Mervyn King: The institutions of monetary policy
Lecture by Mr Mervyn King,1 Governor of the Bank of England, at the American Economic Association
Annual Meeting, San Diego, 4 January 2004.
The references can be found on the Bank of England's website (www.bankofengland.co.uk)
* * *
President, Ladies and Gentlemen,
To have one central bank governor address you today may be regarded as a misfortune, but to invite
two looks like carelessness!
It is a great honour to be invited by this year's President-Elect, Marty Feldstein, to deliver the Ely
lecture. Marty has been my teacher, mentor, colleague and friend for over thirty years, and I never
cease to be amazed by the energy and imagination which he devotes to the study of economic
problems.
I got to know Marty during my time as a Kennedy Scholar at Harvard in 1971. The Kennedy
Scholarships form one part of Britain's national memorial to President Kennedy. The other part is an
acre of land, now American territory, at Runnymede. At the ceremony to open the Runnymede
memorial in 1965, Prime Minister Harold Wilson remarked about President Kennedy that "his eyes
were on the horizon, but his feet were on the ground". Almost thirty years earlier Richard T. Ely
published his autobiography entitled "Ground under Our Feet". Whereas I found the experience of
coming from Europe to the United States intellectually liberating and exhilarating, a hundred years
earlier Ely found academic freedom by making the reverse journey. As he wrote in his autobiography,
"When I first went to Germany I seemed to breathe a new and exhilarating atmosphere of freedom ...
[which] did not exist in [American universities]" (Ely, 1938). Two journeys, separated by a hundred
years, reveal much about what occurred in Europe and America between them. Upon his return, Ely
"undertook to draw up a project for the formation of a society to be called 'The American Economic
Association', which should be broad enough to appeal to all the younger economists who, irrespective
of their personal views, felt the stirring of the new life in economics". His actions helped the AEA to
develop into the great institution it is today.
I have the privilege to work for another great institution, the Bank of England. And, as we celebrate the
150th anniversary of Ely's birth, I thought it would be appropriate to choose as the theme of my lecture
today the role that institutions play in the conduct of monetary policy. In brief, I want to argue that the
core of the monetary policy problem is uncertainty about future social decisions resulting from the
impossibility and the undesirability of committing our successors to any given monetary policy
strategy. The impossibility stems from the observation that collective decisions cannot be enforced so
that it is impossible to commit to future collective decisions; the undesirability reflects the fact that we
cannot articulate all possible future states of the world. It is not possible collectively to commit to
enforce a monetary policy contract with an institution such as a central bank. And, even if we could,
we would not want to because that would prevent us from exploiting new knowledge about the world.
In essence, I want to argue that the relevant theoretical framework could be described as "public
goods meet incomplete contracts". Institutional design is at the heart of collective decisions in a world
of incomplete contracts, and, interestingly, discussion of monetary issues in recent years has focussed
on institutional arrangements.
I shall illustrate the importance of institutional design for the operation of monetary policy by reference
to three case studies: the collapse of exchange rate regimes in Brazil and the United Kingdom;
currency arrangements in Iraq and their reform after the war last year; and the relationship between
central banks and governments when the zero constraint on nominal interest rates is binding.
Money and monetary policy can be traced back to the dawn of civilisation itself. In contrast, central
banks are a recent development. The first central bank was the Riksbank in Sweden, set up in 1668.2
To celebrate its tercentenary it endowed the Nobel Prize in Economics. The Bank of England, the
oldest continuing central bank, opened for business in 1694. Our tercentenary was a more low-key
event: we published a book of conference proceedings. By 1900 there were still only 18 countries with
a central bank. Today the number is 174. The Federal Reserve has yet to reach its centenary. As
institutions go, most central banks are youthful. Indeed, the reputation of central banks as wise and
disciplined institutions, in contrast with the wild excesses of finance ministries, belies their respective
ages. So the history of monetary policy cannot be equated with the history of central banks. But it is a
story about institutions.
I. Externalities in the theory of money
In the history of money, the two key events are the emergence of a medium of exchange and the rise
of institutions governing its management. Those events raise two basic questions which are central to
understanding the nature of monetary institutions. First, why did money evolve as a social or public
rather than a private institution? Second, how can societies reduce the costs of being unable to make
commitments about future collective decisions? The answers to these two questions determine the
nature of modern central banks.
