Economics

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Running head: ECONOMICS
Economics
Name of the student
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Answer 1
Introduction
The investors during the 1990s poured a lot money hoping that those companies will
become profitable after some time. There were specially two factors which led to the burst of
the internet bubble. One is the usage of metrics which is known to ignore the cash flow and
the other is significantly overvalued stocks. The dot com bubble is known to grow due to the
combination of the presence of speculative investments, advance of the venture capital
funding for the startups and also due to failure of the dotcoms for turning a profit. The
investors at that point of time were known to pour huge amount of money into the internet
startups since the 1990s by hoping that those countries will become profitable some day1. The
federal reserve of the United States and the Central bank took many steps for expanding the
money supplies in order to avoid the risk of a deflationary spiral. The government also
enacted huge amount of self reinforcing decline in the global consumption. The Federal
Reserves new and expanded liquidity facilities intended to enable the central bank for
fulfilling the traditional lender of last resort role at the time of crisis while mitigating the
stigma. This kind of credit fix have brought the global financial system to the brink of
collapse. There had been an immediate response from the central bank of England
The Great Depression
The great depression was a severe economic depression which took place worldwide
during the 1930s. It have started in the United States when there was a major fall n the stock
1 Sengupta, Rajeswari, and Abhijit Sen Gupta. "Capital Flows and Capital Account Management in Selected
Asian Countries." Global Financial Governance Confronts the Rising Powers: Emerging Perspectives on the
New G20 (2016): 29.

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prices that took place in 1929 and the stock market crashed for the entire world. As a result
of this , the gross domestic product worldwide declined to 15 percent. The great depression
had a huge devastating effects for both the rich as well as for the poor. The sudden collapse
of the US stock market took place in 29th October 1929 which is also termed as Black
Tuesday. After that the rates of interest have declined a lot and people had to decrease their
spending. Prices in general started to decline leading to a deflationary spiral in 1931. The
main causes of the great depression is the crash of stock market in 1929, bank failures,
reduction in purchase across the board and severe drought condition. One of the main reason
of the Great Depression was the crash of the stock market which is known to take place in 29
the October , 1929. The stockholders at that point f time had lost more than $40billion of
investment and the effect of the crash of stock market rippled throughout the economy. More
than five hundred banks k own to have failed during 1929 and more than three thousand
banks of the collapsed at that time. This kind of situation also made people to spend less
amount of money2. When the huge amount of savings became worthless in nature their
investments started to diminish. Both consumers and companies used to spend less and
therefore, there was recession. For this reason, large number of workers were laid off. Since
most of the people were losing jobs, they were not able to pay for the goods which they had
already bought though instalment plans. Also, at that point of time, the rate of unemployment
rose by more than 20 percent which also meant that less spending to help alleviate the
economic situation. Since The Great Depression lead to severe loss in the economy, the
government off he United States was forced to act for protecting the US industry. The
government at that point of time imposed tariff on the imported goods and for that reason a
large number of trading partners retaliated by imposing tariffs on the goods made in US
which resulted in decline of the world trade between 1929 and 1934. The economic condition
2 Castells, Manuel. Another economy is possible: culture and economy in a time of crisis. John Wiley & Sons,
2017.

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at the time of great depression had been made worse by the year long drought. The year long
drought with traditional arming practice which did not know how to preserve soil lead to
huge amount of dust storms which killed many people. Therefore, thousands of people had to
run when the economy collapsed.
The monetary policy of the Federal Reserve had been is guided between 1929 to 1933
since at that time, it only had two tools for influencing the money supply which are the open
market operations and the discount rate which the banks are allowed to borrow from Fred.
The Federal Reserve at that time paid close attention to the international gold standard. When
there was a crash in the stock market in the year 1929, the response of New York had been
quite rapid and effective in nature3. They at that time were known to inject liquidity by
conducting huge scale of open market operations. The supply of money at that time also fell
sharply and was same till the 1934. The Federal Reserve at that time reduced the amount of
credit outstanding which also forced the banks to sell their assets in order to get emergency
liquidity. After that when the gold standard was abandoned by Great Britain during 1931, the
central bank had to increase the discount rate in order to prevent outflows of capital. This
however had put huge pressure on the banks where more than 1800 failed. Until the month of
April in 1932, large scale open market operations were known to be delayed and for that
reason, by July of that year, the stock market had already crashed and had fallen by a loss of
89 percent.
3 Lins, Karl V., Henri Servaes, and Ane Tamayo. "Social capital, trust, and firm performance: The value of
corporate social responsibility during the financial crisis." The Journal of Finance 72.4 (2017): 1785-1824.

