Macro Lecture 19: Inflation Targeting and International Finance

Transcription

1 Macro Lecture 19: Inflation Targeting and International Finance Inflation Targeting A More Active Fed Recall that we find it useful to divide the Fed policy actions into two categories: application of the Taylor principle and autonomous monetary policies: Application of the Taylor principle. Movements along the upward sloping Fed policy (FP) curve: o An increase in the inflation rate () leads the Fed to increase the real interest rate (r) thereby slowing down the economy. o A decrease in the inflation rate () leads the Fed to decrease the real interest rate (r) thereby speeding up the economy. Figure 19.1 illustrates why the along the upward sloping Fed policy (FP) curve results in a downward sloping aggregate demand (AD) curve by considering an increase in the inflation rate () results in a movement: FP Question: What would the real interest rate (r) equal, if the inflation rate () were percent, given that the Fed does not change its inflation policy? π (%) AD Question: How many final goods and services would be purchased if the inflation rate () were percent, given that all other factors relevant to demand remained the same? π (%) FP Inflation rate () increases Real interest rate (r) increases r (%) Loans become more costly Households and firms purchase less Taylor principle (FP curve) Figure 19.1: Downward sloping aggregate demand (AD) curve AD G&S Fewer goods and services purchased

2 2 Autonomous monetary policies. Shifts of the entire Fed policy (FP) curve: o Autonomous contractionary monetary policy: The Fed becomes tougher on inflation by shifting the entire Fed policy (FP) curve right. At a given inflation rate (), the Fed increases the real interest rate (r). o Autonomous expansionary monetary policy: The Fed becomes easier on inflation by shifting the entire Fed policy (FP) curve left. At a given inflation rate (), the Fed decreases the real interest rate (r). Figure 19.2 illustrates the effect of an autonomous contractionary monetary policy. FP Question: What would the real interest rate (r) equal, if the inflation rate () were percent, given that the Fed does not change its inflation policy? π (%) FP AD Question: How many final goods and services would be purchased if the inflation rate () were percent, given that all other factors relevant to demand remained the same? FP π (%) At a given inflation rate () Real interest rate (r) increases r (%) Loans become more costly Households and firms purchase less Fewer goods and services purchased Figure 19.2: Autonomous contractionary monetary policy AD AD G&S Aggregate demand (AD) curve shifts left In 2012, the Fed adopted inflation targeting. In historic shift, Fed sets inflation target By Jonathan Spicer Wed Jan 25, :35 EST (Reuters) - The Federal Reserve took the historic step on Wednesday of setting an inflation target, a victory for Chairman Ben Bernanke that brings the Fed in line with many of the world's other major central banks. The U.S. central bank, in its first ever "longer-run goals and policy strategy" statement, said an inflation rate of 2 percent best aligned with its congressionally mandated goals of price stability and full employment.. Inflation targeting uses autonomous monetary policies to achieve a predetermined inflation rate target: First, the Fed chooses a target inflation rate. Second, the Fed pursues autonomous monetary policies to meet the target. That is, the Fed shifts the Fed policy (FP) curve intercept to achieve its target inflation rate.

3 3 We begin by reviewing the results from Lab 18.1 in table 19.1 and figure Note that in this lab the Fed only applied the Taylor principle. The Fed did not conduct an autonomous monetary policy; hence, the Fed policy (FP) curve remained stationary. Congress and the President create a deficit by increasing government purchases while keeping taxes unchanged. Higher inflation and a consequently a higher real interest rate (r) resulted. The higher real interest rate crowded out private investment. Govt Con Invest Int Rate Infl Rate Period GDP Purch Deficit Purch Purch r (%) (%) 0 2, , , , , , , , , , Table 19.1: No Inflation Targeting Fed only apples the Taylor principle FP Question: What would the real interest rate (r) equal, if the inflation rate () were percent, given that the Fed does not change its inflation policy? π (%) 3.0 FP π (%) AD Question: How many final goods and services would be purchased if the inflation rate () were percent, given that all other factors relevant to demand remained the same? LRAS AS 7,... AS 0,1 AD 1,2, AD r (%) 2,000 2,100 (Actual) inflation rate increases Expected inflation rate increases AS curve shifts up ç ã å (Actual) inflation rate increases Figure 19.3: Increase in government spending é GDP decreases G&S

