Download Introduction

INTERNATIONAL MONETARY
AND
FINANCIAL ECONOMICS
Third Edition
Joseph P. Daniels
David D. VanHoose
Copyright © South-Western, a division of Thomson Learning. All rights reserved.
The
International
Financial
Architecture
and Emerging
Economies
International Financial Architecture
• The international financial architecture is the
set of international institutions, governmental
and nongovernmental organizations, and the
policies that govern activity in the international
monetary and financial markets.
2
International Capital Flows
• Growth in foreign direct investment (FDI) is one of
the most important developments in international
capital markets.
• An FDI inflow is an acquisition of domestic financial
assets that results in foreign residents owning 10
percent or more of a domestic entity.
• An FDI outflow is an acquisition of foreign financial
assets that results in domestic residents owning 10
percent or more of a foreign entity.
3
Mergers and Acquisitions
• Cross-border mergers and acquisitions are a
driving force of recent growth in FDI in the
developed economies.
• Cross-border mergers and acquisitions entail
combining of firms located in different nations
in which one firm absorbs the assets and
liabilities of another firm (merger) or
purchases the assets and liabilities of another
firm (acquisition).
4
Cross-Border Mergers and Acquisitions
During 1990-2000,
M&A inflows of
the developed
nations increased
by more than 500
percent while
inflows of the
developing nations
increased by nearly
600 percent.
5
Net Capital Flows to Emerging Economies
Despite recent
financial crises,
private capital flows
to the emerging
economies have
grown at a
remarkable rate.
6
Emerging Economies of the
Western Hemisphere
Prior to the 1994
Mexican peso crisis, a
large portion of FDI
inflows consisted of
portfolio capital. Since
1994, FDI flows are a
greater proportion of
the total capital flows.
7
Emerging Economies of Asia
Though the emerging
economies of East Asia
attracted substantial FDI flows
during the mid-1990s, they
relied heavily on portfolio,
bank loans, and other forms of
short-term capital.
8
Capital Allocations and Growth
• With access to foreign capital, domestic
residents and businesses can continue to save
and invest during domestic economic
downturns, thereby smoothing business cycles.
• Access to global capital can also reduce
investment costs for a developing economy,
thereby spurring greater investment spending.
9
Financial-Sector Development
• Because financial intermediaries perform an
important role in channeling capital, financialsector development—the strengthening and
growth of the nation’s financial sector
institutions, payments systems, and regulatory
agencies—contributes to attracting global
capital and promoting domestic saving.
10
Capital Misallocations
• Market imperfections, such as asymmetric
information, adverse selection, herding
behavior, and moral hazard (Chapter 6) may
lead to capital misallocation.
• Policy-created distortions—government
policies that result in a market producing a
level of output that is different from the
economically efficient level of output—may
also result in capital misallocations.
11
Capital Market Liberalization
• Capital market liberalization—policy actions
designed to allow relatively open issuance and
competition in a nation’s stock and bond
market—entails seeking to maximize the
benefits of capital inflows while minimizing
the risk of financial instability and crisis.
12
Liberalization and Financial Crises
• Both portfolio flows and FDI flows have their
benefits and risks.
• Portfolio Investment
– Involves the acquisition of foreign financial assets that
results in less than a 10 percent ownership share in the
entity. Hence, portfolio flows can reverse direction
quickly, generating financial instability.
• Foreign Direct Investment (FDI)
– A long-term investment strategy in which the source of
funds establishes financial control, making FDI a
stabilizing influence on a nation’s economy.
13
Capital Controls
• Some economists advocate the use of capital
controls—legal restrictions on the ability of a
nation’s residents to hold and exchange assets
denominated in foreign currencies.
• Most economists are skeptical of the
effectiveness of capital controls because
empirical studies indicate that only temporary
controls on capital inflows may prove to be
effective.
14
Schools of Thought on Exchange
Rate Regimes
• In the 1990s, there were two schools of thought on
exchange rate regimes.
• The first school of thought was that there should not
be an explicit target for the exchange rate because
small misses of the target could cause perception or
credibility problems.
• The second school of thought was that without an
explicit target, policymakers are unable to establish
policy credibility.
15
The Corners Hypothesis
• By the end of the 1990s a third view, the
corners hypothesis, emerged.
• This view was that countries should not
necessarily fix or float. Rather, they should
have a firm commitment to one end of the
spectrum or the other.
• In other words, policymakers should adopt
either a rigid peg or a pure float.
16
Dollarization
• Since the collapse of Argentina's currency-board
arrangement, a growing number of economists have
advocated dollarization—the replacement of the
domestic currency with the currency of another
nation— for emerging economies. Two possible
problems are the loss of seigniorage revenues and the
loss of discretionary monetary policy.
• Panama, El Salvador and Ecuador are dollarized.
17
Which Regime?
• Today, prominent economists such as Frankel
and Calvo, argue that it all three broad types of
exchange-rate regimes, fixed, float and
intermediate may be appropriate.
• The point is that it is the circumstances
(business cycles and institutions) of the nation
that are most important.
18
International Monetary Fund
• The International Monetary Fund: A multinational
organization that promotes international monetary
cooperation and that provides temporary financial
assistance to nations experiencing balance-ofpayments difficulties.
• Growth in IMF Membership: The number of member
nations in the IMF is now about six times larger than
it was when the organization was founded.
• Conditionality: The limitations on the range of
allowable actions of a government that is a recipient
of IMF loans.
19
World Bank Lending
Even though Africa has the
world’s poorest nations, it has
received only 19 percent of total
World Bank loans since 1990.
20
Crisis Prediction and Early
Warning
• Financial Crisis Indicator: An economic variable
that normally moves in a specific direction and by a
certain relative amount in advance of a financial
crisis, thereby helping to predict a coming crisis.
• Early Warning System: A mechanism that
multinational institutions might use to track financial
crisis indicators to determine that a crisis is on the
horizon, thereby permitting a rapid response to head
off the crisis.
21