FOCUS: THE RETURN OF BRITAIN TO THE GOLD STANDARD: KEYNES VERSUS CHURCHILL

The gold standard was a system in which each country fixed the price of its currency in terms of gold and stood
ready to exchange gold for currency at the stated parity. In 1925, Britain decided to return to the gold standard,
which was in place from 1870 until World War I. As Keynes predicted, because the prices of British goods had
increased more than the foreign price level, Britain faced a real appreciation at a given nominal exchange rate
and remained in recession for the rest of the decade while other countries were growing

FOCUS: THE 1992 EMS CRISIS

• In September 1992, financial markets became convinced realignments of the EMS’s fixed exchange parities
with bands were coming soon.
• Speculative attacks led to ensuring depreciations/devaluations of different countries. Figure 1 Exchange
Rates of Selected European Countries Relative to the Deutsche Mark, January 1992 to December 1993

FOCUS: THE EURO: A SHORT HISTORY

Stages moving to a European Monetary Union (EMU): Stage I: Beginning in 1990, capital controls were
abolished. Stage II: Beginning in 1994, fixed parities of the exchange rate were maintained. Stage III:
THE in
Beginning FEDERAL FUNDS
1999, parities RAT the currencies and a common currency, the euro, were “irrevocably” fixed;
between
the newIn European
the UnitedCentral
States,Bank
the central
(ECB)bankbecame(theresponsible
Federal Reserve) formally
for monetary describes
policy for theitsEuro
monetary
area.
policy by periodically announcing its desired or target level for a nominal interest rate called the
Federal Funds Rate Having announced its target level for the FFR, the Fed then adjusts the
FOCUS: LESSONS
money FROM
supply to steerARGENTINA’S
the actual FFR CURRENCY
as close to itsBOARD In 1991,
target level the Argentina’s president of
as possible
announced
The Federal Funds Rate is the interest rate that banks charge each other foritsovernight
the adoption of a currency board that would stand ready to exchange pesos forloans
dollars
If on
demand.
the Fed wishes the FFR to be 1.8%, all it has to do is to announce that it will lend money to to 4% in
The currency board appeared to work well for a while as inflation fell from 2,300% in 1990
1994. any
However,
bank atas1.8%
appreciation of thewill
interest and dollar
pay in the interest
1.8% second half of the 1990s
on deposits led to
received a decrease
from any bankin demand for
Argentina’s
Given goods,
that theleading to declines
Fed expresses its in output. In
monetary earlyin2002,
policy termsArgentina gave
of the target up the
value currency
of the Federalboard and let
Funds
the peso floatRate, we can re-define monetary policy as follows: Monetary policy is expansionary
when the Fed seeks to reduce the federal funds rate, and Monetary policy is contractionary
when the Fed seeks to increase the federal funds rate Assuming expected inflation (E) is
exogenous, changes in nominal interest rates (such as the FFR) lead to equal changes in real
interest rates