internationa macroeconomics

Transcription

1 internationa macroeconomics ROBERT C. FEENSTRA ALAN M.TAYLOR University WORTH PUBLISHERS

2 Contents Preface XVII CHAPTER 1 The Globai Macroeconomy 1 PART 1 1 Foreign Exchange: Of Currencies and Crises 2,. i u c u D. D L o International How txchanqe Kates Behave J.,..,, c i D. A A U A Macroeconomics Why Exchange Rates Matter 4 - When Exchange Rates Misbehave 6 HEADLINES Economic Crisis in Argentina 8 Summary 9 2 Globalization of Finance: Of Debts and Deficits 10 Deficits and Surpluses: The Balance of Payments 10 Debtors and Creditors: External Wealth 1 3 Darlings and Deadbeats: Defaults and Other Risks 14 Summary 16 3 Government and Institutions: Of Policies and Performance 17 Integration and Capital Controls: The Regulation of International Finance 18 Independence and Monetary Policy: The Choice of Exchange Rate Regimes 19 Institutions and Economic Performance: The Quality of Governance 21 Summary 23 HEADLINES The Wealth of Nations 24 4 Conclusions 25 CHAPTER 2 Introduction to Exchange Rates and the Foreign PART 2 Exchange Market 29 Exchange Rates 1 Exchange Rate Essentials 30 Defining the Exchange Rate 30 * Appreciations and Depreciations 32 Multilateral Exchange Rates 34 i Example: Using Exchange Rates to Compare Prices in a Common Currency 35 HEADLINES By How Much Has the Dollar Fallen? 36 2 Exchange Rates in Practice 38 Exchange Rate Regimes: Fixed versus Floating 39 APPLICATION Recent Exchange Rate Experiences 39 SIDE BAR Currency Unions and Dollarization 45

3 VIM CONTENTS 3 The Market for Foreign Exchange 45 The Spot Contract 46 Transaction Costs 46 Derivatives 47 APPLICATION Foreign Exchange Derivatives 47 Private Actors 48 Government Actions 49 4 Arbitrage and Spot Exchange Rates 51 Cross Rates and Vehicle Currencies 53 5 Arbitrage and Interest Rates 54 Riskless Arbitrage: Covered Interest Parity 55 APPLICATION Evidence on Covered Interest Parity 57 Risky Arbitrage: Uncovered Interest Parity 58 SIDE BAR Assets and Their Attributes 59 APPLICATION Evidence on Uncovered Interest Parity 61 Uncovered Interest Parity: A Useful Approximation 62 Summary 64 6 Conclusions 64 CHAPTER 3 Exchange Rates I: The Monetary Approach in the Long Run 69 1 Exchange Rates and Prices in the Long Run: Purchasing Power Parity and Goods Market Equilibrium 70 The Law of One Price 71 Purchasing Power Parity 72 The Real Exchange Rate 73 Absolute PPP and the Real Exchange Rate 74 Absolute PPP, Prices, and the Nominal Exchange Rate 74 Relative PPP, Inflation, and Exchange Rate Depreciation 74 Summary 76 APPLICATION Evidence for PPP in the Long Run and Short Run 76 How Slow is Convergence to PPP? 77 SIDEBAR Forecasting When the Real Exchange Rate Is Undervalued or Overvalued 78 What Explains Deviations from PPP? 79 HEADLINES The Big Mac Index 80 2 Money, Prices, and Exchange Rates in the Long Run: Money Market Equilibrium in a Simple Model 82 What is Money? 82

