four questions of Krugman provide FOUR issues on which there is a dispute. If you will look through the three previous lectures on Monetary and Fiscal Policy you will find LOTS of question, issues, areas where MMT takes a position which is RADICALLY different from the conventional and standard position. I am expecting about a 1000 words -- a 500 word description of the standard position and a 500 word description of the MMT alternative, but it could range from 600 to 1200 words. Ideally, I would like every student to do a DIFFERENT issue. Note that by doing this assignment, you will learn why Paul Krugman, Nobel Laureate is wrong about some basic macroeconomic issues. Furthermore, policy makers all over the world are following either Krugman (Keynes) or Lucas (Chicago) and both schools of thought are wrong.

In order to avoid clashes on topics, students can WRITE in their names on the current webpage -- like we did in the past -- just put your name down and the topic/issue you have chosen to write on BELOW"

STUDENT NAME -- TOPIC CHOSEN:

For each topic - try to find quotations or articles which defend the standard position, or provide empirical evidence for it. For Example, Reinhart Rogoff argue that High Deficits lead to low growth -- Article linked below shows that RR made a mistake in their calculations. Similarly, try to find empirical evidence for both sides (in the literature, not by original research).

Hina Amber - Theory of Inflation (the relationship between printing money and inflation)

M. NAOMAN KAHN " Does Expansionary Fiscal Policy Reduce Interest Rates"

Minhaj gul: Govt Deficit spending and Crowding out

Zeeshan Malik: Does Government face the same budget constraint as household

Hamza Jan: Fiscal deficits Good or Bad

Farah Inayat: Neutrality of Money

Amaila Buzdar:Fiscal deficits mean Higher taxes in the future --Link to Ricardian Equivalence

Taqi Raza: Functional Finance versus Sound Finance (Differing views on Government Fiscal Constraint)

Dilavar Khan -- The Money Creation

Iqra waheed:Philips curve and NAIRU

Taxes and Fiscal Sovereign Spending: Syed Hassan Ali

Salva Aslam: Sectoral balance

Saima Ashraf: Government and Private Financial Accounting

SHEEBA WAHEED: CENTRAL BANK INDEPENDENCE

Rahima Bibi: "Unemployment Is Used To Control Inflation Rate"