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Response of policymakers during Great Depression
In the United States, the Federal Reserve Bank are known to control the monetary
policy whereas the President controls the fiscal policy. During the year 1932, Franklin D.
Roosevelt, the President of USA created various federal government programs. The president
signed new deals which were designed for creation of more jobs, allowing unionization and
also provided them with unemployment insurance. The new deal made by the president
helped in safeguarding the economy and also prevented another depression. The huge number
of bank failures forced the government to establish the National Credit Cooperation in the
year 1932 which was designed for helping the commercial banks for purchasing marketable
assets and also provide alternative borrowing facilities. The government in 1932 campaigned
in favour of conservative fiscal policy for fighting the Great Depression. The policymakers
however did not do much before 1932. The government advocated for sharp reduction of the
government expenditures and abolished useless commissions. The monetary policy was not
used for stimulating the economy at that period of time. Electing President Franklin
Roosevelt at that point of time became the turning point. He created a series of measures for
fighting great depression which was termed as the “New Deal” which was used for stabilizing
the economy. The government of the United States in terms of fiscal policy, moved away
from the balanced budget by adopting an aggressive spending policy. After that the spending
of government rose from 3.2 percent of gross domestic product to 9.3 percent of gross
domestic product from 1932 to 1936. These spending’s ere then financed by the budget
deficits. The government also created a system of deposit insurance for stabilizing the
banking system. The New Deal made by the government not only brought changes in policy
but also brought changes in attitudes towards the policymaking.

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Asian financial crisis
The Asian Financial crisis originated in Thailand n the year 1997 and then quickly
spread to other parts of East Asia. The financial crisis of Asia was known to be have gripped
much of East as well as Southeast Asia which began in 1997 and increased fears of a
worldwide economic meltdown as a result of financial contagion. The financial crisis have
started in Thailand where the Thai Baht have collapsed and then the government of Thailand
were forced to float the baht. The government was forced to do so due to lack of foreign
currency in order to support its currency peg. The Asian Contagion was the sequence of
currency devaluations that began in 1979. Since the government of Thailand decided not to
peg the local currency o the US dollar, the currency market of Thailand failed for the first
time and then it spread rapidly throughout Asia. As a result of this, the stock market crashed
which also reduced revenues. Due to the devaluation of Baht, the East Asian currencies fell
sharply by 38 percent. The countries which were mostly affected by the Asian financial crisis
were South Korea, Indonesia and Thailand compared to Singapore, Taiwan, Vietnam and
china which were comparatively less affected due to the financial crises. The foreign debt to
gross domestic ratios increased from 100 percent to 167 percent in case of ASEA economies.
One of the reason of the Asian currency crisis was due to macroeconomic weakness. Though
both the fiscal and monetary policies aimed at stabilizing the monetary impact of the large
capital inflows, they however avoided large appreciations against the US dollar which was
the main currency against which they pegged their exchange rates. Many countries include
Thailand and Korea suffered from showdowns of substantial exports in the year 1996 despite
the high rate of investment. The macroeconomic situation at the end of 1996, presented a
troubling situation for some of the countries. During the 1990s, the Asian countries
experienced huge amount of capital inflows which ranged from 3 percent of GDP in case of
Korea to 10 percent in Malaysia. Large amount of inflows of capital, were known to be

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intermediated through weak domestic financial institutions. The combination of large amount
of capital inflows with financial sectors and the involvement of government lead to financial
fragility of an overleveraged corporate sector. During the 1990s, these Asian countries like
Indonesia and Thailand were known to have large amount of deficits in current account while
maintaining the fixed exchange rates encouraged for external borrowing leading to foreign
exchange risk. Devaluation of Chinese currency and the Japanese Yen with the increasing
interest rate of the United States adversely affected the growth of the Asian countries. The
higher US Dollar made the exports of Asian countries more expensive and less completive in
the global markets which slowed the growth of exports of the south Asian countries leading
to the deterioration of the position of the current account.
Response of the policymakers
The situation got better with the intervention of the International Monetary Fund that
provided enough loans for stabilizing the Asian economies. The International Monetary Fund
have provided $110 billion loans Thailand, South Korea and Indonesia for helping them to
stabilize their economies. The financial crisis which took place in Thailand with a lot of
speculative attacks on the baht known to unfold after several decades. The IMF was called in
in order to provide financial support for the above mentioned countries that have been
seriously affected. The strategy includes macroeconomic policies, structural reforms and
financing. An amount of US$35 billion of IMF financial support had been provided to the
Asian economies for adjustments programmes. The monetary policy had been tightened in
order to save the country from the collapse of the exchange rates. The tightening of the
monetary policy were although had been temporary in nature. The tight monetary policy
prevented currency depreciation which can lead to inflation and continuing depreciation of
the currencies. There was only little or no attempt made for raising the interest rates. The
government of Thailand also aimed for contractionary fiscal policy which was introduced for

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reducing the excessive deficit of current account. The programs which were supported by
IMF had been less successful for restoring the confidence of South Korea, Indonesia and
Thailand. The financial markets then stabilized during 1998 at first in Korea and Thailand.
The exchange rates started to recover and then rate of interest also started to decline after
that. The contractionary monetary policy imposed by the government helped in reversing the
pressure of the exchange rate and also prevent the inflationary spirals. Therefore, it can be
said that structural reforms were important for restoring the confidence of the firm.
The international monetary fund recommended a sharp rise in the rate of interest for
restoring confidence, stabilizing the currency and outflow of stem capital for the crisis
affected countries. However, many economist stated that this particular approach made by
IMF was counterproductive. They stated that the low interest rate could have made it quite
easier for the firms for maintain production by restoring the confidence of the investors.
The dot com bubble
The dot com bubble took place in 1994 in the United States. During the dot com
bubble, the value of the equity markets grew tremendously where Nasdaq index increased
from 1000 to 5000 between 1995 to 2000. After that stock market crashed and lasted till
2002. When the stock market crashed, a lot of online shopping companies and
communication companies like WorldCom and Global Crossing have failed and had shut
down. The investors during the 1990s poured a lot money hoping that those companies will
become profitable after some time. There were specially two factors which led to the burst of
the internet bubble. One is the usage of metrics which is known to ignore the cash flow and
the other is significantly overvalued stocks. The dot com bubble is known to grow due to the
combination of the presence of speculative investments, advance of the venture capital

