Transcript Open economies in PK stock-flow consistent models: Applying the

Open economies in PK
stock-flow consistent
models
Applying the principle of
endogenous sterilization to stockflow consistent models
Open economies and PK models
► There
are three traditions of PK analysis
regarding open economies macroeconomics
► The Paul Davidson tradition, regarding the
architecture of the world monetary system
► The Tony Thirlwall tradition, regarding
external constraints on growth
► The Wynne Godley tradition, regarding
stock-flow consistency
The Paul Davidson tradition (1972)
► Concerns
with whether exchange rates
should be fixed or flexible.
► Concerns with the need to have capital
controls, Tobin taxes on international
transactions, etc.
► Concerns with the present architecture,
which has no mechanism inducing surplus
countries to balance their current account
► Concerns with the role of the US dollar
The Tony Thirlwall tradition (1979)
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Inspired by the Harrodian trade multiplier (1933).
Has given rise to many econometric tests
Claims that growth is constrained by the need to balance
the trade account
Claims that growth of a country over the medium run is
equal to the growth rate of exports divided by the local
income elasticity of imports (Thirlwall’s law).
The growth rate of country X exports is equal to the
growth rate of world income multiplied by the income
elasticity of demand for products of country X.
The Wynne Godley tradition (1974, 1999)
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Also inspired by Harrod’s trade multiplier
Based on a national income identity, identified in 1974,
that says that financial balances are such that:
 Private saving minus investment + government surplus = current
account surplus
 Private lending + government lending + non-residents lending = 0
 Private lending = government borrowing + non-residents
borrowing
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Sometimes called the New Cambridge approach
The other breakthrough is the Godley 1999 Levy Institute
working paper, that introduces these ideas in a stock-flow
consistent model
Also an interesting paper by Lance Taylor (2004), based on
the above.
Heuristic proof of the identity
► GDP = PX + G + (X – IM)
► GNP = PX + G + X – IM + YF
► (GNP – PX – T) = (G – T) + (X – IM + YF)
► NAFA = PSBR + CAB
► Net Accumulation of Financial Assets = Public
Sector Borrowing Requirements + Current Account
Balance
► Private surplus = Government deficit + nonresidents borrowing
► (YF = Net foreign income; PX private
expenditures)
Financial balances (net lending) of
US economy 1970-2006
10
Private sector
Net Lending (Percent of GDP)
8
6
Non-residents
4
2
0
-2
-4
-6
Government sector
-8
-10
1970
1973
1976
1979
1982
1985
1988
1991
Years
Non-residents lending = current account deficit
1994
1997
2000
2003
2006
Financial balances, Canada 1970-2007
15
Persons and
Unincorporated
Business
Net Lending (Percent of GDP)
10
Corporations and
Government
Business Enterprises
5
0
-5
Non-residents
-10
Government
-15
1970
1975
1980
1985
1990
Years
1995
2000
2005
2007
The stock-flow model
► Integrates
flows and stocks
► Integrates portfolio decisions (Tobin)
► Links up with portfolio “static” models: Allen
and Kenen (1980), Branson and Henderson
(1985), that are now back in fashion
► Goes beyond the standard models, where
the rest of the world is a given, by
describing two interrelated economies
Kinds of open-economy SFC models
Model
Governments Central
banks
Regime
Reserves,
others
Godley
1999A
2
2
Fixed,
Flexible
Gold
Lavoie 2005
2
1
--
--
Lavoie 2006
2
1+ currency
board
Fixed
US $
G&L 2006
JPKE
2
2
Fixed, with
and without
capital flows;
Flexible
US$, no
interest
payments
flows
G&L 2007
book ch6
2
2
Fixed
Gold, no
capital flows
G&L 2007
book ch 12
2
2
Fixed and
flexible
US $, pricing
equations
Further Kinds of open-economy SFC models
Model
Governments Central
banks
Regime
Reserves
Izurieta 2003 2
2
Dollarization
US$
Lequain 2003 3
(UofO)
2
Fixed
US $
G&L 2006
CJE
3
2
Flexible
US $
Zhao 2006
(UofO)
3
3
Fixed
between
China and
US, flexible
otherwise
US $
The G&L 2007 Chapter 6 model
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Contains broadly the same equations as the chapter 4
model
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No investment, no banks
Consumption depends on current income and past wealth
Portfolio choice between bills and money
Interest rate targeting
There are now exports and imports
Imports are a direct function of local GDP
The imports of one country are necessarily the exports of
the other country
There are capital controls: households of the north
(Canada) cannot hold bills issued in the south (USA) and
vice-versa
Gold reserves
Fixed exchange rates
The redundant equation
It describes the equivalence between
reserve gains by one country and reserve
losses by the other, as can be seen in the
last row of the transactions-flow matrix.