4 CONTENTS IX The Measurement of Money 83 The Supply of Money 84 The Demand for Money: A Simple Model 84 Equilibrium in the Money Market 85 A Simple Monetary Model of Prices 86 A Simple Monetary Model of the Exchange Rate 87 Money Growth, Inflation, and Depreciation 87 3 The Monetary Approach: Implications and Evidence 89 Exchange Rate Forecasts Using the Simple Model 89 APPLICATION Evidence for the Monetary Approach 92 APPLICATION Hyperinflations of the Twentieth Century 93 SIDE BAR Currency Reform 95 HEADLINES The First Hyperinflation of the Twenty-First Century 97 4 Money, Interest, and Prices in the Long Run: A General Model 98 The Demand for Money: The General Model 98 Long-Run Equilibrium in the Money Market 99 Inflation and Interest Rates in the Long Run 100 The Fisher Effect 101 Real Interest Parity 101 APPLICATION Evidence on the Fisher Effect 102 The Fundamental Equation under the General Model 104 Exchange Rate Forecasts Using the General Model Monetary Regimes and Exchange Rate Regimes 107 The Long Run: The Nominal Anchor 108 SIDE BAR Nominal Anchors in Theory and Practice Conclusions 111 CHAPTER 4 Exchange Rates II: The Asset Approach in the Short Run Exchange Rates and Interest Rates in the Short Run: UIP and FX Market Equilibrium 118 Risky Arbitrage Equilibrium in the FX Market: An Example 1 20 Adjustment to FX Market Equilibrium 1 22 Changes in Domestic and Foreign Returns and FX Market Equilibrium 1 22 Summary Interest Rates in the Short Run: Money Market Equilibrium 124 Money Market Equilibrium in the Short Run: How Nominal Interest Rates Are Determined 1 25

5 X CONTENTS Money Market Equilibrium in the Short Run: Graphical Solution 1 26 Adjustment to Money Market Equilibrium in the Short Run 1 27 Another Building Block: Short-Run Money Market Equilibrium 1 27 Changes in Money Supply and the Nominal Interest Rate 1 28 Changes in Real Income and the Nominal Interest Rate 1 29 The Monetary Model: The Short Run versus the Long Run The Asset Approach: Applications and Evidence 130 The Asset Approach to Exchange Rates: Graphical Solution 1 30 Short-Run Policy Analysis 133 APPLICATION The Rise and Fall of the Dollar, A Complete Theory: Unifying the Monetary and Asset Approaches 137 SIDE BAR Confessions of a Forex Trader 139 Long-Run Policy Analysis 140 Overshooting 144 APPLICATION Bemanke's Bold Move 145 SIDE BAR Overshooting in Practice Fixed Exchange Rates and the Trilemma 148 What Is a Fixed Exchange Rate Regime? 149 Pegging Sacrifices Monetary Policy Autonomy in the Short Run: Example 149 Pegging Sacrifices Monetary Policy Autonomy in the Long Run: Example 151 The Trilemma 153 APPLICATION The Trilemma in Europe 154 SIDE BAR Intermediate Regimes Conclusions 155 APPLICATION News and the Foreign Exchange Market in Wartime 157 PART 3 The Balance of Payments QttFIR 5 National and international Accounts: Income, Wealth, and the Balance of Payments Measuring Macroeconomic Activity: An Overview 166 The Flow of Payments in a Closed Economy: Introducing the National Income and Product Accounts 167 The Flow of Payments in an Open Economy: Incorporating the Balance of Payments Accounts 169 Summary National Accounts: Product, Expenditure, and Income 173 Three Approaches 173

6 CONTENTS XI From GNE to GDP: Accounting for Trade in Goods and Services 173 HEADLINES Who Makes the ipod? 175 From GDP to GNI: Accounting for Trade in Factor Services 1 76 APPLICATION Celtic Tiger or Tortoise? 177 From GNI to GNDI: Accounting for Transfers of Income 1 79 What the National Economic Aggregates Tell Us 181 HEADLINES Are Rich Countries "Stingy" with Foreign Aid? 182 Understanding the Data for the National Economic Aggregates 1 83 What the Current Account Tells Us 1 85 APPLICATION Global Imbalances Balance of Payments Accounts: International Transactions 192 Accounting for Asset Transactions 192 Accounting for Home and Foreign Assets 194 How the^balance of Payments Accounts Work 194 Understanding the Data for the Balance of Payments Account 199 What the Balance of Payments Account Tells Us External Wealth 203 The Level of External Wealth 204 Changes in External Wealth 204 SIDE BAR The Nokia Economy 206 Understanding the Data on External Wealth 207 What External Wealth Tells Us Conclusions 211 H E A D L I N E S Lies, Damned Lies Appendix to Chapter 5: External Wealth and Total Wealth 217 CHAPTER 6 Balance of Payments I: The Gains from Financial Globalization Intertemporal Macroeconomics 221 The Long-Run Budget Constraint 222 A Long-Run Example: The Perpetual Loan 226 Implications of the LRBC for Gross National Expenditure and Gross Domestic Product 226 Summary 227 APPLICATION The Favorable Situation of the United States 227 APPLICATION The Difficult Situation of the Emerging Markets Gains from Consumption Smoothing 233 The Basic Model 233 Consumption Smoothing: A Numerical Example and Generalization 234