The two questions relate to two different externalities. The first is a network externality. Money
overcomes the constraint of the double coincidence of wants implied by barter exchange, a view set
out in detail by Carl Menger (1892) and which is modelled explicitly in Nobuhiru Kiyotaki and Randall
Wright (1989). More recently, the existence of money has been linked to the information structure of
the economy. Agents have imperfect information about their potential trading partner's credit history
which explains the emergence of a private sector medium of exchange as an alternative to an
extension of credit (Narayana Kocherlakota, 1998). Our willingness to use and hold money is greater
the more that money is used by other people. There is, therefore, a network effect.
One can imagine, and indeed Friedrich Hayek (1976) advocated, a system in which anyone is allowed
to issue money. The private sector may well co-ordinate on using the money of the 'best' issuer, and
that issuer's behaviour may be kept in check by the threat of entry. But competitive monies have
arisen only rarely and in situations where government money is either absent (as, for example, in
Robert Radford's (1945) study of cigarette money in POW camps) or very badly managed (as in
periods of hyperinflation). Despite the abolition of foreign exchange controls, as recommended by
Hayek, competition among national currencies has not lessened the dominance, within each economy,
of a single public money. Network externalities make it difficult for competing currencies to emerge.
The existence of public money generates a second type of externality to do with intertemporal choices.
The willingness to hold money as either a store of value or a means of payment, or use money as a
unit in which contracts are denominated, depends upon expectations of the stability of the value of that
money. If money takes the form of competing private currencies then there is no inherent problem for
private issuers to maintain the value of their liabilities by backing them appropriately, a commitment
that can be enforced by the legal system. Alternatively, where a private commodity standard is the
solution to the exchange problem, then there is no ability -and therefore no temptation - to devalue.
But a public monopoly means that the demand for money today depends upon expectations of our
collective decisions about the supply of money tomorrow. The key question for a public currency is
how do we prevent the government - ourselves - abusing its issuing power in the future? Collective
decisions today cannot bind future collective decisions. And when monetary policy is set period by
period inefficient outcomes result. The key insight of Finn Kydland and Edward Prescott (1977) was
that the inability to make commitments leads to a failure to internalise the impact of public policies on
the expectations of the private sector.
Dynamic inconsistency was used by Kydland and Prescott (1977) and Robert Barro and David Gordon
(1983a) to demonstrate that rational expectations could lead to an equilibrium in which inflation was
Ex post
higher than desired. it would always seem attractive to create surprise inflation. More recently,
research by Lars Svensson (1997), Michael Woodford (2003) and others has shown that even when
there is no inflation bias there can be a "stabilisation bias" from the exercise of discretionary monetary
policy: one that would lead to a suboptimal combination of output and inflation variability. Those results
have prompted a large volume of research exploring different ways in which the commitment to price
stability could be made credible. And central banks themselves have devoted no less energy to
establishing the importance of their credibility.
Two very different approaches to the time-consistency problem have been discussed in the literature.
One examines contractual relationships between the public and monetary decision-makers that reduce
or eliminate the degree of inflation and stabilization biases resulting from discretionary policy.
Examples include formal adoption of monetary policy rules, a contract between government and
central bank instructing the latter to target price stability, the delegation of monetary policy to a
conservative central banker, and investment in a reputation by current decision-makers. But those
answers from the literature on rules versus discretion are not really solutions. They only move the
time-consistency issue one step back - the policy rule may be abandoned, the central banker fired, the
contract reinterpreted or rewritten.3
The other approach says that real central bankers do not and need not worry about
time-inconsistency; they "just do it", (Bennett McCallum, 1995). Central bankers should simply resist
the temptation to deviate from the time-inconsistent policy, and private agents will eventually come to
accept that resolve. Attractive as such a solution may appear to central bankers, it fails to answer the
challenge posed by the game-theoretic result of Kydland and Prescott. And it fails to explain why it is
that some countries in some periods just do it and others do not. Central bankers who have the
determination and strength of purpose to "take the punch bowl away just when the party is getting
going", in McChesney Martin's memorable phrase, clearly have the "right stuff" - so why don't they
4
"just do it"? A deeper explanation of how this problem can be overcome requires an analysis of what
might be called the "technology of collective decisions".
Individual agents can make contracts because they believe that the legal system is external to both
parties to the contract. But it is difficult to write contracts that commit future collective behaviour.
