Transcript Capital flows, exchange rate trade balances, and all that stuff

Capital flows, exchange
rate, trade balances, and all
that stuff
Outline
• Some very, very, very boring definitions
and a little bit of theory
• What do the data say?
• Why?
• Policy implications
The Balance of Payment
• The BOP keeps track of a country's
payments to foreigners and receipts from
foreigners
– Transactions resulting into a payment to
foreigners are entered in the BOP as a debit ().
– Transactions resulting into a payment from
foreigners are entered in the BOP as a credit
(+).
The Balance of Payment
• The BOP records two types of transactions:
– Transactions that involve exports or imports of goods
and services or transfers are registered in the current
account
• When a Lebanese citizen buys a US made product, this is
recorded as a debit in the Lebanese BOP and as a credit in
the US BOP.
– And viceversa
• Transactions that involve the purchase or sale of
assets are registered in the capital account
• When a Lebanese company buys a US company (building,
bond, ..), the transaction is recorded in the Lebanese BOP as
a debit in the capital account and is recorded in the US as a
credit in the capital account
– And viceversa
• Why debit? Because Lebanon is "importing" the Asset
The Balance of Payment
• By double-entry bookkeeping, every
transaction enters into the BOP twice,
once has a credit and once as a debit
• Example: A US citizen buys hummus from
Lebanon for USD2000 and pays with a
check
– Debit in US current account (import) credit in
the Lebanese current account (export)
– Credit in US capital account and debit in the
Lebanese capital account (US sold a check to
Lebanon)
The Balance of Payment
• CAPITAL ACCOUNT+CURRENT
ACCOUNT=0
• So, what does a Balance of Payment
deficit mean?
Current Account
(1) Exports
Credit
200
(2) Imports
Debit
-700
(3) Uncle Walid from Montreal sends money to Karim in Beirut and Uncle Sam
gives money to the Lebanese govt to fight drug dealers (remittances and aid
are part of net unilateral transfer)
Credit
150
(4) Current account balance (1)+(2)+(3)
-350
Nonreserve capital account
(5) Change in domestic assets held abroad* (increase: -)
Debit
-250
(6) Change in foreign assets held domestically* (increase: +)
Credit
200
(7) Nonreserve Capital Account Balance (5)+(6)
(8) Errors and Omissions (shady figures take back some of the money they
stashed in Dubai, it was a debit when they stashed the money)
-50
Credit
(9) Official settlement balance (4)+(7)+(8)
10
-390
Official reserves transactions
(10) Change in official reserves held abroad (increase: -)
Credit
+400
(11) Change in foreign official reserves held domestically (increase: +)
Debit
-10
(12) Net Change in official reserves
+390
Current Account
(1) Exports
Credit
200
(2) Imports
Debit
-700
(3) Uncle Walid from Montreal sends money to Karim in Beirut and Uncle Sam
gives money to the Lebanese govt to fight drug dealers (remittances and aid
are part of net unilateral transfer)
Credit
150
(4) Current account balance (1)+(2)+(3)
CA
deficit
-350
Nonreserve capital account
(5) Change in domestic assets held abroad* (increase: - )
Debit
-250
(6) Change in foreign assets held domestically* (increase: +)
Credit
200
(7) Nonreserve Capital Account Balance (5)+(6)
(8) Errors and Omissions (shady figures take back some of the money they
stashed in Dubai, it was a debit when they stashed the money)
-50
Credit
(9) Official settlement balance (4)+(7)+(8)
10
-390
Official reserves transactions
(10) Change in official reserves held abroad (increase: -)
Credit
+400
(11) Change in foreign official reserves held domestically (increase: +)
Debit
-10
(12) Net Change in official reserves
+390
Trade balance: (1)+(2) = -500
Capital account balance: (7)+(12)+(8) = 350= Current account balance
BOP
deficit
Some Theory
(but not too much)
very complicated equations
ahead!!!
No, not that complicated!!!
Neoclassical growth
• Assumptions:
– Output (Y) is created by mixing capital (K) and labor (L)
– Technology (A) determines the quantity of output
generated by a given amount of K and L
• If you like equations: Y=A*f(K,L)
– If you believe in Cobb-Douglas Y=AKaL1-a
– There is full employment (yeah, right!)
