Economics International & Macro
Why do economists generally favor free trade? Why restrict trade? How? How do exchange rates matter to the macro economy? How are exchange rates determined in the short-run? The long-run? What's `bad' about a current account deficit? A Financial account surplus? What's wrong with globalization?
Globalization is good / antiwto
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Course Issues
Consumption Function Assignment Final Exam Conflicts what is it? see me after class or office hours with Total Points documentation starting 12/1 Approximate Curve Makeups only if documented conflict in advance A 850 Graduating Seniors? B+ 800 Review Guide, Essential Questions,Q&A B 780 Grade book problems-check NOW! C+ 740 Grading explanation C 670 Extra Credit D 600 Last Class Tues 12/13 F < Final Exam Thursday December 22 8am CAC Gym
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Is Globalization Bad for the U.S.? (and is the world flat?)
Free trade
Comparative Advantage Gains from Trade Economies of Scale International transmission of ideas International Competition
Flat World Globalization
gains larger labor pool how to compete? W/MP
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International (Open-Economy) Macro
Exports, Imports and Aggregate Demand D=C+I+G+X-M Open Economy Macro
Monetary Policy strengthened
Msi I D And Msi $ X & M D more
Fiscal Policy weakened
Gi $D
Additional objectives
exchange rates and balance of payments
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Twin deficits Problem
Government Budget Deficit MAY lead to Current Account (`trade') deficit
Since Y=C+I+G+X-M = C+S+T then M-X=(G-T)+(I-S) that is a trade deficit (M-X) can be caused by a government budget deficit (G-T) (holding I-S) constant Greece?
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World Trade Organization (WTO)
supervise and liberalize international trade 1995 - replaced the General Agreement on Tariffs and Trade (GATT) started in 1948 regulation of trade between participating countries framework for negotiating and formalizing trade agreements dispute resolution process aimed at enforcing participants' adherence to WTO agreements Doha round (wikipedia)
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European Union (wikipedia)
economic and political union of 27 countries
500 million pop, $16 trillion gdp
origins from the European Coal and Steel Community and European Economic Community 1958 - Germany Maastricht Treaty 1993 current name and form supranational independent institutions and decisions negotiated by the member states European Commission, Council of European Union, the Court of Justice of the European Union, and the European Central Bank. Promotes single market through a standardised system of free movement of people, goods, services, and capital enacts legislation in justice and home affairs, and maintains common policies on trade,agriculture, fisheries and regional development. eurozone, 1999 - 17 member states, common currency and monetary policy
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Exchange Rates and Currency Markets
Exchange rates
currency per $ JPY/US$ =84.35 $ per currency US$/JPY=.0119 floating/flexible/dirty or managed float appreciate/depreciate Rates fed Real Exchange rates
FOREX Largest financial Market
Almost $4 trillion daily 30x equity 24 hour over the counter spot and forward futures markets
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Why Do Exchange Rates Matter?
July 2008 1 GBP = $2
Big Mac $4 in US ; 2.5 GBP in England For 2.5 Brits could get $5 and 11/4 big macs
Brits come to U.S. to buy (i.e. U.S exports increase) 11/2011 GBP = $1.55 ( depreciated=$ appreciated)
Big Mac @$4 = 2.58 cheaper in England Stay home U.S. exports drop
Exchange rates->X,M->D
$ up ->X down, M up ->D down
Also, Return on Real and Financial Assets
Brit Bank Accounts in in U.S. 1GBP-> $2->10% a year ->$2.2->1.1 GBP 10% If GBP falls to $1.5? $2.2->1.47 GBP 47% return If currency expected to appreciate-> capital inflow and currency appreciates
Xrates impact trade and capital flows
$ down-> X up, M down -> Curr Acct Improves ->net purchase of U.S. assets down
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How are Exchange Rates determined in the SR?
Flexible/ Floating
Managed or dirty float
S&D for Currency
derived from S&D for goods and services real and financial assets
primarily speculative flows 95% interest rates
Demand interest rate differentialsspeculative flows income growth expected exchange rates
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LR Exchange Rates- PPP
Law of One Price
Trade commodities tend to price equality arbitrage
Purchasing Power Parity
Exchange rates adjust in LR to equalize prices Implications
Exchange rates move in opposite direction to relative price changes Inflation up in A -> currency depreciates Productivity up in A -> currency appreciates
Big Mac (and other) Surveys PPP exchange rates
`real' exchange rate 2010 GDP at `market' exchange rate $4.99 trillion $1=6.49 yuan 2010 GDP at ppp $9.87 trillion
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Big Mac Prices 2008
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What's `wrong' with China's exchange rate regime?
`Fixed' rate (and capital controls)
government buys/sells yuan to maintain if too high outflow of official reserves
eventual devaluation
if too low
inflow of reserve - $ X up, M down Gov't demand for U.S. financial assets
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Tri-Lemma
Choose 2 of three: fixed exchange rates capital mobility discretionary monetary policy control Why? if fix rates and have capital mobility, must use monetary policy to control interest rates to manage demand for currency China fixed rates and capital mobility (partial) loses control of Ms and Ms increases with increases in foreign demand-> inflation? Eurozone, including Greece? no discretionary monetary policy for individ countries
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Fixed versus Flexible Exchange rates
Fixed eases int'l business/trade
Certainty But no adjustment automatic to deficits/surpluses Eventual revaluations Financial crises speculative attacks, etc
Floating automatic adjustments
Considerable uncertainty difficult for intl business Derivatives and other hedging mechanisms
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What's Wrong with a Current Account
Balance of Payments U.S.International Transactions inflows credit + outflows debit Current Account Deficit
Current Economic Activity - Goods & Services, Income, Transfers X-M mostly `bad' - jobs X, M
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What's Wrong with a Financial Account Surplus?