Collectively, we can either meet our previous commitments or we can ignore them. To take just one
example: only a few weeks ago ECOFIN, the council of economic and finance ministers of the
European Union, decided to suspend the excessive deficit procedure - a key feature of the Stability
and Growth Pact - that had been initiated against France and Germany. Ernst Welteke, the President
of the Bundesbank, has since raised serious doubts about whether politicians in Europe are willing to
embrace the collective fiscal discipline, backed up by real sanctions, that is necessary to prevent fiscal
free-riding inside a monetary union.5
II. The role of institutions
The technology of collective decisions describes the feasible set of institutional arrangements that can
be constructed to reduce the costs of the commitment problem. That problem may lead to inefficient
outcomes - the Coase theorem does not apply to collective decisions.6 It is useful to think about the
optimal design of monetary institutions using the insights from the theory of incomplete contracts. That
theory discusses what contracts would look like if certain aspects of the world could not be verified by
an outside enforcer of the contract. In terms of monetary policy, there are two related though distinct
aspects of the commitment problem. First, the inability to enforce commitment, because monetary
arrangements can always be changed in the absence of an outside enforcer, means that no such
arrangement is sacrosanct for all time. Thomas Jefferson believed that the US Constitution should be
rewritten every 20 years or so at a new constitutional convention.7 Second, we cannot fully describe
an optimal monetary arrangement because we do not know all possible states of the world and hence
the policy rule to which we would like to commit. Those two aspects of the technology of collective
decisions create a role for institutions.
But they differ in important ways. If there were only a commitment problem, then we could describe an
optimal state-contingent monetary policy reaction function. Mechanisms could then be devised to
make it less likely that policy would deviate from this optimal plan - perhaps by writing the optimal rule
in the form of a constitutional provision which could be overturned only by a substantial majority, or
financing deficits by issuing index-linked debt. Such mechanisms would make it incentive compatible
collectively to stick to the optimal plan. None of this would have come as a surprise to the authors of
the American Constitution. In Federalist Paper No.10 James Madison points out that "our governments
are too unstable" (p173) and in No. 37 he writes: "the people of this country, enlightened as they are
with regard to the nature ... of good government, will never be satisfied till some remedy be applied to
the vicissitudes and uncertainties which characterise the State administrations" (p243). Outside
observers agreed. In 1835 Alexis de Tocqueville wrote that, "the authority which public men possess in
America is so brief and they are so soon commingled with the ever changing population of the country
that the acts of the community frequently leave fewer traces than events in a private family. .... The
instability of administration has penetrated into the habits of the people".
The stability of institutions is, therefore, one of their greatest assets. Barro and Gordon (1983b)
assumed the existence of an ongoing government or central bank which had an interest in preserving
a reputation for "good" behaviour. A substantial literature, reviewed by Nancy Stokey (2002), analyses
the circumstances in which it is attractive for a "good" government to distinguish itself from a "bad"
government. Stokey shows that if it is not easy to do so, then it may be optimal to impose a monetary
policy rule on all governments in order to reduce the damage done by the prospect of a bad
government in the future. But how can society convince itself that it can eliminate bad government by
adopting a policy rule? A really bad government will simply restore discretion to itself. Good and bad
governments are not independent actors. They reflect the degree of consensus on how to construct
institutions that will pursue consistent objectives.
The experience of high and variable inflation itself can be an important force shaping public attitudes
towards the design of institutions to control it. Differences among cohorts may lead to variations over
time in the optimal shape of institutions, rather as Jefferson advocated. For example, Robert Shiller
(1996) reports that 90% of those born before 1940 in Germany agreed with the statement that 'The
control of inflation is one of the most important missions of German economic policy', compared with
51% of those born from 1950 onwards. Memories of hyperinflation can be vivid: Niall Ferguson cites
the diary of one Frankfurt resident in 1923: "it was more than disorder that smashed over people, it
was something like daily explosions... the smallest, the most private, the most personal events always
had one and the same cause; the raging plunge of money" (p154). So it is not surprising that the
generation of Germans which created the Bundesbank saw it as a crucial component of their new
constitution. Countries, or indeed cohorts, which have not experienced hyper-inflation may be more
willing to adopt monetary arrangements that are less entrenched in constitutional form than the
postwar generation in Germany.
