| Issue | Monetary instability |
| Causes | Inflation • Devaluation • Lack of common currency in the European Union |
| System | |
| Timeline | 1970s-present |
| New Technologies | Alternative digital currencies • Payment methods |
| Geographical Area | |
| Effects on Economy | Trade disputes • Economic nationalism • Increased use of financial instruments for risk management |
| Debate and Experimentation | Ongoing debate and experimentation with monetary policy regimes |
Monetary instability is a chronic issue in the global economy due to the combination of numerous historical, political, and technological factors. Over the decades, the world's major currencies have experienced shifting cycles of inflation and devaluation, leading to repeated disruptions in international trade, investments, and capital flows.
The roots of chronic monetary instability go back to the end of the fixed Bretton Woods exchange rate system in the early 1970s. As countries shifted toward floating exchange rates, they adjusted their monetary policies in response to domestic political considerations, often giving rise to severe inflation or deflation.
Several causes contribute to monetary instability:
International political events and crisis such as wars, debt crises, or geopolitical competition lead to financial stress and currency devaluation. For example, the British pound has experienced chronic devaluation due to the UK's debt and budgetary uncertainties.
Stringent capital controls and currency manipulation by countries trying to gain competitive advantages over trade partners. Economists believe that China devalued its renminbi in 2015 for this reason.
Inappropriate monetary policy causing an imbalance between money supply and inflation or deflation. For example, the European Central Bank has a history of excessively tight monetary policy that has generated deflation and at times monetary instability.
Chronic monetary instability damages global trade and relations by creating uncertainty, imposing transaction costs, and fostering currency manipulation and economic nationalism.
Currency risk increases transaction costs for international trade, discouraging international commerce among smaller firms and smaller economies.
Frequent currency devaluation and revaluation lead to trade disputes and political conflict, especially when countries are imposing asymmetrical exchange rate policies.
Economic nationalism arises when countries protect their own currencies, necessitating capital controls or payment restrictions to prevent capital flight and maintain monetary stability. These policies give rise to friction in the form of trade disputes and tariff retaliation.
Monetary instability has also spurred innovation and experimentation in alternative currencies and payment methods, including cryptocurrencies.
Emergence of cryptocurrencies such as Bitcoin and Ethereum, which circumvent traditional financial intermediaries and provide decentralized, low-cost means of payment.
Debate over the regulation and legal status of cryptocurrencies, in light of concerns about money laundering, tax evasion, and financial instability.
Exploration of central bank digital currencies, which could provide safe and stable alternatives to unstable real-world currencies.
Monetary instability has also incentivized the development of diverse financial instruments and strategies to hedge against monetary risk.
Derivatives markets and instruments, such as futures, options, and forward contracts, allow investors and traders to manage their exposure to specific currencies and asset classes.
Index funds and other passive investment strategies provide an easier way to diversify portfolios across numerous different asset classes and reduce overall currency risk.
Financial engineering supports the creation of esoteric financial products that allow individuals and businesses to manage and hedge against monetary risks, while also enabling financial speculation and potentially increasing systemic financial risks.
Ongoing monetary instability has prompted intense debate among economists and policymakers about the appropriate role of monetary policy in maintaining economic activity and financial stability.
Emergence of unconventional monetary policy, such as quantitative easing and negative interest rates, in response to traditional monetary policy's perceived failure to combat deflation, unemployment, and financial instability.
Some economists and political actors advocate monetary populism, arguing that monetary policy should be more directly accountable to elected officials and citizens.
Discussion of Modern Monetary Theory and the nature of money itself, including the potential for helicopter drops and other ways of directly injecting money into the economy as a way of boosting aggregate demand and combating inflation.
The global economy continues to face chronic monetary instability and ongoing debates about the optimal structure and regulation of national and international financial systems. Despite increasing financial sophistication and transnational coordination, achieving monetary stability remains a significant challenge.