4 4 Now, we consider inflation targeting. As before, suppose that Congress and the President create a deficit by increasing government purchases while keeping taxes unchanged. Unlike the previous lab, however, the Fed is targeting inflation; the inflation target is 2.0 percent, the benchmark inflation rate that we have been using. The Fed recognizes that the expansionary fiscal policy pursued by Congress and the President will shift the AD curve right. If the Fed only applies the Taylor principle, the inflation rate would rise above the 2.0 percent. To meet the inflation target of 2 percent, the Fed must shift the aggregate demand (AD) curve left to counter the expansionary fiscal policy enacted by Congress and the President. Consequently, the Fed pursues an autonomous contractionary monetary policy thereby shifting the Fed policy (FP) curve right as shown in figure The expansionary fiscal policy and the autonomous contractionary monetary policy offset each other; the aggregate demand (AD) curve is stationary and the inflation rate remains at 2 percent. Macro Lab 19.1 helps us understand inflation targeting. Table 19.2 reports the results. Macro Lab 19.1: Inflation Targeting Govt Con Invest Int Rate Infl Rate Period GDP Purch Deficit Purch Purch r (%) (%) 0 2, , , , , , , , , , Table 19.2: Inflation targeting Marco Lab 19.1 FP Question: What would the real interest rate (r) equal, if the inflation rate () were percent, given that the Fed does not change its inflation policy? π (%) FP 0 π (%) AD Question: How many final goods and services would be purchased if the inflation rate () were percent, given that all other factors relevant to demand remained the same? LRAS AS 0,1 Contractary Monetary FP 1,2,... Expansion Fiscal Contractary Monetary AD 1,2, AD 0,1,... r (%) ,000 2,080 Figure 19.4: Increase in government spending G&S

5 5 Macro labs 18.1 and 19.1 both create a deficit by increasing government purchases while leaving taxes unchanged. The labs differ only in the Fed s response: Macro lab 18.1: The Fed does not target inflation; that is, the Fed does not respond with an autonomous contractionary monetary policy in response the expansionary fiscal policy. The Fed only applies the Taylor principle. Macro lab 19.1: The Fed targets inflation; that is, the Fed responses with an autonomous contractionary monetary policy in response the expansionary fiscal policy to prevent the inflation rate from rising. Table 19.3 compares the results from the two labs to determine the long run impact of inflation targeting and more generally the long run impact of autonomous monetary policies. No Inflation Targeting Inflation Targeting: 2.0% Govt Con Invest Int Rate Infl Rate Period GDP Purch Deficit Purch Purch r (%) (%) 0 2, , , , , , , , , , , , , , , , , , , , Table 19.3: Effect of inflation targeting Focus on the long run effect of inflation targeting. In the long run, the Fed s monetary policy: Has no effect on the real economy. Has no effect on real o GDP o Consumption purchases o Investment purchases o Government purchases o Interest rate Has an effect only on the inflation rate. When the Fed targets it remains at 2.0 percent; when the Fed does not target it rises from 2.0 to 3.2 percent. These results illustrate an important macroeconomic principle which has a fancy name: Classical dichotomy: In the long run, monetary policy: Does not affect the real economy. Does affect inflation.

6 6 Foreign Exchange Rates Table 20.1 reports the current euro-dollar exchange. There are two equivalent ways of express the exchange rate: dollars per euro and euros per dollar: Exchange Rate expressed as Dollars per Euro = buys $1.34 Exchange Rate expressed as Euros per Dollar =.75 $1.00 buys.75 Table 19.4: Two equivalent ways to express an exchange rate One reason that international finance can be confusing is that some exchange rates are typically expressed one way and others the other way. For example, British pound-dollar exchange rate is usually expressed in dollars per pound while the Japanese yen-dollar exchange rate is usually cited in yen per dollar. To reduce confusion we will be consistent and always express the exchange rate in foreign currency per dollar. Terminology: Weak and Strong Currencies On the one hand, when the (euro per dollar) exchange rate is low the dollar is weak and the Euro is strong: a dollar buys few euros a euro buys many dollars On the other hand, when the (euro per dollar) exchange rate is high the dollar is strong and the Euro is weak: a dollar buys many euros a euro buys few dollars Exchange Rates and Prices Suppose the price of a Chevy Volt in the U.S. is $30,000. Its price in Europe depends on the euro-dollar exchange rate as show in table Price of a Chevy Volt = $30,000 Weak Dollar (Strong Euro) Strong Dollar (Weak Euro) Exchange Rate.50 per $ per $ per $1.00 Price of Volt 15,000 per $30,000 30,000 per $30,000 60,000 per $30,000 Table 19.5: Exchange rates and the price of a Chevy Volt in Europe A low exchange benefits European consumers because a Chevy Volt costs less in Europe and it also helps U.S. firms because GM will sell more Volts in Europe Similarly, suppose that the price of a BMW in Europe is 60,000. Its price in the U.S. depends on the exchange rate as shown in table Price of a BMW = 60,000 Weak Dollar (Strong Euro) Strong Dollar (Weak Euro) Exchange Rate.50 per $ per $ per $1.00 Price of BMW 60,000 per $120,000 60,000 per $60,000 60,000 per $30,000 Table 19.6: Exchange rates and the price of a BMW in the U.S. A high exchange benefits American consumers because a BMW costs less in the U.S. and it also helps European firms because BMW will sell more cars in the U.S.

