Debt stabilization (Ch. 17) Asset prices (Ch. 14) & the Interest Rate Parity Condition (Ch. 15)

Transcription

1 Deb sablzaon (Ch. 7) Asse prces (Ch. 4) & he Ineres Rae Pary Condon (Ch. 5) 203

2 Inroducon Oulne Chaper 7. ablzaon of publc deb Chaper 4. Inroducon 2. Bond prces and yelds 3. ock prces and yelds 4. Marke effcency 5. Bubbles Chaper 5 6. Foregn exchange marke 7. Ineres rae pary condon 8. Adjusmen of he exchange rae

3 3. Publc deb and defc fnancng Publc deb (% of GDP), 2009 ource: hp://en.wkpeda.org/wk/governmen_deb

4 3. Publc deb and defc fnancng The evoluon of publc deb Defnons B: sock of ousandng publc deb B/Y: publc deb as percenage of GDP To compare he level of deb across counres, we need o normalze he absolue levels by some measure of he counry sze (GDP). Ineremporal budge consran of governmen: prmary defc should be followed by prmary surpluses (Chaper 7) (G T): prmary defc (G >T = defc, G<T = surplus) r: real neres rae Toal budge defc = (G T) + rb

5 3. Publc deb and defc fnancng The evoluon of publc deb ablzaon of deb: B (or B/Y) s no ncreasng ΔB = 0 or ΔB/Y = 0 No growh & no nflaon Here focus on changes n deb level: ΔB=(G-T)+rB If ΔB > 0: oal budge defc and rsng deb elf-feedng mechansm Explosve deb growh Hgher B means hgher neres paymens: rb Even f G-T=0 deb connues o ncrease If ΔB < 0: budge surplus and declnng deb

6 3. Publc deb and defc fnancng The evoluon of publc deb For he sock of deb no o grow (ΔB = 0), he prmary surplus needs o cover he real cos of servcng he deb (T-G)=rB (T-G)/Y=r(B/Y) Deb sablzaon: Prmary surplus = deb servce Here he surplus s bg enough o sop deb of growng, bu s sll no enough o reduce he deb.

7 3. Publc deb and defc fnancng The evoluon of publc deb Growh & no nflaon growh rae of GDP (ΔY/Y) = g Growh rae of (ΔB/B)=(G-T)/B + r Change n deb rao over GDP growh n (B/Y)= ΔB/B ΔY/Y =(G-T)/B + r - g Δ (B/Y)=(G-T)/Y+(r-g)B/Y If Δ(B/Y)=0 (T-G)/Y=(r-g)B/Y If he economy s growng: s easer o keep he deb/gdp rao sable over me. If g>r he governmen doesn even need o run a prmary surplus o sablze he deb over GDP rao

8 3. Publc deb and defc fnancng The evoluon of publc deb Growh & nflaon (sudy a home) Addonal revenue of he governmen: egnorage Money ha s creaed s worh more han coss o produce. Example: f coss he U governmen $0.05 o produce a $ banknoe, he segnorage s $0.95 (gans of CB belong o governmen) Governmen can use hs revenue o fnance par of s expendures. Hgher segnorage gans means more money prnng hgher nflaon (nflaon ax) = r + π e lower real neres paymens rsng nflaon

9 3. Publc deb and defc fnancng The evoluon of publc deb Growh & nflaon Here he defc can be fnanced also by ncreasng money supply. Fnancng he budge defc wh new borrowng Fnancng he budge defc wh newly prned money ΔB+Δ(M0/P)=(G -T)+rB Δ(B/Y)+Δ(M0/P)/Y=(G-T)/Y+(r-g)B/Y The governmen creaes nflaon by ssung money Wh nflaon: s even easer o manan he deb/gdp rao sable over me.

10 3. Publc deb and defc fnancng Ne debs and prmary budge balances, 2004 (% of GDP) Ne deb Acual prmary budge Requred prmary surplus: b n 2004 surplus n o sablze absolue...o sablze sze of deb deb/gdp rao Belgum Germany Ireland Ialy Neherlands a These are forecass produced n 2003 by he OECD. b The requred surplus assumes a 5% real neres rae and a 2.5% real GDP growh rae. ource: OECD, Economc Oulook

11 3. Publc deb and defc fnancng How much counres need o mprove her prmary budge surplus?