ECONOMICS
funding for the startups and also due to failure of the dotcoms for turning a profit. The
investors at that point of time were known to pour huge amount of money into the internet
startups since the 1990s by hoping that those countries will become profitable some day.
However, when the capital markets were investing a lot of money to this particular sector, the
start ups were in a race to become fast. The companies without any kind of proprietary
technology is known to abandon the fiscal responsibility and the spent a fortune on
marketing for establishing brands which would help in differentiating themselves from the
competition. Some of the startups were known to spent as much as more than 90 percent of
their budget on advertising. Huge amount of capital started to flow into the Nadaq by 1997
where by 1997, 40 percent of the venture capital investments had been gig to the internet
companies. In the year 1997, around 300 of the 457 IPOs had been related to the internet
companies. The bubble ultimately then busted in a spectacular manner leaving many
investors
Facing huge loses where several internet companies bust. The companies which
survived the bubble was Amazon, eBay and Priceline. The year 1997 had a period of rapid
technological advancement which took place in lot of countries. However, it was the
commercialization of the internet which is known to led to the greatest expansion of the
capital growth faced by many countries. Though the high tech markets like Oracle, Intel and
Cisco were known to drive the growth of the technology sector, it was the start of the dotcom
companies which is known to fuel the stock market since 1995. The bubble which formed
after the 1995 were known to be fed by cheap money, overconfidence of the market, pure
speculation and easy capital. The venture capitalists then freely invested in any company
which has a “.com”after its name. The valuations were known to be based on earnings . The
firms which had to generate huge amount of revenue or profits went to the market with the
initial public offerings where the prices of the stock markets tripled. The investors at that

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point of time were known to pour huge amount of money into the internet startups since the
1990s by hoping that those countries will become profitable some day. However, when the
capital markets were investing a lot of money to this particular sector, the start ups were in a
race to become fast. The companies without any kind of proprietary technology is known to
abandon the fiscal responsibility and the spent a fortune on marketing for establishing brands
which would help in differentiating themselves from the competition. The Nasdaq index
peaked on March 2000 which nearly doubled over the year. When he market was at its peak
huge number of huge tech companies known to have placed a huge sell orders on their stocks
which lead to a sparking panic selling among the investors. After few weeks, the stock
market have known to lost 10 percent of its value. When the investment capital started to dry
up, the lifeline of the Dotcom companies also dried up. The dotcom companies which had
reached the market capitalization in hundreds of millions of dollars known to have become
worthless within few months. By 2001, most of the dotcom companies folded and trillions of
dollars of investment capital known to have evaporated.
Policymakers response to the problems
Considering this particular internet bubble, where investors had lost huge aim of
money it can be said that popularity always does not mean equal amount of profit. The hot
internet stock might do well in the short term they are not reliable for the long term
investments. During the long run, the stocks need a strong source of revenue for performing
well in investments. Companies are also appraised by measuring their future profitability
however, speculative investments can turn out to be highly dangerous in nature. Investing in
sound business model is also very important. Many investors were also not realistic
concerning about the growth of the revenue at the time of the first internet bubble. People
only recognize bubbles after its bursts. The central bank are known to strive for delivering the
stability in prices, financial growth and the growth. The asset price bubbles are known to

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present a direct threat for achieving these goals , therefore, the monetary policymakers had to
accord them a role in their policy decisions. The expansion of an asset price bubble may lead
to a debilitating misallocation of economic resources. Therefore an appropriate monetary
policy in case of assert bubbles remains unclear. Some of the policymaker shave suggested
that the monetary policy should be used to reduce the asset price bubble for alleviating its
adverse consequence on the economy. While the other policymakers commented that such
policy might be impractical and unproductive.
One of the monetary policy that had been proposed is the standard policy and the
other is the bubble policy. One of the aim of the bubble policy is to reduce asset price bubble.
Therefore it has been found out that the movement in the bubble component might have a
serious impact on the macroeconomic performance. Therefore, it is preferable for the central
banks to eliminate this source of macroeconomic fluctuations directly. The firms which had
to generate huge amount of revenue or profits went to the market with the initial public
offerings where the prices of the stock markets tripled. The investors at that point of time
were known to pour huge amount of money into the internet startups since the 1990s by
hoping that those countries will become profitable some day. However, when the capital
markets were investing a lot of money to this particular sector, the start ups were in a race to
become fast. On the other hand, when the asset price bubble expands, the standard policy
recommends that higher interest rates can offset any economic stimulus which is generated
by the bubble. This policy therefore will try to reduce the size of the bubble by setting the
interest rate higher. By doing so, this particular policy will trade off the near term deviations
from the central bank’s ,macroeconomic goals for the better overall macroeconomic
performance.