The second aspect of the technology of collective decisions that creates a role for institutions is our
ignorance of all possible future states of the world. That means that even if we were able to commit to
a policy rule, we would choose not to do so. The exercise of some discretion is desirable in order that
we may learn. The most cogent argument against the adoption of a fixed monetary policy rule is that
no rule is likely to remain optimal for long. Nor is this just a question of learning about parameter
values. That would yield an optimal state-contingent procedure for updating the monetary policy rule. It
is that we are unwilling to commit now never to learn from future experience. So we would not want to
embed any rule deeply into our decision-making structure, such as giving it the force of law or making
it part of the constitution. Instead, we delegate the power of decision to an institution that will
implement policy period by period exercising "constrained discretion". The status and purpose of such
institutions can be embedded into the law or constitution, which may increase the cost of reversing the
delegated powers, but the optimal policy path should be open to change in response to learning. Since
we cannot hope to describe ex ante what it is we expect to learn, and since new ideas are unlikely to
be uniformly recognised and instantly accepted, it may be sensible to delegate both the immediate
policy decision and the process of learning to the same institution.8
An interesting example of seeking flexibility to allow for learning occurred during the writing of the US
constitution. One draft clause specified that Congress should be allowed to "... emit bills on the credit
of the United States". There was a debate on a proposition to strike out the clause. Madison's notes
describe George Mason's position on the subject: "Though he had a mortal hatred to paper money,
yet, as he could not foresee all emergencies, he was unwilling to tie the hands of the legislature".9
Edmund Randolph was of a similar opinion: "... notwithstanding his antipathy to paper money, [he]
could not agree to strike out the words, as he could not foresee all the occasions that might arise."
So the ideal is a framework that will implement what we currently believe to be the optimal monetary
policy strategy and will deviate from that only if collectively we change our view about what that
strategy should be. Our ignorance is too pervasive to allow the adoption of a rule for how learning
should occur. So if it is sensible to delegate both policy decisions and the process of learning to
institutions such as central banks, that in turn requires those institutions to have political legitimacy
and an acceptance that they will not redistribute income and wealth in favour of some groups rather
than others at the expense of the objective given to them.10 Where such institutions are difficult to
create, the 'external effect' - as Stokey (2002) called it - of good monetary policy will not be captured.
And if the result is a monetary policy that is sufficiently bad, it may result in a radical switch to a unit of
account determined externally, an obvious example of which is dollarisation.
Monetary institutions, therefore, play two different roles. First, they expand the possibility frontier of the
technology of collective decisions and can be designed to raise the cost of those decisions deviating
from pre-announced contingent paths. Second, they are set up explicitly to exercise a degree of
discretion - "constrained discretion" - subject to the broad objective of price stability. Discretion is
inevitable because of the need to learn about the economic environment. Institutions thereby become
repositories of experience and knowledge which they communicate to society as a whole.
III. Case Study I: Exchange rate regimes in Brazil and the UK
I want to illustrate the importance of institutions and the credibility of their stability by three case
studies. My first example concerns the collapse of exchange rate regimes in Europe and Latin
America. It demonstrates that economic institutions require a broad base of political support if financial
markets are to believe that those institutions are likely to survive.
For a while fixed exchange rate regimes enjoyed a degree of support in both Europe, with the
Exchange Rate Mechanism (ERM), and Latin America. But experience shows that, in terms of
credibility in financial markets, the design of those policy regimes was less important than the fact of
their having broad political support.
Brazil in 1998-99 is a case in point. In 1998 Brazil operated a crawling peg exchange rate regime. As
can be seen from Chart 1, throughout that year markets expected the Real to depreciate as evidenced
by the fact that the implied forward exchange rate was lower than the spot rate by more than the crawl
would imply.11 In order to defend the crawling peg, the central bank raised interest rates in September
1998 from 20% to 40% a year. The implied forward exchange rate promptly fell. Raising interest rates
actually increased the expectation that the peg would be abandoned, since markets knew that high
interest rates were likely to prove politically unsustainable. Any government prepared to keep interest
rates that high was not likely to win re-election. In January 1999 a second speculative attack on the
peg occurred. And this time the peg was abandoned. Although short-term interest rates were raised
while the peg was being defended, they were soon lowered to more sustainable levels. The
expectations that had been built into forward exchange rates were proved correct.
Chart 1: Exchange rates and monetary
policy in Brazil, Jan 1998-Dec 1999
Reais/$
Per cent
50 0
45
0.5
40
Spot exchange
35 Overnight
rate (rhs)
1
interest rate
30
(lhs)
25 1.5
20
Implied
2
15
forward
10
exchange rate
2.5
(rhs)
5
0 3
Jan-98 May-98 Sep-98 Jan-99 May-99 Sep-99
Source: JP Morgan and Banco Central do Brasil
In the literature on target zones for exchange rates, it is assumed that raising interest rates is a
successful method for supporting the exchange rate because of uncovered interest parity. But this
ignores the possibility that raising interest rates to defend a fixed exchange-rate regime will simply call
into question the durability of the regime itself and raise the probability that the peg or target zone will
be abandoned. In such circumstances an increase in interest rates may lead to a fall in the exchange
rate.
