Monetary policy: Breaking the rules

Posted: October 21, 2014 in economy
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AS UNPLEASANT as global economic conditions look just now we can at least be thankful that things aren’t anywhere near as bad as they were in 2009, to say nothing of 1931. Neither are those sorts of nasty scenarios a risk. Right?There are lots of reasons to think the world will keep trucking along in coming years as it has over the last two. Yet the risk of a new and painful downturn, though still small, is growing. That growing risk is due to the surprising and disconcerting re-emergence of monetary phenomenon that haven’t really been seen since the gold standard of the 1930s.It is easy enough to see how the gold standard as practiced between the first and second world wars got the global economy into serious trouble. In its idealised form, the standard was supposed to work in a rather elegant way. Economies on the standard pegged their currencies to gold and consequently to all other gold-standard currencies. Should a country develop a big balance of payments deficit, adjustment ought to occur automatically. To pay for imports in excess of exports gold needs to flow out of the deficit economy. Because all the money in circulation in an economy should be backed by gold at some ratio, gold outflows force the central bank to pull money out of the economy, generating deflation. Falling prices raise the competitiveness of the deficit economy, and eventually the deficit …

via Economic Crisis


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