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Financial crisis
The financial crisis which is known to take place during 2007 and 2008 was also
termed as the global financial crisis. The financial crisis had been the most serious financial
crisis after the great depression. This crisis started in 2007, with a crisis in the subprime
mortgage market in the United States. It have then developed into a full grown financial
crisis with the collapse of the famous investment bank, Lehman Brothers. Excessive risk-
taking by banks such as Lehman Brothers helped to magnify the financial impact globally.
One of the main reason behind the crisis was the US housing bubble which have peaked in
2006. The easy availability of the credit in the United States fuelled by large inflows of the
foreign funds after the Russian debt crisis in 1997 known to have resulted in the boom of
housing construction and also facilitated the debt financed spending of the consumer. As
banks started to give out more loans to the potential home owners the price of housing started
to increase. The loans of various types was easily available and t consumers assumed an
unprecedented debt loan. Another reason behind the financial crisis is the easy availability of
loans. The lower rate of interest encourage large amount of borrowing the federal reserve
known to have lowered the interest rate in order to soften the impacts f the collapse of the dot
com bubble. Due to the low interest rate it was noticed that there was a rise in housing nstaed
f business investment. There was also pressure on the interest rates which was created by the
high and rising US current account deficit which peaked along the housing bubble. The
financial crisis mostly took place due to several reasons that include subprime lending,
predatory ending, incorrect pricing of risk, wrong banking model, deregulation, easy credit
creation and increased debt burden. Huge increase in the commodity prices lead to the
collapse of the housing prices. The price of oil also increased a lot before the financial crisis
took place. An increase in oil prices tends to divert a larger share of consumer spending into
gasoline, which creates downward pressure on economic growth in oil importing countries.

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The financial crisis in the year 2007-2008 was mainly caused due to the deregulation in the
financial industry which permitted banks for engaging in hedge fund trading with the
derivatives. The housing prices started to fall when supply have outpaced the demand. The
growth of the subprime mortgages also lead to the financial crisis. The easy availability of the
credit in the United States fuelled by large inflows of the foreign funds after the Russian debt
crisis in 1997 known to have resulted in the boom of housing construction and also facilitated
the debt financed spending of the consumer. As banks started to give out more loans to the
potential home owners the price of housing started to increase. The loans of various types
was easily available and t consumers assumed an unprecedented debt loan. Another reason
behind the financial crisis is the easy availability of loans. The lower rate of interest
encourage large amount of borrowing the federal reserve known to have lowered the interest
rate in order to soften the impacts of the collapse of the dot com bubble.
Response of the policymakers
The federal reserve of the United States and the Central bank took many steps for expanding
the money supplies in order to avoid the risk of a deflationary spiral. The government also
enacted huge amount of self reinforcing decline in the global consumption. The Federal
Reserves new and expanded liquidity facilities intended to enable the central bank for
fulfilling the traditional lender of last resort role at the time of crisis while mitigating the
stigma. This kind of credit fix have brought the global financial system to the brink of
collapse. There had been an immediate response from the central bank of England. During
the period of 2008, the central bank have known to purchase worth of US $2.5 trillion of the
government debt which was also considered the largest liquidity injection into the credit
market. There was also regulatory proposals and long term responses. In the year 2009, the
President of the United States known to have signed for American recovery and reinvestment
act. The president along with its advisors have also known to have proposed some regulatory

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proposals in 2009. These regulatory proposals were known to address the consumer
protection, executive pay and also have expanded regulations of the shadow banking systems.
Again in the year 2010, Obama have known to propose more regulations which limits the
ability of the banks for engaging in property trading. The government have actively known to
rescue prominent financial firms. The executive branch of the government is also known to
involve in maintaining stability in the financial system. The Federal Reserves have always
been extremely active in making sure that the financial system will continue to function
properly during the credit crisis4. The government took these action for providing stability to
the financial markets support the availability of the mortgage finance and will also protect the
taxpayers from excessive losses. Another principle for minimizing the impacts of financial
crisis is to maintain confidence in the safety of the banking system.
Conclusion
The great depression had a huge devastating effects for both the rich as well as for the
poor. The sudden collapse of the US stock market took place in 29th October 1929 which is
also termed as Black Tuesday. After that the rates of interest have declined a lot and people
had to decrease their spending. Prices in general started to decline leading to a deflationary
spiral in 1931. The financial crisis which is known to take place during 2007 and 2008 was
also termed as the global financial crisis. The financial crisis had been the most serious
financial crisis after the great depression. This crisis started in 2007, with a crisis in the
subprime mortgage market in the United States. It have then developed into a full grown
financial crisis with the collapse of the famous investment bank, Lehman Brothers.
Excessive risk-taking by banks such as Lehman Brothers helped to magnify the financial
impact globally. One of the main reason behind the crisis was the US housing bubble which
4 Deyoung, Robert, et al. "Risk overhang and loan portfolio decisions: small business loan supply before and
during the financial crisis." The Journal of Finance 70.6 (2015): 2451-2488.