12 4. How o sablze he publc deb ablzng he publc deb hor-run: hree possble approaches all nvolve coss for he prvae secor!.cu he defc by ncreasng axes/reducng publc expendure Vruous road, bu cosly! 2.Prnng money and axng holders of nomnal asses (works f governmen bonds are long-erm and no lnked o nflaon). Effecve only f nflaon s no ancpaed. Less lkely wh ndependen cenral bank Worked ncely for he U.K> n he 9 h cenury; no anymore

13 4. How o sablze he publc deb ablzng he publc deb 3. Defaul on deb Advanage: reduce expendures oday Dsadvanage: ges harder o borrower n he fuure Popular: defaul on foregn deb To pay back deb: you need o run a prmary curren accoun (PCA) surplus PCA >0 In case of defaulng: counry wll no ge any new foregn cred n he near fuure, canno borrow abroad PCA = 0 Defaul on domesc deb: very unpopular among populaon Concluson: he counry can be emped o defaul on he foregn deb.

14 4. How o sablze he publc deb ablzng he publc deb Medum and long run:. Ineres rae relef (r) Hgher defaul rsk hgher neres rae hgher defaul rsk (selffulfllng prophesy) European ably Mechansm (EM): offers counres n need o borrow a lower raes n exchange for srucural reforms (Greece, Porugal, Ireland, Cyprus). Economc growh (g) Increase growh rae o ncrease GDP lower deb/gdp rao

15 Chaper 4: Expecaons and asse prces

16 Inroducon Inroducon Today: Asse markes: focus on he role of expecaons Durably of asses mples ha asse markes are mplcly forward lookng, and are drven by he uncerany abou he fuure Prces (& neres raes) depend on expecaons on fuure evens Bonds ocks Exchange rae Leraure: Chaper 4: NOT relevan: 4.5., 4.5.2, 4.6., boxes 4.2 & 4.3 Burda and Wyplosz: ONLY relevan secons 5., 5.2 (no 5.2.3),

17 . ylzed facs ylzed facs Two very mporan asses are raded on he fnancal markes ocks (=shares) A clam on a par of he profs or earnngs of a frm afer operang coss and neres have been pad Bonds Recognon of deb by he borrower along wh a schedule of paymens concernng boh neres and prncpal Enles he holder o fxed fuure neres paymens (coupons) and he repaymen of he prncpal (face value) a he end of he perod Negave correlaon beween prce and reurn (yeld)

18 2. Asse prces and yelds - Bonds Bond prces and yelds How o oban he prce and he yeld of a bond? I can buy a bond wh a one year maury wh a face value of V= 00 Two possbles: Inves P oday n a bond receve V nex year Inves P oday a he bank receve (+)P nex year No-prof rule: Equvalen fnancal operaons carry he same neres rae. P(+) = V P=V/(+) Prce of bond, P : presen value of oal expeced paymen The lower P relave o V he hgher he yeld ()

19 2. Asse prces and yelds - Bonds Bond prces and yelds Opon : bond wh 2-years maury L : long run neres rae for a bond wh a L years maury Ineres I receve for my bond when L=2: (+ 2 )(+ 2 ) - 2* 2 Assumpon for he momen: absence of a maury premum Opon 2: wo consecuve bonds wh one year maury each : oday s rae of reurn on a one year bond e +: expeced rae of reurn on a one year bond ha s expeced o preval nex year. Ineres I receve for wo -year bonds: (+ )(+ e +) - + e + The neres rae on a LT bond = average of he shor erm neres rae ha people expec o occur over he lfe of he LT bond

20 2. Asse prces and yelds - Bonds Term srucure of neres raes No-prof rule: Equvalen fnancal operaons carry he same neres rae. (2* 2 ) = + e + reurn on he 2-year nvesmen = he expeced reurn on wo consecuve one year nvesmens Formally, he yeld curve can be wren as: L : long erm neres rae Ψ: maury premum Any expeced change n fuure neres raes wll have an effec on he long erm neres raes prevalng oday. Boh acual and ancpaed acons by he cenral bank wll have an effec on he curren neres raes. L L L e L