A second example of the same phenomenon is the pressure on sterling during 1992 and its forced
departure from the Exchange Rate Mechanism on 16 September of that year. Massive speculation on
that day led to the announcement in the morning of a 2 percentage points rise in interest rates and,
when that failed to dampen the pressure on sterling, of a further 3 percentage points rise in rates. That
second announcement, far from bolstering the exchange rate, merely convinced financial markets that
Britain's membership of the ERM could no longer be sustained politically. The strong political
commitment to joining European monetary union, which was the effective support for other currencies
in the ERM, was absent in the United Kingdom.
Following its departure from the ERM, the UK introduced an inflation target regime for monetary policy.
It succeeded in bringing inflation down to around 21⁄2 percent (see chart 2).
Chart 2: UK inflation and inflation
expectations, Oct 1991-Oct 2003
Per cent
7
Implied inflation
(a )
from IGs
6
RPIX inflation rate
5
4
3
2
Inflation
Bank
1
target
independence
announced
0
Oct-91 Oct-93 Oct-95 Oct-97 Oct-99 Oct-01 Oct-03
(a
)Implied average inflation expectations from 5 to 10 years ahead, derived from index-linked
gilts. Source: Bank of England, ONS
But long-term inflation expectations did not fall as quickly. Only after the announcement in May 1997
by the new Labour government that the Bank of England would be made independent did inflation
expectations fall quickly to the target level, as can be seen from chart 2. That reform created an
expectation that it would be in the interests of all political parties not to repeal the legislation. For the
first time since the Second World War, there was a broad-based and credible commitment in the UK to
stable and low inflation.
The need for any monetary regime to command sufficient support in order to acquire a reasonable
lifeexpectancy was given insufficient weight in the discussions that took place at the IMF and elsewhere
on Brazil and other financial crises of the 1990s. The point is made by Guillermo Calvo and Frederic
Mishkin (2003) when they write, "the key to macroeconomic success in emerging market countries is
not primarily their choice of exchange rate regime, but rather the health of the countries' fundamental
macroeconomic institutions, ... less attention should be focused on the general question whether a
floating or a fixed exchange rate is preferable, and more on these deeper institutional
arrangements" (p5).12
IV. Case Study 2: Currency reform in Iraq
The importance of expectations about the future of monetary institutions is illustrated by the recent
monetary history of Iraq. This second case study demonstrates that expectations of future collective
decisions can have a major impact on the value of a currency quite independently of the policies
pursued by the current government. Expectations of monetary decisions within a given policy regime
may be less significant than expectations of changes in the regime itself. In Iraq, regime change took
on a new meaning. What is particularly interesting about Iraq is the link between expectations of a
change in political regime and movements in currency values.
Prior to the Gulf War in 1991 the Iraqi currency was the dinar. Following that war Iraq was divided into
two parts that were politically, militarily and economically separate from each other: southern Iraq was
under the control of Saddam Hussein and the enforcement of the northern no-fly-zone meant that
northern Iraq became a de facto Kurdish protectorate. In the South, Saddam's regime struggled to
cope with UN sanctions, and resorted to printing money to finance growing fiscal deficits. Unable to
import notes printed abroad because of sanctions, the regime printed low-quality notes in Iraq that
bore Saddam's image. In May 1993, the Central Bank of Iraq announced that the 25 dinar note, then
the highest denomination note in circulation, would be withdrawn and replaced by a new locally printed
note. These were known as 'Saddam' or 'print' (because of the offset litho print technology used)
dinars. Citizens had three weeks to exchange old for new notes. So many notes were printed that the
face value of cash in circulation jumped from 22 billion dinars at the end of 1991 to 584 billion only four
years later. Inflation soared to an average of about 250% a year over the same period. As a result the
smaller denomination notes became worthless in Southern Iraq.
In the North, however, matters were rather different. Residents in that part of Iraq had no opportunity
to exchange their notes. And it was no accident that, because of expropriation of cash in the banks by
the Saddam regime, the holders of the high denomination notes were disproportionately in the North.