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have peaked in 2006 The main causes of the great depression is the crash of stock market in
1929, bank failures, reduction in purchase across the board and severe drought condition. In
the United States, the Federal Reserve Bank are known to control the monetary policy
whereas the President controls the fiscal policy.
Answer 3
Introduction
The impossible trinity is a famous concept in the international economics which states
that is not possible for having all three of the following which are the fixed foreign exchange,
independent monetary policy and free capital movement. In the 19th century, the gold
standard implied fixed exchange rates since all the gold standard central bank are known to
fixed their values of currency in terms of gold. On the other hand, Bretton woods systems
which operated in 1970 made the fixed exchange rate mandatory as long as the international
capital mobility had been blocked and the countries could use the monetary policy for the
domestic goals. Most of the advanced economies known to have moved to the floating
exchange rates for allowing the both the international capital mobility along with the
monetary policy to move towards the domestic objectives. The policy trade offs in the
impossible trinities are intrinsic to the responses of globalization. The trilemma model is
known to comprise autonomous monetary policy, free flow of capital and fixed currency
exchange rate.
A small open economy which wishes to maintain financial integration can regain its
monetary autonomy by following the floating exchange rate and giving up the fixed rate.
Under the regime of the flexible exchange rate, the expansion of the domestic supply of
money will be reducing the rate of interest which will also result in capital outflow in search
of high amount of foreign yield. The excess demand for the foreign currency is known to

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depreciate the exchange rate. A large money supply will be reducing the interest rate by
increasing the domestic investment and also weaken the domestic currency which also
expands through increased net exports. Achieving monetary independences needs the small
open economy for giving up exchange rate stability which also implies a shift from the right
vertex of the trilemma to the left. Giving up the financial integration will prevent the
arbitrage between the foreign bonds and domestic bonds and will delink the domestic interest
rate from the foreign interest rate. Some of the countries are need to choose the degree of
financial integration and flexibility of exchange rate.
Even in the case of fixed exchange rate system, the credibility of the fixed exchange
rate will be changing overtime and the central bank also does not follow the strict version of
the currency board. The fundamental contribution of the Mundell Flemming framework is
termed as the impossible trinity which also states that a country might choose any two of the
following three policies. For more than century, the efforts to cope with the monetary
trilemma known to have varied across the time and space along with the mixed success. The
gold standard of the 19th and the 20th century used to practice fixed exchange rates since all
the gold standard central banks used to fix their currencies value in terms of gold. The gold
standard however meant that the autonomous monetary policy was way more feasible in
nature. One of the most important realizations which came out of the global financial crisis
between 2007 and 2009 was that the standard models of macroeconomic stabilization had not
paid enough attention to the financial markets.
The Bretton Woods System
The Bretton Woods System have known to establish rules for the commercial and
financial relations among US, Canada and Japan. The main features of the Bretton Woods

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System were that each country were obliged to adopt a monetary policy which maintained its
external exchange rate within 1 percent by tying its currency to gold. The Bretton woods
system known to have operated after the Second World War during 1970s, which mandated
the exchange rates as long as the capital mobility was blocked where the countries use
independent monetary policies. Under the system of Bretton woods in 1944, there was a
presence of fixed exchange rate where every country had been pegging to the US dollar.
Under the system of Bretton woods, the fiscal policy had been used freely as a tool of macro
stabilization. When the currency value of the country is known to become too weak for the
dollar, the bank will be buying its currency in the foreign exchange markets which will again
lower the supply of the currency and increase its price. However, the members of the Bretton
Woods Systems had agreed to avoid any kind of trade wars. The member countries would not
also take any kind of actions in those cases when foreign direct investment began to
destabilize their economies. Therefore, under the system of Bretton Woods, the countries
were maintain a fixed exchange rate. The countries with fixed exchange rate might run in
short of international reserves at that point of time. Therefore, the International Monetary
Fund had been created as an emergency lender. The Bretton woods system could not have
worked without the help of the International monetary fund. The countries also could devalue
or revalue the capacity which are subject to the approval of IMF in the circumstances of
fundamental disequilibrium.
Therefore, by removal of the capital mobility the Bretton Woods system set up a
resolution of the monetary trilemma that is usually based on the stability of the exchange rate
along with the autonomy of the monetary policy. The long run inflation is usually determined
by the US monetary policy but during some conditions, the IMF funding was meant to ensure
that such adjustments can only take place only in response to highly persistent shocks.
However, the stability of the fixed exchange rates of Bretton Woods had been predicted for