– Growth (in per capita terms) is driven by investment
(more K) or exogenous technological change (more A)
– Since there are no unemployed resources, the only
way to accumulate capital is to consume less
• So, less consumption => higher savings=> more capital=>
more growth
– It's a bit more complicated than this
Neoclassical growth
• In an open economy, investment can be
financed with foreign savings
• Closed economy
– Y=C+G+I
– Since S=Y-C-G
– We have: S=I
• Open economy
– Y=C+I+G+EXP-IMP=C+I+G+CAB
– Therefore: S=Y-C-G=I+CAB
– And: S-CAB=I
– Capital inflows are often referred to as foreign
savings
Implications
• Poor countries are poor because have a low
capital stock
• Return to capital should be higher in
countries with a low capital stock
• Capital should flow from rich to poor
countries
• Developing countries that receive more
capital should grow at a faster rate
• Capital account liberalization should lead
to higher growth
Outline
• Some very, very, very boring definitions
and a little bit of theory
• What do the data say?
• Why?
• Policy implications
Theory suggests that:
• Capital should flow from rich to poor
countries
– Without capital controls rich countries should
run current account surplus and poor countries
should run current account deficits (capital
should go South)
• Capital account liberalization should lead
to higher growth
Countries liberalized capital flows…
…but capital is going North!
Current Account Balance (% of GDP)
A. Weighted averages
Global imbalances
8
6
4
2
0
-2
-4
-6
-8
1980
1984
1988
1992
1996
2000
2004
Developing countries
Developed countries
Emerging economies in Europe
...still going
2000
1500
1000
European Union, excl. Germany
500
Germany
Japan
United States
0
Fuel-exporting countries
China
Other transition economies
-500
Other developing countries: Africa
Other developing countries: America
Other developing countries: Asia
-1000
-1500
2005
2006
2007
2008
2009
2010
2011
19
Current Account Balance (% of GDP)
B. Sim ple ave r age s and 25th and 75th
pe r ce ntile s of the dis tr ibution
6
4
2
0
-2
-4
-6
-8
-10
-12
-14
1980
1983
1986
1989
1992
1995
1998
2001 2004 2007
D ev elo ping c o untries
D ev elo ped c o untries
Em erging ec o no mies in Euro pe
25th perc entile fo r all c o untries
75th perc entile fo r all c o untries
Current Account Balance (% of GDP)
A. Em e r ging-m ar k e t e conom ie s
6
4
2
0
-2
-4
-6
-8
-10
1980
1983
1986
1989
1992
1995
1998
2001 2004 2007
A frica
A sia
Latin A merica
Eastern Euro pe and CIS
4.0
Current account Balance EMs
(% of GDP)
3.0
2.0
0.0
-1.0
-2.0
-3.0
2008
2006
2004
2002
2000
1998
1996
1994
1992
1990
1988
1986
1984
1982
-4.0
1980
% of GDP
1.0
But who is borrowing and
who is lending?
• Remember from our boring definitions:
Current Account +
+ Nonreserve capital account +
+ Official reserves transactions = 0
The balance of payment in EMs
1,500,000
Reserves (-increase)
Errors and omissions, net
1,000,000
Resident lending abroad, net
Official flows, net
Private flows, net
Current account balance
0
-500,000
The current account is positive (so DC don’t
need capital) and yet the private sector is
importing capital. Therefore, the official
sector needs to export capital.
-1,000,000
2009
2007
2005
2003
2001
1999
1997
1995
1993
1991
1989
1987
-1,500,000
1985
million USD
500,000
But who is borrowing and
who is lending?
• Remember from our boring definitions:
Current Account +
+ Nonreserve capital account +
+ Official reserves transactions = 0
• The current account is positive (so DC don’t
need capital) and yet the private sector is
importing capital. Therefore, the official sector
needs to export capital.
Stock of Internat. Res. (EMs)
5,000,000
4,500,000
4,000,000
3,000,000
2,500,000
2,000,000
1,500,000
1,000,000
500,000
20
08
20
06
20
04
20
02
20
00
19
98
19
96
19
94
19
92
19
90
19
88
19
86
19
84
19
82
19
80
0
19
78
million USD
3,500,000
But who is borrowing and
who is lending?