7 XII CONTENTS Summary: Save for a Rainy Day 238 SIDE BAR Wars and the Current Account 238 APPLICATION Consumption Volatility and Financial Openness 239 APPLICATION Precautionary Savinq, Reserves, and Sovereiqn Wealth Funds 240 HEADLINES Copper-Bottomed Insurance 242 HEADLINES The Next Globalization Backlash? Gains from Efficient Investment 243 The Basic Model 243 Efficient Investment: A Numerical Example and Generalization 243 Summary: Make Hay while the Sun Shines 247 APPLICATION Delinking Saving from Investment 247 Can Poor Countries Gain from Financial Globalization? 249 APPLICATION A versus k 254 SIDE BAR What Does the World Bank Do? 258 HEADLINES A Brief History of Foreign Aid Gains from Diversification of Risk 260 Diversification: A Numerical Example and Generalization 260 APPLICATION The Home Bias Puzzle 266 Summary: Don't Put All Your Eggs in One Basket Conclusions 270 Appendix to Chapter 6: Common versus Idiosyncratic Shocks 275 CHAPTER 7 Balance of Payments II: Output, Exchange Rates, and Macroeconomic Policies in the Short Run Demand in the Open Economy 278 Preliminaries and Assumptions 279 Consumption 279 Investment 281 The Government 281 The Trade Balance 282 HEADLINES Soaring Loonie Drives Canadian Shoppers South 284 APPLICATION The Trade Balance and the Real Exchange Rate 286 SIDE BAR Barriers to Expenditure Switching: Pass-Throuqh and the J Curve 287 Exogenous Changes in Demand Goods Market Equilibrium: The Keynesian Cross 291 Supply and Demand 291 Determinants of Demand 292

8 CONTENTS XIII Factors That Shift the Demand Curve 294 HEADLINES Expenditure Switching and the Dollar Devaluation 295 Summary Goods and Forex Market Equilibria: Deriving the IS Curve 296 Equilibrium in Two Markets 296 Forex Market Recap 296 Deriving the IS Curve 298 \ Factors That Shift the IS Curve 299 Summing Up the IS Curve Money Market Equilibrium: Deriving the LM Curve 302 Money Market Recap 302 Deriving the LM Curve 304 Factors That Shift the LM Curve 304 Summing Up the LM Curve The Short-Run IS-LM-FX Model of an Open Economy 306 Macroeconomic Policies in the Short Run 307 Monetary Policy under Floating Exchange Rates 308 Monetary Policy under Fixed Exchange Rates 309 Fiscal Policy under Floating Exchange Rates 310 Fiscal Policy under Fixed Exchange Rates 312 Summary 313 APPLICATION The Rise and Fall of the Dollar in the 1980s Stabilization Policy 317 APPLICATION of Australia, New Zealand, and the Asian Crisis Problems in Policy Design and Implementation Conclusions 322 Appendix 1 to Chapter 7: The Marshall-Lerner Condition 327 Appendix 2 to Chapter 7: Multilateral Real Exchange Rates 329 CHAPTER 8 Fixed versus Floating: International Monetary PART 4 Experience 331 Applications and 1 Exchange Rate Regime Choice: Key Issues 333 ^ M'.^.J^.V.? APPLICATION Britain and Europe: The Big Issues 333 Key Factors in Exchange Rate Regime Choice: Integration and Similarity 339 Economic Integration and the Gains in Efficiency 339 Economic Similarity and the Costs of Asymmetric Shocks 340 Simple Criteria for a Fixed Exchange Rate 340