7 7 Summary: Who benefits from a weak Dollar Question: Who benefits from a strong Dollar (strong Euro)? (weak Euro)? European consumers. American consumers. American firms. European firms. Foreign Exchange Market for Dollars: Europeans Demand American Goods and Services Europe Demand Dollars Foreign Exchange Market Supply Dollars United States Americans Demand Europoean Goods and Services Figure 19.5: Foreign exchange market As figure 20.1 shows, Europeans demand dollars to purchase American goods and services. Americans supply dollars to purchase European goods and services. Demand and Supply As the exchange rate in terms of Euros per Dollar increases. ã é Does the Dollar become Does the Euro become more or less expensive for more or less expensive for Europeans? More. Americans? Less. Do U.S. produced Do European produced goods and services become goods and services become more or less expensive for more or less expensive for Europeans? More. Americans? Less. Do Europeans demand Do Americans demand more or fewer U.S. produced more or fewer European produced goods and services? Fewer. goods and services? More. Do Europeans demand Do Americans supply more or fewer Dollars? Fewer. more or fewer Dollars? More. The demand curve for Dollars is The supply curve for Dollars is downward sloping. upward sloping In reality, the American price elasticity of demand for European goods determines whether Americans supply more or fewer Dollars when the exchange rate in terms of Euros per Dollar increases. The quantity of Dollars Americans supply equal the price of European goods times the quantity of European goods demanded. For simplicity, we make the realistic assumption that the demand is elastic; consequently, Americans supply more Dollars.

8 8 Figure 20.2 illustrates the demand and supply curves in the foreign exchange market: Foreign Exchange Market Demand Curve: European Demand for Dollars Supply Curve: American Demand Euros per Dollar Euros per Dollar Euros per Dollar S G&S S G&S Equ Exch Rate D G&S D G&S U.S. Exports Dollars Dollars U.S. Imports Dollars U.S. Net Exports = 0 Figure 19.6: Foreign exchange market and net exports Demand Curve: How many Dollars would Europeans demand, if the exchange rate were Euros per Dollar given that all else relevant to demand remains the same? Question: Why do Europeans demand Dollars? Answer: To obtain Dollars to purchase American and services. European Purchases of American Goods and Services U.S. Exports Supply Curve: How many Dollars would Americans supply, if the exchange rate were Euros per Dollar given that all else relevant to supply remains the same? Question: Why to Americans supply Dollars? Answer: To obtain Euros to purchase European goods and services. U.S. Purchases of European Goods and Services U.S. Imports Figure 20.3 illustrates the equilibrium, U.S. Exports equal U.S. Imports. But the data plotted in figure 14.3 casts doubt on our analysis. Something must be missing. U.S. imports have exceeded U.S. exports for more than ten years. Question: What are we missing? 2,500 2,000 1,500 1, Real Exports, Imports, and Net Exports: (billions of 2009 dollars) Imports Exports Net Exports 1, Figure 19.7: Exports, imports, and net exports:

9 9 Answer: As figure 20.4 illustrates, we are forgetting that Europeans demand dollars not only to purchase American goods and services, but also to purchase American assets (stocks, bonds, etc.) Similarly, American supply dollars to the foreign exchange market not only to purchase European goods and services, but also to purchase European assets. Europe Europeans Demand American Assets Europeans Demand American Goods and Services Demand Dollars Foreign Exchange Market Supply Dollars Americans Demand Europoean Goods and Services Americans Demand European Assets Figure 19.8: Foreign exchange market with goods and assets United States American goods and services purchased by Europeans + American assets purchased by Europeans In equilibrium: = European goods and services purchased by Americans U.S. Exports U.S. Imports + European assets purchased by Americans After a little algebra provides some more intuition: In equilibrium: American goods and services purchased by European goods and services purchased by = European assets purchased by Europeans Americans Americans American assets purchased by Europeans U.S. Exports U.S. Imports é ã é ã U.S. Net Exports (NX) = U.S. Net Capital Outflow (NCO) At the present time U.S. net exports have been negative. U.S. Net Exports < 0 ã é U.S. Exports < U.S. Imports American goods and services purchased by Europeans < European goods and services purchased by Americans In net, Europe is sending goods and services to the U.S. What are Europeans getting in return? Europe must be receiving American assets in return. Since in net Europe is sending goods and services to the U.S., the U.S. must be sending assets to Europe in return. European assets American assets < purchased by Americans purchased by Europeans é ã U.S. Net Capital Outflow (NCO) Question: What would be required for U.S. Net Exports to equal 0? Answer: U.S. Net exports will equal 0 whenever U.S. Net Capital Outflow (NCO) equals 0; that is, whenever U.S. purchases of European assets just equals European purchases of American assets.

10 10 Benchmark Case: Net Exports = 0 As a benchmark case, suppose that European assets purchased by American equal the American assets purchased by Europeans. Consequently, the demand and supply curves would shift to the right by the same amount and the equilibrium exchange rate would be unaffected: Foreign Exchange Market Demand Curve: European Demand for Dollars Supply Curve: American Demand Euros per Dollar Euros per Dollar Euros per Dollar S G&S S G&S Eur U.S. Assets Equ Exch Rate Assets D G&S D G&S U.S. Exports Dollars Dollars U.S. Imports Dollars U.S. Net Exports = 0 Figure 19.9: Foreign exchange market with goods and assets Benchmark case As figure 20.5 illustrates, U.S. Exports of goods and services still equal U.S. Imports of goods and service; hence, Net Exports are still zero. Net Exports and the U.S. Real Interest Rate Question: What would occur if real interest rates rose in the U.S.? Answer: Figure 14.6 addresses this question: Europeans find Americans find U.S. Assets European Assets more attractive less attractive The demand curve for Dollars The supply curve for Dollars shifts to the right shifts to the left Foreign Exchange Market Demand Curve: European Demand for Dollars Supply Curve: American Demand Euros per Dollar Euros per Dollar S G&S+A Euros per Dollar S G&S+A Europeans demand more U.S. assets S G&S Equ Exch Rate D G&S+A D G&S+A Americans demand fewer European assets D G&S U.S. Exports Dollars Dollars U.S. Imports Dollars U.S. Net Exports < 0 Figure 19.10: Foreign exchange market with goods and assets U.S. real interest rate rises Since the equilibrium exchange rate rises, U.S. export of goods and services decrease, U.S. imports of goods and services increase; hence net exports are now negative as shown in figure 20.6.

11 Macro Lecture 20: Greek Debt Crisis Greek Debt Crisis Figure 21.1 depicts the situation facing the Greek government in 2011: Greek Treasury promises to pay the owner x,xxx Euros on January 15, 2011 Greek Treasury promises to pay the owner x,xxx Euros on February 15, 2011 Greek Treasury promises to pay the owner x,xxx Euros on March 15, 2011 Greek Government Finances Tax Revenue Euros Greek Treasury Euros Bondholders Euros Purchases of Transfer Goods and Services Payments Figure 20.1: Greek government finances January 14, 2011 Fitch lowers Greece's rating to BB+. March 7, 2011 Moody's cuts Greece's credit rating to B1 from Ba1. March 29, 2011 S&P's cuts Greece's rating to double-b-minus from double-b-plus. May 9, 2011 S&P's cuts Greece's rating from BB- to B. May 20, 2011 Fitch downgrades Greece to B+, with negative outlook. June 1, 2011 Moody's cuts Greece's credit rating cut to Caa1; outlook negative. June 13, 2011 S&P's cuts Greece's rating to CCC; outlook negative. June 21, 2011 Greek Prime Minister George Papandreou narrowly wins a vote of confidence in his government. June 29, 2011 Parliament passes a host of tax increases and spending cuts. July 13, 2011 Fitch downgrades Greece to CCC from B+. July 25, 2011 Moody's cuts Greece's rating to Ca. July 27, 2011 S&P's cuts Greece's rating from BB- to CC. October 3, 2011 Government presents 2012 budget to Parliament calling for sharp increases in taxes and spending cuts. October 18, 2011 Violent protests erupt amid a 48-hour general strike. November 1, 2011 Government announces a January referendum on the latest bailout that effectively amounts to a vote on whether Greeks want to endure the further financial sacrifices necessary to remain in the euro zone. November 2, 2011 Greece's cabinet approves plans for a referendum. German Chancellor Angela Merkel and French President Nicolas Sarkozy meet with Greek Prime Minister George Papandreou and Finance Minister Evangelos Venizelos in Cannes, France.

