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Society-Centered Approach to
Macroeconomic Policy
International Political Economy
Prof. Tyson Roberts
Balance of Payments (BoP)
Current account
• Current account balance =
Current receipts – Current Expenditures
• Current includes
– Goods & services
– Income receipts (interest & dividends)
– Transfers (foreign aid, remittances)
2
Balance of Payments (BoP)
Capital account
• Capital Account Balance =
Capital Inflows – Capital Outflows
• Capital includes
– FDI (managerial control)
– Indirect investment (shares & bonds without
control)
– Cross-national checking accounts
3
What is macroeconomic policy?
• Fiscal policy (government borrowing &
spending)
• Monetary policy (interest rate, inflation rate)
• Exchange rate policy (fixed vs. floating, strong
vs. weak)
4
Macroeconomic Accounting
• Y = C + I + G + (X – M)
• S = Y – (G + C)
• SG = T - E
5
Fiscal Stimulus
• Increase E or cut T
– Recommended during recessions
– Increases GDP by increasing G or C, but
– Worsens current account (i.e., increases foreign
debt) unless domestic savings increases (which
requires less consumption, i.e., austerity)
Reinhart & Rogoff (2010) calculated that
excessive debt creates great risk of
recession…
Figure 2. Government Debt, Growth, and Inflation: Selected Advanced Economies, 1946-2009
5.0
6
GDP growth (bars, left axis)
5.5
4.0
5
Inflation
(line, right axis)
4.5
2.0
4
Inflation
GDP growth
3.0
3.5
1.0
3
0.0
Average Median
Debt/GDP
below 30%
-1.0
Average Median
Debt/GDP
30 to 60%
Average Median
Debt/GDP
60 to 90%
Average Median
Debt/GDP
above 90%
2.5
2
Notes: Central government debt includes domestic and external public debts. The 20 advanced economies included
are Australia. Austria, Belgium, Canada, Denmark, Finland, France, Germany, Greece, Ireland, Italy, Japan,
Netherlands, New Zealand, Norway, Portugal, Spain, Sweden, the United Kingdom, and the United States. The
number of observations for the four debt groups are: 443 for debt/GDP below 30%; 442 for debt/GDP 30 to 60%;
199 observations for debt/GDP 60 to 90%; and 96 for debt/GDP above 90%. There are 1,180 observations.
Sources: International Monetary Fund, World Economic Outlook, OECD, World Bank, Global Development
Finance, and Reinhart and Rogoff (2009b) and sources cited therein.
Oops…
They calculated wrong:
Increased debt levels have incremental relationship
with GDP growth (Herndon et al 2013)
Figure 3: Real GDP growt h vs. public debt/ GDP, country-years, 1946–2009
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Public Debt/GDP Ratio
Notes. Real GDP growth is plotted against debt/ GDP for all country-years. The locally smoothed
regression function is estimated with the general additive model with integrated smoothness
estimation using themgcv package in R. The smoothing parameter is selected with the default crossvalidation method. The shaded region indicating the 95 percent confidence interval for mean real
The negative correlation between debt and GDP
growth is low past growth making debt/GDP high, not
by current debt/GDP making future growth low
If lenders believe governments will repay loans, Debt:GDP ratios
can exceed 200% without triggering high interest rates (UK)
Source: Bank of England
Meanwhile, as Keynes predicted, fiscal austerity
(in times of recession) leads to slower growth
se for Austerity Has Crum bled by Paul Krugman | The New York Review of Books
7/ 30/ 13 6
e answer is that the results were disastrous—just about as one would have predicted fr
As with trade policy, fiscal policy creates winners
and losers
Winners (from fiscal stimulus)
• Workers
• Government sector
• Some capital (government
contractors, etc.)
• Current tax payers (if tax
cuts)
Losers (from fiscal stimulus)
• Future tax payers (?)
– If stimulus is successful,
economy will grow enough to
cover stimulus costs
• Private borrowers if
government crowds out
– However, during recessions,
private borrowers often on
sidelines
• Some capital
– Higher wages
Monetary Stimulus
• Cut interest rates
– Recommended during recessions, not booms
– Increases GDP and jobs by increasing I (including
business, cars, homes)
– Lower interest rates weakens currency (if floating)
• increases exports 
• increases costs of imports 
– Higher priced imports, higher wages, higher
demand for commodities => inflation
THE U.S. PHILLIPS CURVE
(annual data, 1953 to 1969)
CPI inflation
14.0
13.0
12.0
11.0
10.0
9.0
8.0
7.0
6.0
5.0
4.0
3.0
2.0
1.0
0.0
-1.02.0
3.0
4.0
5.0
6.0
Unemployment
7.0
8.0
9.0
10.0
11.0
15
Winners and Losers from Monetary
Stimulus: Partisan Model
Winners
• Labor
• Current borrowers (e.g.,
home buyers, some
businesses)
• Associated with Left parties
Losers
• Capital/savers (lowers
interest payments, inflation
risk – includes well-off
retirees)
• Associated with Right
parties
• Also parts of financial sector
(mortgages, etc.)
• Also future borrowers (asset
prices driven higher)
Unemployment tends to drop more under
Democratic presidents than under Republicans
Low income households do better than high income households
under Democratic presidents; High income households do better
than low income households under Republican presidents
(Bartels)
Why no inflation in past 5 years
despite low interest rates?