9 XIV CONTENTS APPLICATION Do Fixed Exchange Rates Promote Trade? 342 APPLICATION Do Fixed Exchange Rates Diminish Monetary Autonomy and Stability? Other Benefits of Fixing 348 Fiscal Discipline, Seigniorage, and Inflation 348 SIDE BAR The Inflation Tax 350 Liability Dollarization, National Wealth, and Contractionary Depreciations 350 ; HEADLINES The Last Temptation? 357 Summary Fixed Exchange Rate Systems 359 Cooperative and Noncooperative Adjustments to Interest Rates 360 Cooperative and Noncooperative Adjustments to Exchange Rates 362 APPLICATION The Gold Standard International Monetary Experience 368 The Rise and Fall of the Gold Standard 368 Bretton Woods to the Present Conclusions 375 CHAPTER 9 Exchange Rate Crises: How Pegs Work and How They Break Facts about Exchange Rate Crises 380 What Is An Exchange Rate Crisis? 380 How Costly Are Exchange Rate Crises? 381 SIDE BAR The Political Costs of Crises 383 Summary How Pegs Work: The Mechanics of a Fixed Exchange Rate 385 Preliminaries and Assumptions 385 The Central Bank Balance Sheet 386 Fixing, Floating, and the Role of Reserves 388 How Reserves Adjust to Maintain the Peg 388 Graphical Analysis of the Central Bank Balance Sheet 389 Defending the Peg I: Changes in the Level of Money Demand 391 APPLICATION Risk Premiums in Advanced and Emerging Markets 394 APPLICATION The Argentine Convertibility Plan before the Tequila Crisis 398 Defending the Peg II: Changes in the Composition of Money Supply 400 APPLICATION The Argentine Convertibility Plan after the Tequila Crisis 406

10 CONTENTS XV The Central Bank Balance Sheet and the Financial System 407 SIDE BAR The Great Reserve Accumulation in Emerging Markets 410 HEADLINES Too Much of a Good Thing? 41 2 Summary How Pegs Break I: Inconsistent Fiscal Policies 414 The Basic Problem: Fiscal Dominance 414 A Simple Model 414 APPLICATION The Peruvian Crisis of Summary How Pegs Break II: Contingent Monetary Policies 422 The Basic Problem: Contingent Commitment 423 A Simple Model 424 APPLICATION, The Man Who Broke the Bank of England 429 Summary Conclusions 431 Can We Prevent Crises? 431 CHAPTER 10 The Euro The Economics of the Euro 440 The Theory of Optimum Currency Areas 440 Simple Optimum Currency Area Criteria 441 What's the Difference between a Fix and a Currency Union? 442 Other Optimum Currency Area Criteria 443 APPLICATION Optimum Currency Areas: Europe versus the United States 446 Are the OCA Criteria Self-Fulfilling? 450 HEADLINES Currency Unions and Trade 452 Summary The History and Politics of the Euro 453 A Brief History of Europe 453 Summary The ECB and the Eurozone in Theory and Practice 461 The European Central Bank 461 HEADLINES The ECB Is from Mars, the Fed Is from Venus 464 The Rules of the Club 466 Sticking to the Rules "470 4 Conclusions: Assessing the Euro 471 HEADLINES Whither the Euro? 475

11 XVI CONTENTS CHAPTER 11 Topics in International Macroeconomics Exchange Rates in the Long Run: Deviations from Purchasing Power Parity 480 Limits to Arbitrage 481 APPLICATION It's Not Just the Burgers That Are Cheap 484 Nontraded Goods and the Balassa-Samuelson Model 485 Overvaluations, Undervaluations, and Productivity Growth: Forecasting Implications for Real and Nominal Exchange Rates 487 APPLICATION Real Exchange Rates in Emerging Markets 490 Conclusions Exchange Rates in the Short Run: Deviations from Uncovered Interest Parity 492 HEADLINES Eastern Europe and the Euro 493 APPLICATION The Carry Trade 493 HEADLINES Mrs. Watanabe's Hedge Fund 497 APPLICATION Peso Problems 498 The Efficient Markets Hypothesis 500 Limits to Arbitrage 503 Conclusions Global Imbalances 508 Facts about Emerging Global Imbalances 508 A Model of Saving and Investment in the World Economy 508 APPLICATION The Savings Glut 514 Looking Backward: How We Got Here 515 Looking Forward: What Next? 516 SIDE BAR Reserves and Global Imbalances 516 Debtors, Creditors, and the Long-Run Budget Constraint 51 8 Real Exchange Rates and Global Imbalances: Two Views 519 Conclusions Debt and Default 524 A Few Peculiar Facts about Sovereign Debt 525 A Model of Default, Part One: The Probability of Default 526 APPLICATION Is There Profit in Lending to Developing Countries? 532 A Model of Default, Part Two: Loan Supply and Demand 533 APPLICATION The Costs of Default 536 Conclusions 540 APPLICATION The Argentina Crisis of HEADLINES Is the IMF "Pathetic"? 545 INDEX 1-1