12 2 November 3, 2011 After more members of the leading socialist party say they won't support a surprise plan for a euro referendum, Greek Prime Minister George Papandreou loses his majority in Parliament and says he will drop his plan for a referendum if new talks with a leading opposition party secure support to push through harsh fiscal cuts. November 4, 2011 Prime Minister George Papandreou narrowly survives a no-confidence vote, but prepares to step down to make way for a bipartisan government to approve the bailout deal and pave the way to elections. November 6, 2011 The country s major political parties agree to form a national unity government and Prime Minister George Papandreou agrees to resign. Greek Prime Minister Agrees to Step Down Wall Street Journal November 7, 2011 Matina Stevis, Costas Paris and Stellios Bouras Parties to Form Coalition, Aiming to Meet Terms of EU Bailout ATHENS Greece's major political parties on Sunday agreed to form a national unity government that will oversee elections after putting in place a debt-slashing deal, in the hope of averting financial catastrophe and winning back the trust of the nation's European partners. Greek Prime Minister George Papandreou waves from his car as he leaves the presidential palace after a meeting with President Karolos Papoulias and Mr. Samaras in Athens on Sunday. Opposition leader Antonis Samaras met with Prime Minister George Papandreou on Sunday to settle on who will lead the bipartisan government and what its life span and powers will be. The deal came about after Prime Minister George Papandreou agreed to step down to make way for a new prime minister under a commonly accepted government. The administration is hoping to agree on a new government by Monday, ahead of a meeting of euro-zone finance ministers in Brussels that is expected to discuss whether to release Greece's next aid payment. Government spokesman Elias Mossialos said cabinet ministers serving in the new coalition will be named as early as Monday and the new government could be sworn in by the end of the week. November 7, 2011 A day of wrangling ends without the announcement of a new head of the country's interim government. Lucas Papademos, a former ECB vice president, and IMF director Panagiotis Roumeliotis were among the possible new leaders whose names were being circulated. November 9, 2011 Leaders end a meeting without naming a new prime minister. Negotiations will reconvene on Nov. 10, the president says. November 10, 2011 Lucas Papademos, a former European Central Bank vice president, is officially named as Greece's new prime minister after four days of intense talks to form a coalition government. November 11, 2011 Lucas Papademos is sworn in as prime minister, along with an interim cabinet that maintains Evangelos Venizelos as finance minister. November 16, 2011 Interim Prime Minister Lucas Papademos wins a vote of confidence, moves to negotiate the release of the latest loan installment for Greece, delayed by political turmoil in Athens.

13 3 We will now use what we have just learned about the foreign exchange market to analyze this crisis. Figure 21.2 begins with the benchmark case: Benchmark Case: Net Exports = 0 Foreign Exchange Market Demand Curve: European Demand for Dollars Supply Curve: American Demand Euros per Dollar Euros per Dollar Euros per Dollar S G&S U.S. Assets D G&S Equ Exch Rate Eur Assets U.S. Exports Dollars Dollars U.S. Imports Dollars U.S. Net Exports = 0 Figure 20.2: Foreign exchange market with goods and assets Benchmark case Question: What effect did the possibility that Greece would be unable to meet their bond obligations have on the attractiveness of European and American assets? Answer: Clearly, Europeans found U.S. assets more attractive shifting the demand curve to the right and Americans found European assets less attractive shifting the supply curve to the left. Figure 21.3 illustrates the effect on the foreign exchange market: Europeans find U.S. Assets more Americans find European Assets less attractive attractive The demand curve for Dollars shifts to the right The supply curve for Dollars shifts to the left Foreign Exchange Market Demand Curve: European Demand for Dollars Supply Curve: American Demand Euros per Dollar Euros per Dollar S G&S+A Euros per Dollar S G&S+A Europeans demand more U.S. assets S G&S Equ Exch Rate D G&S+A D G&S+A Americans demand fewer European assets D G&S U.S. Exports Dollars Dollars U.S. Imports Dollars U.S. Net Exports < 0 Figure 20.3: Foreign exchange market Fear of Greek default The threat of Greek default should cause the equilibrium exchange rate in terms of Euros per Dollar.