Of the seven billion 25 dinar notes in circulation in Iraq at that time, about five billion circulated in
Kurdish-controlled Iraq. So the Saddam dinar did not circulate in the North, and the old dinar notes
continued to be used. They were known as the 'Swiss' dinar - so-called because although the notes
had been printed by the British company De La Rue, the plates had been manufactured in
Switzerland. The Swiss dinar developed a life of its own and in effect became the new currency in the
North. No Swiss dinar notes were issued after 1989, and since there was no issuing authority there
was at most a fixed, and probably a declining money stock in the North. As a result the Swiss and
Saddam dinars developed into two separate currencies.
For ten years, therefore, Iraq had two currencies: one issued by the official government and the other
backed by no government at all. The Swiss dinar continued to circulate in the North, even though
backed by no formal government, central bank, nor any law of legal tender. For a fiat currency this was
an unusual situation. Whatever gave the Swiss dinar its value was not the promise of the official Iraqi
government, or indeed any other government.13
Although there was little or no trade between North and South Iraq, both the Swiss and Saddam
dinars were traded against the dollar. The implied Swiss to Saddam dinar cross-exchange rate from
1997 onwards is shown in Chart 3.14
Chart 3: Saddam/Swiss Dinar
exchange rate, Jul 1997-Oct 2003
Saddam/Swiss Dinars
(log scale)
400
200
100
50
Jul-97 Jul-98 Jul-99 Jul-00 Jul-01 Jul-02 Jul-03
Source: United Nations, Central Bank of Iraq
After 1993 the Swiss dinar deviated from parity and rose to around 300 Saddam dinars to the Swiss
dinar by the time Saddam's regime was deposed in 2003. The appreciation of the Swiss dinar is
clearly a consequence of the evolution of the actual and expected money supplies in the two
territories.
Given the monetary and fiscal policies pursued by the Saddam regime, the rise of the Swiss dinar
against the Saddam dinar is, perhaps, understandable. But what is less obvious is the path of the
Swiss dinar against the US dollar. Chart 4 shows the Swiss dinar-dollar exchange rate from 1997
onwards.
Chart 4: The Swiss Dinar/Dollar
exchange rate, Jul 1997-Oct 2003
Swiss Dinar/$
0
5
10
Swiss Dinar/$
15
20
25
30
35
Jul-97 Jul-98 Jul-99 Jul-00 Jul-01 Jul-02 Jul-03
Source: United Nations, Central Bank of Iraq
After fluctuating in the early 1990s, the Swiss dinar rose sharply against the US dollar from the middle
of 2002 as the prospect of an end to the Saddam regime increased. It rose from around 18 to the
dollar in May 2002 to about 6 to the dollar by the beginning of May 2003 when the war ended. That
appreciation reflected expectations about (i) the durability of the political and military separation of
Kurdish from Saddam-controlled Iraq and (ii) the likelihood that a new institution would be established
governing monetary policy in Iraq as a whole that would retrospectively back the value of the Swiss
dinar. The political complexion of Northern Iraq led to the assumption that the currency used there
would have value once regime change had occurred.
In other words, the value of the Swiss dinar had everything to do with politics and nothing to do with
the economic policies of the government issuing the Swiss dinar because no such government
existed. As someone might have said, "it's the political economy, stupid!"
Another illustration of this is shown in Chart 5 which plots the Swiss dinar/dollar exchange rate against
the values of futures contracts showing how expectations about the political order in Iraq were
evolving.
Chart 5: Exchange rates and regime change
in Iraq, Sep 2002-Dec 2003 Swiss Dinar/$
Cents
100 0
Saddam deposed by
a
90 2
end June 03
Saddam captured by
b
80 4
end Dec 03
70 6
60 8
50 10
Swiss Dinar/$ (rhs)
40 12
30 14
20 16
10 18
0 20
Sep-02 Dec-02 Mar-03 Jun-03 Sep-03
Source: United Nations, Central Bank of Iraq, Tradesport Exchange Limited
a
Value in cents of a contract that paid 100 cents if Saddam is deposed by the end of June 2003, and 0 otherwise
b
Value in cents of a contract that paid 100 cents if Saddam was captured by the end of December 2002, and 0 otherwise
One futures contract paid out 100 cents if Saddam was deposed by the end of June 2003 and nothing
otherwise. As the chance of Saddam's regime being deposed (and the price of the future) rose, the
Swiss dinar appreciated against the dollar. Later there was also a future that paid 100 cents if Saddam
was captured by the end of December 2003, and nothing otherwise. As the chance of this happening
(and the price of the future) fell last autumn, the Swiss dinar fell against the dollar. It has just risen
ag