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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 ● 20 ● ● ● ● Real GDP Growth ● ●● ● ● ● ● ● ● ●● ● ● ● ●● ● ● ● ●● ● ● ● ● ●● ●● ●● ● ● ● ● ●● ● ● ●●●● ● ● ● ● ● ● ●●● ● ● ● ● ●●● ●● ● ● ●● ● ● ● ● ● ●● ●● ● ● ● ● ●● ● ● ●● ● ●● ● ● ●●●● ● ●●● ●● ● ● ● ● ● ● ●● ●●● ●●● ● ● ● ● ● ●● ●●●●●● ● ● ● ●●● ● ●●● ●●● ● ● ●● ● ●●● ●● ● ● ● ● ● ●● ● ●●●● ● ● ● ●● ● ● ● ●●●● ● ●● ● ●● ●● ● ●●●● ●●● ● ●● ● ●●●● ●● ●●●●●● ● ●●● ●● ● ● ● ●●●● ●● ●●●●● ● ●● ●●●●●●● ● ● ● ● ● ●● ● ●● ●●● ●●●●●●●● ●●● ●●●● ● ●● ●●●● ●●●●●●●●●●●●●● ● ● ● ●●●● ●●●● ● ●●● ●●●●●●●● ● ●●●● ●●●●●● ●●●●● ●●● ●●● ●● ● ● ●● ● ● ● ● ●● ●● ● ● ● ● ●● ● ● ● ●●●●●●● ●● ● ●●● ●● ●●● ● ● ●●● ●●●●●●●●●●● ● ● ●● ●● ●●●●●●●● ● ●●●● ●●● ●● ●● ● ● ● ●●●●● ●●● ● ● ● ● ● ● ● ● ● ● ● ●● ●●● ● ●● ● ● ● ● ● ● ●● ● ● ●●● ●● ●● ● ● ●●●● ● ●●●●●●●●●● ●● ●●●● ● ● ● ● ● ● ● ● ● ● ● ● ● ● ● ● ●● ● ● ● ● ● ● ●● ● ●●●●●●● ●●●●● ●●●● ●● ● ●● ●● ● ● ● ● ● ●● ●● ●● ●●● ●● ●● ●●●● ●●●●● ● ●●● ●● ● ● ●●●●● ● ● ● ● ● ● ● ● ● ● ● ● ● ● ● ● ● ● ● ● ● ● ● ● ●● ● ● ● ● ● ● ● ● ● ● ● ●● ●●●● ●●●●● ● ●●●●●●●●●● ● ●● ●● ● ●●●●● ●●●●●● ● ● ● ● ●● ●●●● ●● ● ● ● ● ● ●●●●●●●●● ● ● ● ● ● ● ● ● ● ● ● ● ● ● ● ● ● ● ● ● ● ● ● ● ● ●● ●● ● ● ● ●● ● ● ●● ● ● ●●●●●● ●●● ●●●●●●●●●●●●●● ●●●●● ● ●●● ● ●● ●● ●●●● ●● ● ● ● ● ● ● ● ● ● ● ● ● ● ● ● ● ● ● ● ● ● ● ●●●●● ●●● ●●●●● ● ● ●●●● ●●● ● ● ●● ●●● ● ● ● ●● ● ●● ● ●●●● ● ● ●● ● ● ● ● ● ● ● ●● ●●●●●● ● ●●● ● ●●●● ● ●● ● ● ●●●●● ● ● ●●●● ●● ● ● ●●●●● ● ● ●● ●●● ●● ● ● ● ● ●● ● ● ● ● ● ●●●●●●● ● ● ● ● ●●● ● ●● ●●● ●● ●● ● ●●●●● ●●● ●● ● ●●● ● ●●● ● ● ●● ● ● ● ● ● ● ● ● ● ● ● ●● ● ● ● ● ●● ●● ● ● ● ● ● ● ● ●● ● ● ● ●● ● ● ● ●● ●● ● ●●●● ● ● ● ● ● ●● ● ● ● ●● ● ● ● ● ● ● ● ● ● ● ● ● ● ● ● ● ● ● ● ● ● 10 0 ● ● ● ● ● ● ● ● ● ● ●● ● ● ● ● ● ● ● ● ● ● −10 ● ● 0 30 60 90 120 150 180 210 240 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