21 2. Asse prces and yelds - Bonds Yeld curves Wha s he lnk beween shor (T) and long-erm (LT) neres rae? Ineres rae Euro area Theory Ceers parbus, loans wh longer maury are characerzed by hgher neres rae. Due o mpaence 2. Longer maury mples more uncerany (Mos people are rsk averse) Years Maury

22 2. Asse prces and yelds - Bonds Bond prces and yelds In he able below: Face value V = Descrpon of he paymen sream P Prce n euros gven yeld : V P presen value of Yeld gven prce P: V A. One year pure dscoun bond payng euro a end of year B. Two year pure dscoun bond payng euro a end of 2 nd year C. Ten year pure dscoun bond payng euro a end of 0 h year D. Consol payng euro per annum, forever An ncrease n lower P P P P 0 P

23 3. Asse prces and yelds - ocks ock prces ock reurns are unceran, as hey depend on he unceran fuure profably of a frm. ocks (= shares): rsker han bonds, bu hgher yeld possble pays dvdends dependng on he frm s profs How are sock prces and reurns deermned? No-prof rule: reurn on a governmen a one-year bond should be equal o he oal reurn on shares afer one year. d : dvdend pad on he sock a he end of each perod q : sock prce n he begnnng of perod. q + : sock prce f I wan o sell sock n he nex perod.

24 3. Asse prces and yelds - ocks ock prces No-prof rule: reurn on a governmen a one-year bond should be equal o he oal reurn on shares afer one year. Yeld on safe bond d q q q q / Dvdend yeld Capal gan q d q BUT omorrow s sock prce wll depend on he sock prce prevalng he day afer omorrow, prey much n he same way as does for oday. q d q e ( ) 2

25 3. Asse prces and yelds - ocks ock prces If he sock prce doesn grow oo fas, hen we can wre he curren sock prce q 0 as q 0 d In oher words, he marke values a company on he bass of wha earns oday and wha wll earn n he fuure. Ths s he so called he fundamenal value of an asse. Defnon: presen value of expeced dvdends Expecaons of marke parcpans drve prces

26 4. Marke effcency Informaon and marke effcency Expecaons abou he fuure are formed usng all avalable nformaon New nformaon changes expecaons of fuure dvdends and hus changes mmedaely he prces oday. bu only f unexpeced! Oherwse s no new nformaon Changes n sock prces should hus no be predcable! Effcen marke hypohess a marke s effcen f prces fully reflec all avalable nformaon Implcaon: publcly avalable nformaon canno earn conssenly above average reurns Marke prce s an unbased esmae of he rue value of he nvesmen Devaons of he marke prce from he fundamenal value are random.

27 5. Bubbles Bubbles Are fnancal markes really effcen? Prces of asses can dffer from her fundamenal value hrough nose raders Msnformed or ac rraonal and can nfluence he prce of an asse. The asse hen has for a shor me a value dfferen from wha was expeced speculave bubbles Overly opmsc expecaons d q Asse prces rase as long as people beleve ha hey wll rase q

28 5. Bubbles Tulpmana, 637

29 5. Bubbles Housng Prce Index, 978:Q=00 Housng Prces n Ireland, 978:Q 200:Q4

30 5. Bubbles Bubbles Cred drven bubbles Drven by creds: more creds buy more asses asse prces ncrease hgher asse prces make loans easer because hgher collaeral or more capal upward spral Asse prces are well above her fundamenal value When bubble burs dffcul o pay back creds and lenders reduce supply of cred prces declne downward spral The bubble of he subprme: Asse prces rose followng growh n cred When asse prces fell people couldn remburse Endangered he healh of fnancal nsuons and pu no danger he whole fnancal sysem Dre consequences for he whole (world) economy

31 6. Foregn Exchange markes - nroducon The role of he exchange rae markes Foregn exchange markes upply and demand of he currency deermnes s prce = nomnal exchange rae Moneary auhores nervene on he exchange rae marke Fxed exchange rae regmes Fnancal nermedares buy and sell currences on he behalf of her cusomers who need currences for her ransacons The volumes raded on he exchange rae markes are very large Remnder: s he number of foregn currency uns per domesc un Example: =.5 =.5$

32 6. Foregn Exchange markes - nroducon Forward and spo exchange rae The basc deal nvolves smply exchangng mmedaely one currency for anoher po exchange rae () s he exchange rae for currency exchanges on he spo, or when radng s execued n he presen. An alernave s o agree now on he exchange rae for a ransacon a a specfed fuure dae Forward raes (F) are exchange raes for currency exchanges ha wll occur a a fuure ( forward ) dae. Forward daes are ypcally 30, 90, 80, or 360 days n he fuure. Raes are negoaed beween wo pares n he presen, bu he exchange occurs n he fuure.