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ΔorS = −ΔorN
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Simulations
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start from a full stationary state, where
both economies are in a balance of
payments position (a trade balance, since
there are no private capital transactions).
► When a shock is being imposed upon this
fixed-exchange rate model, the economies
reach a quasi stationary state, where flows
reach a constant, but where some stocks
are changing.
Impact of an increase in the propensity
of the South to import
Impact of an increase in the
propensity of the South to import
The twin deficits !
The compensation thesis in action
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The South has a trade deficit, therefore it is losing gold.
The South has a government deficit, therefore, its
government needs to issue bills.
The central bank purchases the bills, at about the same
rhythm that it is losing gold, acting simply to keep the
interest rate on bills constant.
There is endogenous sterilization of the gold losses (the
compensation thesis).
Despite being on a gold exchange standard, the “Rules of
the game” do not apply. Hume’s “price-specie flow”
mechanism has no bite.
The compensation thesis in action
Compensation again
Limits of compensation
Obviously this mechanism can go on only as long
as there are gold reserves in the South country.
► Note that the North country has no reason to
change its behaviour, as long as it does not object
to accumulating gold reserves.
► It can be shown that gains or losses of gold
reserves will continue as long as the following
equality is not fulfilled for each country:
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Y = GNT/θ = X/μ
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 Where GNT are total government expenditures net of
taxes collected on interest payments;
 and where θ is the tax rate and μ is the propensity to
import.
Policies to stop losing gold
Y = GNT/θ = X/μ
first term is the Blinder fiscal stance equation;
the second term is the Harrod trade equation.
► If the propensity to import is overly high, this
means that the fraction is overly small; the other
fraction (the fiscal stance) must thus be reduced,
either by raising the tax rate of reducing
government expenditures (the IMF solution to all
problems of emerging economies!)
► The following graph assumes a mechanism that
reduces government expenditures when losing
gold.
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Evolution of the balances of the South country – net acquisition of
financial assets by the household sector, government budget balance,
trade balance – following an increase in the South propensity to import,
with fiscal policy reacting to changes in gold reserves
A more complex model ?
► What
if there was a more complex model,
with capital flows, dollar reserves, etc.
► This is the chapter 12 model.
► Results will be essentially the same, except
that due to interest payments on foreign
debt, the current account balance will rise
exponentially (while the trade balance
remains constant) if nothing is done.
Effect of an increase in the US propensity to import on UK variables
Effect of an increase in the US propensity to import, within a fixed exchange rate
regime with endogenous foreign reserves, on the UK current account balance and
elements of the balance sheet of the Bank of England (the UK central bank):
change in foreign reserves, stock of money, holdings of domestic Treasury bills
Using interest rates
► What
if a country has a current account
deficit problem, and tries to solve it by
raising interest rates instead of decreasing
government expenditures ?
► Will this also bring the economy back to a
full steady state ?
► The answer is no
Interest rates are destabilizing
Contradicting received wisdom
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Alan Greeenspan and others have been saying that
Chinese accumulation of US Treasury bills is making it
difficult for them to manage their monetary policy; but
the above analysis strongly suggests that they are
mistaken.
Mainstream authors would say that the UK (or Chinese)
central bank of our model is “sterilizing” foreign
reserves, by selling domestic Treasury bills on the open
market. In a way, it is true. But this is not the result of
any intentional policy, where central bankers are actively
intervening in financial markets.
The UK (Chinese) central bank, just like the US one, is
simply attempting to keep interest rates constant. Bills
are provided to those who demand them at the set rate
of interest. The central bank provides cash on demand
to its citizens.
What about flexible exchange rates?
This is discussed in G&L JPKE 2005-6.
► Also in the G&L book, chapter 12, with a full
model, complete with partial exchange-rate
pass through, price and income import
elasticities, etc.
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