• Large gross flows but no net inflows
– The traditional channel (developing countries
need capital) is not at work
• This is strange, but maybe there are
efficiency gains associated with foreign
private capital
– Foreigners are better at allocating capital
– FDIs have positive spillovers
–…
• If this were the case, we should observe that
CAL has a positive effect on growth
– (the second prediction)
Capital account liberalization and economic growth
(IMF estimates)
Capital account liberalization and economic growth
(Rodrik and Subramanian)
Capital account liberalization and economic growth
(Rodrik and Subramanian)
Summing up
• Theory
– Capital should flow from rich to poor countries
– The private sector should lend money to countries
that need capital
– Capital account liberalization should increase
economic growth
• Reality
– Capital flows from poor to rich countries
– The private sector lends money to countries that don’t
need it
• (and governments of developing countries lend it back to
governments of rich countries)
– Capital account liberalization has no effect on growth
Outline
• Some very, very, very boring definitions
and a little bit of theory
• What do the data say?
• Why?
• Policy implications
Why doesn’t theory match the facts
• Problems with the theory
– Primacy of savings etc.
– Yes, but not today
• Problems with the international finanancial
architecture
– ILOLR does not work well and countries don’t
trust it
– Lack of cooperation
ILOLR does not work well and
countries don’t trust it
• When did global imbalances start?
A. Weighted averages
• Yes, after the Asian
crisis
• Why? 8
4.0
3.0
6
4
2.0
2
-2
0.0
-4
-1.0
-6
-8
-2.0
1980
1984
1988
1992
1996
2000
2004
2008
2004
2002
2000
1998
1996
1994
1992
1990
1988
1986
1984
1982
-4.0
Developing countries
Developed countries
Emerging economies in Europe
2006
-3.0
1980
% of GDP
1.0
0
ILOLR does not work well and
countries don’t trust it
• If the global insurer does not work well,
countries will self-insure with international
reserves
5,000,000
4,500,000
4,000,000
3,000,000
2,500,000
2,000,000
1,500,000
1,000,000
500,000
20
08
20
06
20
04
20
02
20
00
19
98
19
96
19
94
19
92
19
90
19
88
19
86
19
84
19
82
19
80
0
19
78
million USD
3,500,000
Lack of cooperation
• Consider two countries:
– Country A has an inflation rate of 2% and an interest
rate of 5%
• Real interest rate 3%
– Country B has an inflation rate of 8% and an interest
rate of 11%
• Real interest rate 3%
• We expect that the currency of country B will
depreciate
• (if not country B will lose competitiveness and run larger and
larger current account deficits)
– By how much?
• Approximately 6% per year
– This is called uncovered interest parity (UIP)
– This will also guarantee relative PPP
Lack of cooperation
• We expect that the currency of country B will depreciate
– But a smart investor can say:
– I can borrow at 5% in A and lend at 11% in B. If the XR does not
move too much, I can make easy money
– This is called CARRY TRADE
• Note that carry trade pushes money from A into B
• By creating demand for the currency of B it prevents a depreciation
of B. In fact, B may even appreciate
– Exchange rates will move in the WRONG direction
– Of course, this cannot last forever.
• Country B will keep losing competitiveness and run larger and larger
current account deficits
• At the end they will be a currency crisis in B,
– But, it may last for a while, and the longer it lasts the worst the
crisis
Outline
• Some very, very, very boring definitions
and a little bit of theory
• What do the data say?
• Why?
• Policy implications
Reform the International Financial
Architecture
• Self-insurance is inefficient and trade
agreements cannot survive with "exchange rate
disagreements“
– We need to re-establish trust in the global insurer
– The world economy needs a new code of conduct
going far beyond the existing framework of
international rules of trade policy as agreed in the
World Trade Organization (WTO)
• We need mechanisms to prevent “wrong”
movements of the exchange rate
– UNCTAD PPP and UIP rules
Reform the International Financial
Architecture
• This reform process may take time
• In the meantime, protect yourself:
– If the risk taking behavior of financial
intermediaries cannot be regulated perfectly, we
need to find ways of reducing the volume of
transactions… What this means is that financial
capital should be flowing across borders in
smaller quantities, so that finance is primarily
national (Keynes)
– members may exercise such controls as are
necessary to regulate international capital
movements.. (IMF Articles of Agreements)
Capital flows, exchange
rate, trade balances, and all
that stuff