Exchange Rate and International Finance Min Shu Waseda University 2018/5/29 International Political Economy 1
Outline of the lecture International balance of payment Fixed and floating exchange rate The political economy of exchange rate Trilemma in international finance Regional financial cooperation and integration International financial institution and regulation International financial crisis Group Presentations 2018/5/29 International Political Economy 2
Group Presentation in Thematic Classes Contents of the group presentation Related chapter in Global Political Economy Pre-assigned current issues Chapter 8 for Group 7 Ch13: The Political Economy of Development Current issues for Group 8 Development Financing: from World Bank to NDB and AIIB 2018/5/15 International Political Economy 3
International balance of payment From the economy of goods to the economy of capital Exchange of goods money-based transaction exchange of money International trade and international finance International balance of payment Current account Balance of trade, net factor income and net transfer payments Capital account Foreign direct investment, portfolio investment, other investment, reserve account 2018/5/29 International Political Economy 4
International balance of payment Foreign exchange reserves Foreign reserves: foreign currencies, SDRs, foreign assets, etc. Managing the exchange rate the use of foreign reserves Sovereign wealth fund (SWF) Balancing International payment Adjusting the exchange rate Regulating domestic price and demand, sometimes involuntarily Establishing a rule-based international mechanism 2018/5/29 International Political Economy 5
Fixed and floating exchange rate Fixed exchange rate system To achieve foreign exchange stability, the value of the country s currency is matched to the value of another currency Small range of exchange rate movement is allowed Floating exchange rate system The value of the currency fluctuates according to the demand and supply of the foreign exchange market The monetary authority may intervene to prevent extreme appreciation or depreciation Some in-between systems of exchange rate A basket of currencies as a fixed target Managed floating exchange rate 2018/5/29 International Political Economy 6
The political economy of exchange rate: Fixed exchange rate Fixed exchange rate and international financial order Hegemonic stability and international finance Gold standards (1820-1914): the hegemony of the UK Bretton Woods System (1945-1971): US hegemony It was still necessary to coordinate the exchange rate among major economies Fixed exchange rate and domestic politics During the inter-war period, the Left governments preferred gold standard: prioritizing stability in international trade Fixed exchange rate is often found in politically stable democratic countries: maintaining stable financial policy Undemocratic countries also prefer fixed exchange rate: to compensate for weak domestic financial institutions 2018/5/29 International Political Economy 7
The political economy of exchange rate: Floating exchange rate Coordination of financial and economic policies Locomotive Theory (1977-1978) The coordination among US, Japan and Germany were vital to the growth of world economy Plaza and Louvre Agreements (1985-1987) Japan and Germany agreed to appreciate their currencies against the USD, and take stimulus domestic economic policies to reduce their trade surplus, however The obstacles to policy coordination Analytical uncertainty Policy uncertainty 2018/5/29 International Political Economy 8
Plaza Agreement 2018/5/29 International Political Economy 9
The trilemma in international finance It is impossible to achieve simultaneously the three (desirable) macro-economic policy objectives Stable currency: fixed exchange rate Autonomous monetary policy Free movement of capitals Empirical examples Japan: floating exchange rate The Euro Zone: non-independent monetary policy China: restriction on transnational capital flows 2018/5/29 International Political Economy 10
Regional financial integration Regional financial integration in Europe 1970 the Werner Report Coordinated floating exchange rate: Snake 1979 European Monetary System ECU and ERM 1993 Maastricht Treaty: Economic and Monetary Union 1999 The single currency entered institutional transactions 2002 Euro entered market transactions 2009- The Eurozone Crisis Regional financial cooperation in East Asia The Chiang Mai Initiative: from bilateral currency wasp agreements to a multilateral pool of foreign currencies Asian Currency Unit? 2018/5/29 International Political Economy 11
International financial institution and regulation International Monetary Fund (IMF) As part of the Bretton Woods System, the IMF was set up in 1944 To provide emergency loans to imbalanced countries Surplus countries vs. deficit countries The US influences on the IMF IMF, US Treasury, the Wall Street Regulating international finance The bankruptcy risk of private financial institutions Bank for International Settlements (BIS) The Basel Accords (I, II, III) Implementation through domestic legislation 2018/5/29 International Political Economy 12
International financial crisis Fixed exchange rate and currency crisis Risk: current account deficit + capital account surplus Under fixed exchange rate, speculative attack against overvalued currencies Difficult to keep the fixed exchange rate without adequate foreign reserves East Asian Financial Crisis Thailand, Indonesia, Malaysia and South Korea experienced sudden and substantial currency depreciation in 1997 Domestic property bubble and deficit of the current account Contagion across the East Asian financial markets Conditionality of the IMF loans: domestic financial reforms 2018/5/29 International Political Economy 13
International financial crisis Financial crisis resulting from a bubble economy Gap between commodity economy and financial economy In particular, bubble tends to occur in the real estate market Bubble economy burst financial institutions bankruptcy financial flow decelerated/stopped declined economic growth The sub-prime loan problem in the US Due to sub-prime loans, real estate bubble emerged The burst of real estate bubble led to financial insolvency The downturn of US economy led to a global recession Re-building international financial system Financial regulation, IMF, role of emerging economies The rise of G20 2018/5/29 International Political Economy 14
Group Presentation The evolution of international financial system US interest rate and developing economies 2018/5/29 International Political Economy 15
Discussion What does the hegemonic stability theory tell us about the international financial order? Why is it necessary to pursue coordination among major economies to ensure financial stability? How did the Euro influence the international financial system? What is the main cause of international financial crisis: insufficient regulation or self-interested investors? 2018/5/29 International Political Economy 16