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continuing limited cross border mobility of capital. The policymakers had to struggle with the
financial plumbing. One of the important factor leading to the success of Bretton Woods is
that the opportunity of the capital flows grew where the unwanted leakages seeped through.
Therefore, the fixed exchange rates became tougher to maintain. Under this particular system,
the rise in the instability of the exchange rate was implied by greater capital mobility.
However during the year 1970, the United States had been suffering from huge amount of
stagflation which is known to be a deadly combination of recession and inflation. The IMF
came into place in order to help the member countries when their currency values became too
low. The IMF was also responsible for enforcing the Bretton Woods agreement. During the
time of Breton Woods Agreement, the World Bank had been set up for lending the European
countries which were known to be devastated by the Second World War. Although presently,
the World Bank is known to loan money for economic development projects in the emerging
market countries. The gold standard is a kind of monetary system in which the standard
economic unit of account is known to be based on fixed exchange rate.
The impossible trinity states that a country a country can fix its exchange rates and
also allow free flow of capital with other countries. However, in this case that particular
country will not be able to achieve independent monetary policy since the fluctuations of the
interest rate will lead to stressing of currency pegs and cause them to break. On the other
hand, a country can choose to have independent monetary policy and free flow of capital.
However, the fixed exchange rates and the free flow of capital are mutually exclusive in
nature. Therefore, when there will be free flow of capital, the fixed exchange rates will not be
present. However, when a country will be choosing fixed exchange rates with independent
monetary policy, it cannot have a free flow of capital5. The Gold Standard is known to
5 Fahad, Mobashsher Mannan, Md Faruque Hossain, and Nisar Ahmed. "The Double Edged Blade of
Consumerism & the Impossible Trinity–Bangladesh." Journal of Economics and Sustainable Development 7.6
(2016): 121-135.

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follow two rules that is current convertibility and the stability of the exchange rate. During
the First World War, the convertibility had been suspended and the stability of the exchange
rate had been abandoned. At that time European nations wanted to return gold standard for
restoring their credibility of the currencies.
Failure of the Bretton woods
The Bretton Woods system known to have dissolved between 1968 and 1973 where
the President announced temporary suspension of the dollars convertibility into gold. When
the dollar had struggled throughout 1960, the crisis have known to mark the breakdown of the
system. An attempt for reviving the fixed exchange rates failed and by the year 1973, the
major currencies have known to float against each other. With the collapse of the Bretton
Woods System, IMF members have been free to choose any form of exchange agreement
which will allow the currency to freely float which will be pegging it to another currency or a
basket of currencies. The collapse of the Bretton Woods system of the fixed exchange and
been one of the most accurately and one of the most predicted major economic events. From
the moment of full convertibility on the current account transactions, the steady growth of
official and private dollar claims in the hand of foreigners. The impossible trinity states that a
country a country can fix its exchange rates and also allow free flow of capital with other
countries. However, in this case that particular country will not be able to achieve
independent monetary policy since the fluctuations of the interest rate will lead to stressing of
currency pegs and cause them to break.
Floating exchange rate
The floating exchange rate is a kind of exchange rate regime were the value of the
currency is allowed for fluctuation in response to foreign exchange market. One of the major
advantage of the floating exchange rate is that it is known to be self-attuned in nature. The

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floating exchange is also known to allow greater liquidity which the central bank can control
but are also subject to attacks by the speculators. The floating exchange rate is the one where
the market can set the price according to the currency. One of the biggest benefit of floating
exchange rate is that it act as a shock absorber for adjusting the imbalances. The monetary
trilemma implies that the countries during the 1970s could orient monetary policy towards
the domestic goals. Since 1970s, both the flexibility of the exchange rate and the capital
mobility will increase. Presently, many advanced countries have moved towards the floating
exchange rate where they sacrificed the fixed exchange rates for allowing both the
international capital mobility along with the monetary policy to move towards the domestic
objectives. Moving towards the floating exchange rate were known to be both advantageous
and disadvantageous in nature.
The impossible trinity states that the capital mobility in combination with the floating
exchange rate will help in empowering monetary policy for focussing on the domestic
objectives. However, the monetary policy only can be an ineffective tool for addressing the
problems related to instability. Due to the monetary trilemma therefore, the domestic
monetary policy under the floating exchange rate as well as under the open capital account
can face a harsher trade off between the conventional macroeconomic goals and financial
stability. Countries more specifically are known to operate in an increasingly interconnected
world which is known to be true specially in case of smaller economies of the globalized
world. According to the basic monetary trilemma, it is known that when there are free capital
flows, it is quite possible to have independent monetary policies through the exchange rate
flexibility. Even in case of a closed economy, the monetary policy will not be able to deliver
proper financial stability. The various advantages of the floating exchange rates is that there
is a presence of stability of balance of payments since the imbalances in the balance of
payments can lead to change in the exchange rates. Therefore it can be said that a deficit in

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the balance of payments can help in triggering currency depreciation. This can make the
exports cheaper in of foreign countries which will also lead to increase in their demand. The
floating exchange rates are also known to provide protection against various imported
inflation. Unlike the fixed exchange rate, there is absence of any restrictions t trade with these
currencies. The free floating exchange rates also do not require any kind of monetary issuing
authorities for keeping large amount of foreign currency reserves for defending the exchange
rate. Therefore, those reserves can be used for importing the capital goods in order to
promote economic growth.
The euro area crisis, which have known to take place in case of banking oversight
where the resolution were fully vested at the member state level. The structural weakness also
played an important role in the euro crisis. Even in the closed economy, the monetary policy
alone cannot help in delivering the financial stability. In the open economy, the problem of
monetary policy is known to be even worse. The availability of tools might be constrained by
the financial policy trilemma which is quite distinct from the monetary trilemma. The
financial trilemma implies that the effectiveness of macro prudential tools is constrained in a
financially globalized world. The monetary trilemma also suggest that the flexibility of
exchange rate is known to be the best response to the foreign monetary shocks. However, in
case of open economies, the policy of financial stability can be more effective with the
benefit of multilateral regulatory coordination and cooperation.
Therefore, it can be stated that floating exchange rates might be quite helpful in many
countries, they are known to be the centre of all the problems. They might provide extra
monetary policy space but always do not offer complete insulation from the foreign shocks.
Although a substantial number of countries were not willing to allow their currencies to float
freely in nature. However, those who pegged their currencies believed that this choice of not
allowing the currencies to float resulted due to the fear of floating. Even during the early era

