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Describe the Policy Trilemma for Open Economies. Use a chart/diagram to illustrate your answer. Can this trilemma help explain the collapse of the Bretton Woods system - Essay Example

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The trilemma in economics states it is impossible to have, a fixed rate change, free capital movement and an independent monetary policy at the same time in an economy. It is a thesis that is created on the policies of uncovered interest rate parity and the experience that many…
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Describe the Policy Trilemma for Open Economies. Use a chart/diagram to illustrate your answer. Can this trilemma help explain the collapse of the Bretton Woods system
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Describe the Policy Trilemma for Open Economies. Use a chart/diagram to illustrate your answer. Can this trilemma help explain the collapse of the Bretton Woods system

Download file to see previous pages... The policy suggests that a bank can only pursue two of the valiance simultaneously while avoiding making a loss or a breaking down of the economy. (See figure 1). To better understand this phenomena assume that the world operates at an interest rate of 6 %. If the main bank in an economy tries to set the interest rate lower than the 6%, may be 5 percent, the home currency of the economy will experience pressure on depreciation. This will prompt businesspersons to lower their yields of the domestic currencies and invest more on the foreign currency. If the same economy insists on a free capital flow, the only way to safeguard from depreciation would be to sell their foreign reserves. (See figure 2)
Even with measurers like these eventually, the currency will depreciate because the foreign reserves will run dry. It is up to the economists of the economy to gauge and see which of the two policies they will follow. The policy makers of an economy are charged with the responsibilities to decide if to follow the three inconsistent or to look for the better option of combining two of the best in their case. Each of the combinations has different effects on the economy. It is best to choose which policy to implement depending with the state in which the economy is. Studies have shown that the economies that have been affected much by this phenomena insisted of maintaining an open market while maintaining a fixed interest rate. It is very important for an economist and a policy maker to understand how these variances affect the flow of the economy. With a fixed interest rate, it becomes hard for an economy to make money from foreign currency (Masih 2005).
Since the end of World War 2, the world of economy was defined by the Bretton Woods system. This system saw only a few nations excel economically. This system of financial management created the rules ...Download file to see next pagesRead More
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