• Low interest rates increase inflation because
– Low unemployment and high utilization of
factories and other resources increases costs of
production
– High demand for finished goods increases prices
• For many years, unemployment remained
high => capacity remained underutilized,
demand remained fairly flat => low inflation
– Inflation is also restrained by cheap
imports/strong dollar
Exchange rate policy
• Float vs. fixed vs. adjustable fix vs. managed
float
• Convertibility vs. exchange restrictions
• Strong vs. weak currency
Exchange rate and monetary policy
• How does a fixed exchange rate affect
monetary policy?
• How does a floating exchange rate affect
monetary policy?
Partisan model
• Leftist (pro-labor) parties prefer domestic
autonomy for stimulus over fixed exchange
rate & low inflation
• Rightist (pro-capital) parties prefer stable
exchange rates & low inflation
22
Sectoral model
(Assumes capital mobility)
Preferred degree of exchange rate stability
High
Low
Non-tradable goods
industry
Strong
Financial services
Preferred level of
exchange rate
Weak
Export-oriented
industries
Import-competing
industries
?Financial services
Source: Based on Frieden 1991
23
Macroeconomic policy trilemma
“The Unholy Trinity”
Fixed exchange rate
Capital mobility
Floating exchange rate
Monetary autonomy
24
International Monetary System
1st Age of Globalization: Gold Standard
• Fixed exchange rate: pegged to gold
• Balance of Payment surplus in form of gold
reserves
• Automatic (market) adjustment mechanism:
25
Automatic (market) adjustment
mechanism under Gold Standard
•
•
•
•
•
•
•
•
•
BoP deficit =>
Gold shortage =>
High interest rates (to attract gold/currency) =>
Less domestic borrowing for local investment =>
Fewer jobs=>
Lower wages =>
Lower prices for domestic produced goods =>
Increased exports, decrease imports =>
BoP balance
26
International Monetary System
1st Age of Globalization: Gold Standard
• Fixed exchange rate: pegged to gold
• Balance of Payment surplus in form of gold
reserves
• Automatic (market) adjustment mechanism:
• No monetary policy autonomy
– Interest rates dictated by market
– Central bank goal is to hold gold, not to create
jobs or tame inflation
27
Macroeconomic policy trilemma
“The Unholy Trinity”
Fixed exchange rate
Capital mobility
Floating exchange rate
Monetary autonomy
28
World Wars & Interwar Period
• WWI: Gold standard suspended, replaced with
exchange controls
• 1920s: Paper money printed to finance
government, hyperinflation in parts of Europe
• USD & Pound reserve currencies
• 1928: US worried about exuberance, raises
interest rates, pegged currencies match =>
Depression
• Faith lost in US currency, capital controls, chaos
• WW2
29
Bretton Woods system
• Goal: stable exchange rates AND domestic
economic autonomy
• Components:
– Exchange rate “flexibility” (adjustable peg to gold –
NOT a “flexible exchange rate” policy)
– Capital controls (currency exchange restrictions)
– Stabilization fund (all members contribute, can
borrow during BoP deficits)
– IMF (to monitor members’ policies & BoP, decide
when devaluation warranted, and manage fund)
30
Some causes of Bretton Woods
• Belief Systems:
– Keynesian Revolution
• Interests and Institutions
– Which actors gained political power after WW2,
relative to the Gold Standard period?
– Is this explained by the Electoral Model, the
Partisan Model, or the Sectoral Model?
ISI under BW
• Remember how Latin American and African
countries had fixed, overvalued exchange
rates as part of their ISI policies?
– Is this an example of the Electoral Model, the
Partisan Model, or the Sector Model?
Macroeconomic policy trilemma
“The Unholy Trinity”
Fixed exchange rate
Capital mobility
Floating exchange rate
Monetary autonomy
33
Fall of BW
• 1958-1970: US ran major BoP deficits
– Vietnam War, Great Society, etc.
– Dollar as reserve asset => US doesn’t need to
maintain BoPs; can “print money”
– US doesn’t want to reduce spending or contract to
restore BoP
– Excessive deficits undermine credibility of the US
to repay gold for dollars
– As speculators begin to expect dollar devaluation,
they demand gold for dollars
34
End of Bretton Woods
http://www.youtube.com/watch?v=iRzr1QU6K1
o
35
Example: Nixon’s speech
• What exchange rate and trade policy changes
did Nixon make?
• Why did he make those changes (economic vs.
political explanations)?
• Is this decision explained by the Electoral
Model, the Partisan Model, or the Sectoral
Model?
Post-Bretton Woods/ Washington Consensus
Fixed exchange rate
Capital mobility
Floating exchange rate
Monetary autonomy
37
Example from 1980s
• US car making firms were upset by Japanese
automakers taking market share in the US and
wanted the US and wanted the US to be
devalued relative to the Yen
– Is this an example of the Electoral Model, the
Partisan Model, or the Sector Model?
Post-Bretton Woods
• Washington Consensus: 1970s-~2009:
– High capital mobility, but USD still trusted reserve
currency, in part because of Fed
(more in Lecture 14)
– Steady growth with managed financial crises
(more in Lecture 16)
39
Conclusions
• Globalized finance offers many benefits
(capital inflows, investment opportunities,
etc.) but also risks (bubbles, capital flight, loss
of autonomy, loan defaults)
• Governments are faced with tradeoffs
– Exchange rate stability vs. macroeconomic
autonomy vs. capital mobility
• Choices governments make are influenced by
interest groups, institutions, and ideas