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of the floating rate, the new risk of financial stability existed. For most of the most important
macroeconomic shocks involve the cages in policy by the US Federal Reserve. The
impossible Trinity also states that the floating exchange rate and the capital mobility will help
in empowering the monetary policy for focussing on domestic objectives. In case of the
financial trilemma, the countries had to choose between the national financial policies,
financial stability and integration into global financial markets. When there is a presence of
huge amount of integration in the global financial markets where each of the nation retains
the national sovergnity, then the regulatory arbitrage may undermine the financial stability.
As a result of the financial trilemma, the domestic monetary policy which is known to be
under a floating exchange rate and open capital account will not face an easy trade off
between the conventional goals of macro economy. Therefore, the burden on the domestic
financial stability policy will be higher in nature.
The main advantages of the flexible exchange rate is that the floating exchange rate
that there is no need of large reserves for developing the economy. These reserves can
therefore be used for importing goods and other items for promoting faster economic growth.
A floating exchange rate also helps in insulating a country from inflation. If a country is with
a payment surplus and under a fixed exchange rate, it would tend to import inflation from the
deficit countries. Under the floating exchange rate, the balance of deficit of the country can
be rectified by changing the external price of the country. Therefore, a floating exchange rate
will allow the government for pursuing the objectives of internal policy such as growth in full
employment in the absence of demand pull inflation without any kind of external constraints.
The interwar period had been marked by the end of the gold standard regime and the new
level of macroeconomic disorder in the country. The gold standard also meant that the
autonomous monetary policy was infeasible. The chosen macroeconomic policy regime of
the impossible trinity is known to comprise of three policy goals which are the full freedom

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of the cross border capital movements, fixed exchange rate and an independent monetary
policy which is oriented towards the domestic objectives. During the interwar period, the
gold standard transmitted the contractionary impulses emanating from the United States
worldwide, and made it impossible to combat the incipient Depression. This particular
situation lead to countries switching to prioritizing domestic policies, abandoning the
exchange rate pegs, open capital markets. After the interwar period failed a new regime took
place which was termed as the Bretton Woods.in the year 1973 the fixed exchange rates were
abolished and the world entered into the era of capital mobility along with floating rates
which exist currently. The capital mobility have however been proved troublesome on many
occasions.
The trilemma and the economic and monetary union
A lot of crisis took place specially took pace fir the fundamental regime shifts. Under
the classical gold standard, fixed exchange rates and the open capital markets, it meant that
the goal of the central bank was to maintain the gold reserves and stay on gold. The country
after that have known to increase the rate of interest which resulted to deflation where
competitiveness is restored in the long run. This particular approach of economic policy was
doing well with the liberal philosophy of the time. However it was gradually undermined by
the growing rigidity of the labour markets and products. This also meant that the
unemployment cost increased also leading to increase in the political cost. Within Europe, the
move towards the floating exchange rate had been a serious challenge because of the threat
which the sharp exchange rate movements might pose to the common market.
If a country is with a payment surplus and under a fixed exchange rate, it would tend to
import inflation from the deficit countries. Under the floating exchange rate, the balance of
deficit of the country can be rectified by changing the external price of the country. The fact

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that the gold stand had conceived in economically turbulent times meant that there had been
inherent structural weakness which added to mounting financial instability. The gold standard
which existed in much of the global economy until the first world war meant that the money
supply was known to be determined by the gold reserves which was held by the central bank.
Monetary policy under the gold standard
The central bank were known to have two monetary policies under the classical gold
standard which were maintain the convertibility if the fiat currency into gold at the fixed
price while defending the exchange rate. Secondly, speeding up the adjustment process to the
imbalance of the balance of payments. During the time of the classical gold standard, all the
countries were known to fix their value of their currencies in terms of gold6. The domestic
currencies were freely convertible into gold at the fixed price and there was absence of any
restrictions on the import an export of gold. The gold coins were known to be circulated as
the domestic currencies. During the 1930’s the gold standard can be stated as an example of
the macroeconomic impossible trinity were only two of the capital mobility that is the fixed
exchange rates and the independent monetary policy can be met.
With the fixed exchange rate and with free capital flows, the central bank cannot exert
the autonomous monetary policy. When they tried to break the rules, the system known to
have collapsed. Therefore, it can be sated that the gold standard was one of the important
factor which led to the great depression. The fact that the gold stand had conceived in
economically turbulent times meant that there had been inherent structural weakness which
added to mounting financial instability. The gold standard which existed in much of the
global economy until the First World War meant that the money supply was known to be
determined by the gold reserves which was held by the central bank. During that point of
6 Kugler, Peter, and Tobias Straumann. "International Monetary Regimes: The Bretton Woods System."
Handbook of the History of Money and Currency (2018): 1-21.

