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International Finance
Chapter 1
The Global Macroeconomy
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Chapter Outline
• Foreign exchange: currencies and crises
• Globalization of finance: debts and deficits
• Government and institutions: Policies and
Performance
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Intro to International Macroeconomics
• large-scale economic problems in global
interdependent economies.
• key economy-wide variables such as exchange
rates, prices, interest rates, income, wealth, and
the current account.
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Foreign Exchange: Currencies and Crises
• Countries have different currencies, therefore a complete
understanding of how a country’s economy works requires
that we study the exchange rate (the price of foreign
currency).
• Because products and investments move across borders,
fluctuations in exchange rates have significant effects on
the relative prices of home and foreign:
o goods (such as autos and clothing),
o services (such as insurance and tourism), and
o assets (such as equities and bonds).
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Foreign Exchange: Currencies and Crises
• How Exchange Rates Behave
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Foreign Exchange: Currencies and Crises
Questions •How are exchange rates determined?
•Why do some exchange rates fluctuate sharply in the short
run, while others are almost constant?
•Can exchange rates be forecast in the long run?
•How do exchange rates affect the real economy?
•How do changes in exchange rates affect the values of
foreign assets, and hence national wealth?
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Foreign Exchange: Currencies and Crises
• In an exchange rate crisis a currency experiences a
sudden and pronounced loss of value against another
currency following a period in which the exchange rate had
been fixed or relatively stable.
• There have been more than 27 exchange rate crises in the
12-year period from 1997 to 2011.
• In some cases, including Argentina in 2002, exchange rate
crisis lead to governments declaring default (i.e., a
suspension of payments).
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Foreign Exchange: Currencies and Crises
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Foreign Exchange: Currencies and Crises
• Governments in crisis may appeal for external help from
international development organizations, such as the
International Monetary Fund (IMF) or World Bank, or
other countries.
Questions • Why do exchange rate crises occur? Rational or not?
• Why are these crises so economically and politically
costly?
• What steps might be taken to prevent crises, and at
what cost?
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Globalization of Finance: Debts and Deficits
Current Account --CA = EX – IM = Y – ( C + I + G)
• CA>0
– Exports > Imports
– Total income > total spending
– Net foreign wealth is increasing
• CA<0
– Exports < Imports
– Total income < total spending
– Net foreign wealth is decreasing
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Globalization of Finance: Debts and Deficits
Source: U.S. Department of Commerce, Bureau of Economic Analysis
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Globalization of Finance: Debts and Deficits
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Globalization of Finance: Debts and Deficits
Questions •How do different international economic transactions
contribute to current account imbalances?
•How are these imbalances financed? How long can they
persist?
•Why are some countries in surplus and others in deficit?
What role do current account imbalances perform in a wellfunctioning economy?
•Why are these imbalances the focus of so much policy
debate?
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Current Account Deficit
• A country borrows from another to finance its
spending.
• CA deficit adds to a country’s debt.
• A debtor is not necessarily a bad thing. It depends
on how a nation spends its borrowed money: on
current consumption or on productive investment.
If it is the latter, then the nation’s future production
would increase and more than offset its debt. As a
result, the nation will enjoy an enhanced ability to
consume more goods and services in the future.
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Debtors and Creditors: External Wealth
• Total wealth or net worth = assets - liabilities
• A surplus (saving money by buying assets or paying down
debt ) helps increase net worth.
• Similarly, a deficit (taking on debt or running down savings)
contributes to a lower net wealth.
• From an international perspective, a country’s net worth is
called its external wealth and it equals the difference between
its foreign assets and its foreign liabilities.
• Positive external wealth makes a country a creditor nation;
negative external wealth makes it a debtor nation.
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U.S. Gross Foreign Assets and Liabilities,
1976 - 2009
Source: U.S. Department of Commerce, Bureau of Economic Analysis, June 2010
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Globalization of Finance: Debts and Deficits
Questions •What forms can a nation’s external wealth take and does the
composition of wealth matter?
•What explains the level of a nation’s external wealth and
how does it change over time?
•How important is the current account as a determinant of
external wealth? How does it relate to the country’s present
and future economic welfare?
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Government and Institutions: Policies and
Performance
• Government actions influence economic outcomes in
many ways by making decisions about exchange rates,
macroeconomic policies, debt repayment, and so on.
• To gain a deeper understanding of the global
macroeconomy, economists study policies, rules and
norms, or regimes in which policy choices are made.
• At the broadest level, research also focuses on
institutions, a term that refers to the overall legal,
political, cultural, and social structures that influence
economic and political actions.
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