33 6. Foregn Exchange markes - nroducon Ineres raes and exchange raes Under he assumpon of perfec capal mobly nvesors can buy asses denomnaed n any currency uppose ha you buy a foregn bond expecng o oban an neres rae *, where * s evaluaed n erms of foregn currency An exchange rae mus be used o conver he reurn of he foregn asse n erms of domesc currency The reurn on he foregn bond (= neres paymens convered n o domesc currency) crucally depends on he exchange rae beween domesc and foregn currency

34 7. Ineres rae pary condon Ineres raes and exchange raes Wha s he lnk beween domesc reurn (), foregn reurn (*) and he exchange rae? To answer hs queson, we wll re-explore he neres pary condon consderng now he exchange rae. In parcular, we wll dscuss The uncovered neres rae pary condon (UIRP), whch nvolves rsk-akng The covered neres rae pary condon (CIRP), whch nvolves no rsk-akng behavor

35 7. Ineres rae pary condon -UIRP Uncovered neres rae pary Neherlands UA + (+) = (+*) / e + * $ e e * expeced apprecaon of vs-à-vs $ (+*) $ If <* expeced o apprecae

36 7. Ineres rae pary condon -UIRP Uncovered neres rae pary Neherlands UA + (+0.03) = (+0.04)2/2.02 2$ (+0.04) $ * e <* $ deprecaes / apprecaes (by %): : =2$ +: =2.02$

37 7. Ineres rae pary condon -UIRP Uncovered neres rae pary UIRP: Foregn exchange rsk s no covered. The Duch nvesor nvess n $ 2. The reurn on hs nvesmen s (+*)$. He hen needs o conver hs amoun back no When = *: If he has deprecaed, he Duch nvesor makes a prof If he has apprecaed, he Duch nvesor realzes a loss

38 7. Ineres rae pary condon -CIRP Covered neres rae pary Neherlands + (+) UA = $ (+*) / e /F + (+*) $ F s se so ha we ge he same reurn abroad and a home Agree oday on + F * F * F

39 7. Ineres rae pary condon -CIRP CIRP versus UIRP CIRP Agens cover hemselves agans he exchange rae rsk Emprcally verfed UIRP Agens are wllng o ake rsks Emprcally no verfed One possble explanaon s ha ndvduals are no rsk neural,.e. hey are rsk-averse An augmened verson of he uncovered neres pary ha conrols for a me-varyng rsk premum performs beer e emprcally *

40 UIRP and exchange rae adjusmen e e * * ) ( One mporan mplcaon of he UIRP s ha he curren exchange rae depends on curren neres raes and * bu also on he expeced exchange rae e + Behavor smlar o sock prces. Drven by expecaons 8. Exchange rae adjusmen

41 Forward lookng exchange rae e n n n e e e e e * * 2 2 * * 3 * 2 2 * * 3 * * * 2 * * Exchange rae adjusmen

42 8. Exchange rae adjusmen Exchange rae adjusmen e * uppose you have a sudden ncrease of he domesc neres rae: ( > *) Then should mmedaely rase (.e. apprecae) However: UIRP ells us ha > * should be assocae wh an expeced deprecaon of he domesc currency * e

43 8. Exchange rae adjusmen Exchange rae adjusmen Is here a conradcon? In fac, no! When ncreases above *, nsananeously jumps up Bu as UIRP requres a deprecaon of he domesc currency, afer he jump, he exchange rae deprecaes Ineres rae a home decreases whle currency deprecaes

44 8. Exchange rae adjusmen Nomnal exchange rae, neres raes Exchange rae adjusmen Jump n s followed by a deprecaon of and a decrease n.,* * Tme