Harmes: Institutional Investors and Polanyi's Double Movement

Harmes, A. 2001. Institutional investors and Polanyi's double movement: a model of contemporary currency crises. Review of International Political Economy 8, no. 3: 389-437.

"This article constructs a model of contemporary currency crises which incorporates the role played by institutional investors and the dynamics associated with Karl Polanyi's notion of the 'double movement'. Polanyi's double movement, and its recognition of the need to integrate politics with economics, is used to explain why so many governments are prone to pursue policies that lead to a speculative attack against fixed exchange rates and why virtually every modern fixed exchange rate regime has ended in crisis. Evidence on the short-term and herd behavior of institutional investors is used to explain why contemporary currency crises do not appear to be justified by underlying economic fundamentals and why these crises do so much more damage than their earlier counterparts" (389; from abstract).

There have been more frequent currency crises since the collapse of Bretton Woods in the early 70s. There are two key features of these crises: the speculative actions that attacked the economic systems of these countries were not based on fundamentals and secondly is the severity of the damage caused by these attacks.

Overview of Mundell Flemming on 391.

Dornbusch et all promote the Washington Consensus view that low taxes, free markets and solid monetary policy will cause returns in the long-run (391).

The author explores financial crises from the perspective of Polanyi's double movement. What the double movement doesn't explain is why crises have become pronounced in the 90s. For that, the author explores the increase in herd mentality that arises from increased institutional investors.

"In policy terms, the key difference between the model presented here and those expounded by proponents of the Washington consensus relates to the viability of the different policy options contained within the unholy trinity or Mundell-Fleming thesis. Where neoclassical models focus on policy autonomy and government intervention designed to stimulate employment and protect wages as the cause of currency crises, this article has located the origins of recent crises with the policy options of capital mobility and fixed exchange rates. Many observers have argued that capital mobility has become a structural feature of the global political economy. Whether true or not, the same argument would seem to apply to democracy and, in turn, to the need for governments to retain their monetary policy autonomy. If this is the case, if both capital mobility and democracy have become structural features of the global political economy, then Polanyi's insights imply that fixed exchange rates...are no longer a viable option" (432).

UPDATE:

"...under conditions of capital mobility, governments are forced to choose between either price and exchange rate stability or monetary policy autonomy; they cannot pursue both simultaneously. For example, if a government sought to maintain a stable exchange rate, it would have to forgo the option of stimulating its economy through a monetary expansion. This is the case as an expansionary policy would cause domestic interest rates to fall below foreign rates, leading to an outflow of capital and, in turn, to a depreciation of the currency. To prevent governments from pursuing such expansionary policies (which are regarded as inflationary), proponents of the Washington consensus have often promoted institutional reforms designed to pre-commit governments to policies of price and exchange rate stability. Such measures range from granting full independence to central banks, to the adoption of fixed exchange rates, to the more drastic measure of creating a currency board" (391).