This section discusses Robert Mundell's monetary approach to the balance of payments. The monetary approach tries to understand the imbalance between supply and demand for money in the international markets. Mundell, who was trained as a Keynesian at MIT, believed that fiscal policy should focus on domestic income stabilization and that monetary policy should focus on the balance of payments.
In order to better understand and defend the Bretton Woods system Mundell developed his monetary approach. His hope was that the monetary approach would explain the constraints that were placed on the domestic economic policy which needed to be understood so the Bretton Woods system could function.
There was a argument though between what Mundell and the followers of the Bretton Woods system believed, and what Milton Friedman believed. Friedman saw the fixed exchange rates supported by Mundell and Bretton Woods, as price fixing, and that the fixed rates would require assistance to remain fixed. Friedman said that having fixed rates and the intervention that would go along with it is the real threat to world trade.
The problem with fluctuating exchange rates was that investors would have to develop some way to hedge their investment to protect against the flexible rates.
A for Hoyt.
ReplyDeleteMundell was trained as a Keynesian (in the Keynesian heyday) but by this time he was regarded as right-wing, bordering on unemployable because of his politics.
There's a huge point here, that's pretty easy, but not discussed much outside of Ph.D. classes. It is that the Mundell approach suggests that monetary policy doesn't do much good with fixed exchange rates, and the flip side (not mentioned here) is that fiscal policy doesn't do much good with flexible exchange rates. For finance, this implies that what is driving nominal rates of return is monetary policy.
FWIW: This also implies that since the U.S. has flexible exchange rates with much of the world, a fiscal stimulus package like that passed under Obama in 2009 (or Bush's in 2008) isn't so much a bad idea as a complete waste of time and effort.
BTW: You are now an intellectual great-grandchild of Harry Johnson. He was the dissertation advisor to my dissertation advisor.