14 4 Figure 21.4 illustrates what actually occurred: Exchange Rate of Euros per Dollar Oct Nov Dec 11 Figure 20.4: Euro-dollar exchange rate: Oct 2011-Jan 2012 Speculation Question: What would occur if individuals expected the Dollar to become dramatically stronger and hence the Euro dramatically weaker in the near future? For example suppose that you have 7,600 deposited in a Paris bank that you plan to use in one month when you will be vacationing in France. Furthermore, as a consequence of the European debt crisis you expect the dollar to strengthen with the exchange rate rising from.75 per $1.00 today to 1.00 per $1.00 a month from today: 7,600 Today: Exchange Euros for Dollars Exchange Rate.76 per $1.00 $10,000 Month Later: Exchange Dollars for Euros Exchange Rate 1.00 per $ ,000 Figure 21.5 illustrates that the exchange rate would rise today: If others share your view ã é Dollars become Euros become more attractive today less attractive today Demand curve for Supply curve for Dollars shifts to the right Dollars shifts to the left é ã Equilibrium exchange rate actually does rise As you can appreciate, speculation can be very disruptive to foreign exchange markets. Foreign Exchange Market for Dollars Euros per Dollar S G&S+A Equ Exch Rate D G&S+A Dollars Figure 20.5: Foreign exchange market Speculation

15 5 Greece, Creditors Cite Progress on a Debt Pact Wall Street Journal January 20, 2012 By Alkman Granitsas, Matina Stevis and Costas Paris ATHENS The Greek government and its private-sector creditors appeared to be closing in on a debtrestructuring deal on the basis of new proposals, raising hopes it would pave the way for another multibillioneuro bailout for the country. That optimism helped fuel a rally in financial markets across Europe, with the Athens stock exchange rising 2.9% and Greek banking stocks gaining 5%. Greece's efforts to get relief from its private-sector creditors recently have faltered. This week's resumption of the talks came after talks between the two sides broke down Jan. 13 amid differences about the future interest rate Greece would pay bondholders. What rate is chosen could determine how much of a loss creditors will take on the current value of their Greek debt holdings. After 2.5 hours of talks late Thursday, both sides announced that progress had been made in the negotiations with another meeting scheduled for Friday. January 18, 2012 The government resumes talks with its private creditors over a plan to restructure the country's debt as it scrambles to secure a deal demanded by its European partners for a new bailout package. January 25, 2012 Greece's private-sector creditors meet in Paris to "determine the next course ahead" in talks to help ease the ailing country's debt burden. January 27, 2012 The key goal of debt talks between Greece and its bond holders should be to ensure the government has a debt equivalent to 120% of gross domestic product by 2020, IMF Chief Christine Lagarde tells reporters in Davos. January 29, 2012 Greek Prime Minister Papademos heads to Brussels to negotiate a new bailout after weekend talks with private creditors over a planned debt restructuring near a deal. February 5, 2012 Political leaders fail to agree on unpopular reforms as part of an international aid package. Greece continues to be locked in difficult negotiations with international creditors on the loan terms. February 7, 2012 Political leaders resume talks amid a nationwide strike by civil servants and private-sector workers to protest new cutbacks. February 9, 2012 Greece's leaders agree on austerity moves needed for a new bailout, but euro-zone finance ministers demand a vote in the Greek Parliament, setting the stage for further uncertainty. February 12, 2012 Parliament passes new austerity measures demanded by bailout creditors to ensure that Greece will receive 130 billion in bailout money. More than 100,000 protesters march to the parliament; riots rage. February 23, 2012 Parliament approves a massive bond swap that would wipe 107 billion off the country's privately-held debt, a day before Greece is expected to launch a formal offering to private bondholders. February 27, 2012 Standard & Poor's cuts Greece's long-term credit rating to selective default. February 28, 2012 The European Central Bank, responding to the latest rating agency downgrade of Greece, says it would no longer accept the country's bonds as collateral for loans.

16 6 March 9, 2012 Greece says 83% of bondholders have submitted to massive debt swap deal, precipitating the largest-ever sovereign-debt default and the first for a Western European country in half a century. Greece plans to invoke so-called collective-action clauses to impose the exchange on most of other bondholders. March 14, 2012 Euro-zone countries sign off on a 130 billion bailout for Greece, ending a negotiating process that started in July The hope is that the package will be enough to keep Greece funded until As the threat of Greek default we would predict that the exchange rate would fall as illustrated in figure Exchange Rate of Euros per Dollar Oct Nov Dec Jan Feb Mar 12 Figure 20.6: Euro-dollar exchange rate: Oct 2011-Apr 2012