Financial Account (Capital Account ) Net financial inflows net purchases of real and financial assets U.S. purchase of foreign assets debit since funds flow out Foreign purchase of U.S. assets credit since funds flow in Surplus `Bad' since foreign ownership of U.S. assets increasing U.S. indebtedness up Opposite of Net Capital Outflow Sum to 0 Current Account Deficit -> Financial Account Surplus Or NX=NFI
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Greece?
Inflation, high costs ->imports>exports Current Account Deficits -> Capital Account surpluses (borrowing from Abroad) Large gov't deficits twin deficit problem and lots of domestic and international debt Tri-lemma with `fixed' exchange rates, no discretionary monetary policy What if had own currency?
PPP inflation-> depreciation->X up, M down, etc Harder to borrow
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Evolution of Int'l Financial System
Gold Standard 1870-WWI
Fully convertible currencies fixed wt fixed exchange rates Price-specie automatic adjustment-Hume
Curr Acct deficit->Gold Ouflow->Ms falls->Prices fall->X up, M down-> deficit ends
Bretton Woodsfixed exchange rates 1944-1973
Keynes - $ reserve currency $35 per ounce gold Other currencies fixed to $ - interventions as necc IMF, World Bank no ability for reserve currency to be devalued, collapse
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Int'l Financial System-Now
Flexible Rates for Majors since '73
Development of forward markets and derivatives for hedging exchange rate risk
Futures in currencies
EMU 1/1/1999
Single currency, `fixed' rates
Asian Financial Crisis
Fixed rates, speculative attacks, hot money (capital flows)
China's fixed rate / peg
Up 21+% against dollar since 2005 Before crisis tril-lemma inflation concerns
World-wide financial crisis
Central bank coordination No world lender of last resort
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Foreign Exchange Crises
Mexico 1994 Tequila Crisis
Fixed exchange rates, dollar loans, large current account deficit; bank losses Devalued (50%) and floated; also hot money Fed and Treasury helped out
East Asian 1997 - Thailand, Indonesia, South Korea
Fixed exchange rates above mkt hot money
Borrowing in dollars capital outflows and Speculative attacks
Devaluation and float, pain, IMF structural reforms, anger
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More
Iceland
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International Financial Organizations
Basel Committee on Banking Supervision
10 central banks, 1973, recommendations to central banks, informal, avoid regulatory arbitrage Basel II risk based capital requirements
Bank for International Settlements (BIS) 1930
Bank for central banks Coordination of monetary policy, informal Settlements for international central banks
International Monetary Fund -1944
Stabilize (fixed) exchange rates Financial assistance to countries in financial and economic difficulties Loans, stringent fiscal policies
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Intl Financial Organizations &Systems
World Bank
Loans to developing countries
Payments Systems
U.S. ACH
CHIPS and Fedwire
Committee on Payment and Settlement Systems (CPSS)
BIS
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Putting it together
Free trade good in theory (and practice) X,MD y,P M>X Current Account Deficit (CAD) Financial Account Surplus (FAS)
Weakens aggregate demand, slows economy, selling assets or going into debt
Balance of Payments CAD+FAS=0
Funds in credit (+), out, debit (-) CAD `bad' since weakens agg D FAS `bad' since debt
xrates X, M
CAD $ (flex xrates) since X increases D for $ "weak" $ X M CAD (Agg D ) Self-adjusting (but uncertainty in intl business)
Hedging thru derivatives
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More
Xrates
SR flexible/floating (or dirty/managed float)
D derived from demand for goods, svcs, assets
LR PPP exchange rates adjust to equal prices
Infl A > infl B currency A depreciates
Twin Deficit Problem
Since I=S+(T-G)+(M-X) )(M-X)=(I-S)+(G-T)
Cet. Par. If G-T up, M-X up Gov't Budget Deficit MAY lead to curr acct deficit
Tri-Lemma can only get 2 of following three
Capital mobility, monetary policy control, fixed exchange rates.
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International (Open-Economy) Macro
Exports, Imports and Aggregate Demand Monetary Policy strengthened
Additional objective
exchange rates and bop
Trilemma
Can only have 2 of following:
Fixed exchange rates Capital mobility Control of monetary policy
Fiscal Policy weakened
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Monetary Policy with Open Economy
Additional channel, strengthened
M up->i down->$ down->X up, M down->D up
Additional `goal'/concern of Fed
Weakening $ - possible inflation (import costs) Reduced confidence in $ - reduced demand for assets and Cap acct weakened.
Borrowing costs increased
Nominal Anchor exchange rate targeting Dollarization
Currency Board
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Key Points
Free Trade, Comparative advantage, Globalization SR Exchange Rates Flexible Rates S&D for currency Long-Run Exchange Rates PPP costs/inflation Balance of Payments international transactions Current account deficit X<M Capital Account Surplus - debt Evolution of International Financial System Gold standard, Bretton woods fixed rates, Flexible rates, ? Open Economy Monetary Policy X.M->D; Ms->$->D
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