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time, the capital was free to move in and out of the national economies, the capital flows and
fresh supplies of gold was known to be determined by the interest rates, money supply and
economic activity. Under the gold stand of the impossible trinity the Central Bank was
known to gave up the independent monetary policy, however held to the managed exchange
rate and free capital mobility. There was an almost theological belief in the virtue of the gold
standard that it could survive. The gold standard was relaxed during the First World War
which resulted to high amount of inflation in the major economies. After the first world war,
both the US and Britain were known to follow the deflation policy while France and
Germany expected inflation. However during the 1930s, France went back to the gold
standard which lead to a highly competitive and a fast growing economy7. Britain on the
other hand followed the same policy restoring its pre war level. This resulted to
uncompetitive domestic economy with huge level of unemployment and trade deficits there
was also huge pressures the gold reserves since the sustainability of the exchange rate known
to face huge pressure. After inflicting huge costs on the real economy, the exchange rate
could not be maintained and the gold standard had to be abandoned in 1931.
Therefore it can be said that the impossible trinity is one of those aspects of the nature
of things which makes life difficult. The trilemma suggest that a country can follow only two
of the three policies at once which are the fixed exchange rates, discretionary domestic
monetary policy and international capital mobility. In order to keep the exchange rates fixed,
the central bank should ether restrict the flows of capital or give up the control over the
domestic money supply. In case of the classical gold standard, it have maintained the fixed
exchange rates and have also allowed the free flow of financial capital internationally by
making it impossible to alter the domestic money supply, inflation rate and interest rate. In an
ideal world, the countries would like to have a fixed exchange rate, monetary policy
7 Lo, Chi. China’s impossible trinity: The structural challenges to the “Chinese Dream”. Springer, 2016.

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discretion and capita mobility, all at the same time. this kind of situation will be providing
them with enough benefits. Although in the real world, there is a presence of trade offs.
All the countries want exchange rate stability for the the exchange market that is
know to allocate resources to their best uses globally. When a country will be lowering its
domestic rate of interest to stave off recession, the currency will be depreciating which will
lead to the loss of exchange rate stability. During the time of the classical gold standard, all
the countries were known to fix their value of their currencies in terms of gold. The domestic
currencies were freely convertible into gold at the fixed price and there was absence of any
restrictions on the import and export of gold. The gold coins were known to be circulated as
the domestic currencies. During the 1930’s the gold standard can be stated as an example of
the macroeconomic impossible trinity were only two of the capital mobility that is the fixed
exchange rates and the independent monetary policy can be met. With the fixed exchange
rate and with free capital flows, the central bank cannot exert the autonomous monetary
policy. When they tried to break the rules, the system known to have collapsed when the
government firmly fixes the rate of exchange, capital will emigrate to places where it will be
able to earn huge return until and unless the capital flows will be restricted. Specifically the
foreign exchange market is termed as the free exchange market8. The free floating exchange
rate was known to be characterized by volatility of the exchange rates with capital mobility.
Between the second world war and the early 1970s, there had been affixed foreign exchange
regime termed as the Bretton Woods system and before that many nations were on the gold
standard. There was also a huge capital fight under the gold standard which resulted in
speculative attacks on the currencies. The fact that the gold stand had conceived in
economically turbulent times meant that there had been inherent structural weakness which
added to mounting financial instability. The gold standard which existed in much of the
8 Aizenman, Joshua. "International Reserves, Exchange rates, and Monetary Policy–From the Trilemma to the
Quadrilemma." (2017).

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global economy until the first world war meant that the money supply was known to be
determined by the gold reserves which was held by the central bank. During that point of
time, the capital was free to move in and out of the national economies, the capital flows and
fresh supplies of gold was known to be determined by the interest rates, money supply and
economic activity.
Conclusion
It can be said that the impossible trinity is one of those aspects of the nature of things
which makes life difficult. The trilemma suggest that a country can follow only two of the
three policies at once which are the fixed exchange rates, discretionary domestic monetary
policy and international capital mobility. In order to keep the exchange rates fixed, the central
bank should ether restrict the flows of capital or give up the control over the domestic money
supply. In case of the classical gold standard, it have maintained the fixed exchange rates and
have also allowed the free flow of financial capital internationally by making it impossible to
alter the domestic money supply, inflation rate and interest rate. The impossible trinity is a
famous concept in the international economics which states that is not possible for having all
three of the following which are the fixed foreign exchange, independent monetary policy
and free capital movement. In the 19th century, the gold standard implied fixed exchange rates
since all the gold standard central bank are known to fixed their values of currency in terms
of gold. The main advantages of the flexible exchange rate is that the floating exchange rate
that there is no need of large reserves for developing the economy. These reserves can
therefore be used for importing goods and other items for promoting faster economic growth.
A floating exchange rate also helps in insulating a country from inflation.

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