* Your assessment is very important for improving the workof artificial intelligence, which forms the content of this project
Download excess demand for tradables
Business cycle wikipedia , lookup
Exchange rate wikipedia , lookup
Non-monetary economy wikipedia , lookup
Global financial system wikipedia , lookup
Nouriel Roubini wikipedia , lookup
Economic bubble wikipedia , lookup
Foreign-exchange reserves wikipedia , lookup
Fear of floating wikipedia , lookup
Quantitative easing wikipedia , lookup
Austrian business cycle theory wikipedia , lookup
Ragnar Nurkse's balanced growth theory wikipedia , lookup
Helicopter money wikipedia , lookup
Modern Monetary Theory wikipedia , lookup
International monetary systems wikipedia , lookup
Fiscal multiplier wikipedia , lookup
Money supply wikipedia , lookup
Balance of payments wikipedia , lookup
Interest rate wikipedia , lookup
US Current Account and Macroeconomic Policy Puzzle in the world economy Relatively high growth rates in the world economy Budget deficit in many of the advanced economies Huge US current account deficit Yet, real interest rates (both short and long term) are low. %Change in world output Real long term interest rates US Japan 8 country average UK IMF WEO April 2007 IMF WEO April 2007 Similarly in the US, The CA has been in deficit every year since 1992. Until 1997, the deficit was modest but it grew thereafter. In 2006 deficit was 5.2% of GDP. US indicators in 2005 Long-term (nominal) interest rates had been falling and were now below 4%. Residential and business investment had been been rising and was now at 16.5% of GDP, (well above the average for the 1990s). Two views regarding the situation: 1. Optimistic 2. Pessimistic Optimistic view: What really matters for interest rates is the global economy, and The problem may be too much savings, rather than too little. This is called the “savings glut” view. This was adopted by the Fed. Sources of savings glut: Companies (US,German, Japanese, Cinese) make profits but they do not invest. Oil exporters are reluctant to invest in oil exploration. Reserves in China accumulating in the hands of the government. Examples of savings glut: Rising in oil prices giving oil-producing countries such as Russia and Saudi Arabia far more money than they can use right away. The aging workers of Europe are saving for the future US undistributed profits Possible positive outcome Around the world, Increased productivity, Improved living standards Cheap money makes it easier to provide for the equipment and infrastructure. Increased supply reduces inflationary pressures. Outcome in the US U.S. private and public sectors managed to acquire big increases in housing construction health-care military spending Without inflation Risks (pesimistic view) To finance the CA deficit, US sucks in savings from abroad that could not be relied on for ever. US needs to borrow from abroad or to sell assets—shares, bonds, property. Risks of savings glut Instead of going into productive investments, cheap money overheats spending and inreases asset prices ingredients for a bust. Case for unsustainability: US side A CA deficit results in an increase in foreign liabilities and a high net foreign liabilities/GDP ratio. CA deficit feeds itself since the interest payments increase as liabilities increase. Hence trade deficit needs to shrink. Depreciation of the $ may be required. Case for sustainability: US side US is a high growth economy and offers a good home for investment: not enough profitable investment opportunities in the rest of the world. “sophisticated US finance view”: dynamic, high saving developing countries suffer from inadequate financial markets and their domestic market is a poor venue for their liquid Criticism of the case for sustainability: A high growth country does not need to run a deficit in CA (eg UK in the 19th century had a surplus) A rising deficit means that demand growth exceeds output growth Foreign claims are not invested in high yield assets such as stocks but are in the form of debt with low returns Case for unsustainability: creditors’ side You cannot be a borrower for ever, but you can be a creditor as long as you wish to be. The creditors may change their minds given that risk exposure is rising and the return to their investments is very low. In China, reserves make up half of GDP. Case for unsustainability: creditors’ side When reserves accumulate as a result of intervention in the foreign exchange market it has monetary consequences. Reserve increases lead to monetary expansion without sterilization. Sterilization measures may not be applied indefinitely. Case for sustainability: creditors’ side Creditors have reasons to continue to finance the US: 1. Some are rich countries with structurally high savings: Germany, Japan, Singapore, and Switzerland 2. Some rely on export-led growth: East Asian countries Case for sustainability: creditors’ side Creditors have reasons to continue to finance the US: 3. Some fear currency crises and want to avoid CA deficits and external borrowing (Brazil and Malaysia) 4. Oil exporters want to be prepared for adverse circumstances Case for sustainability: creditors’ side China is a host to all of those motives: Huge structural saving surplus Export-led growth Fears financial instability High growth performance has created a resouce that may not be maintained in the future US macroeconomic policy “Savings glut” view: the root of the problem is excess savings arounf the world “Money glut” view: Us monetary policy (low interest rates) is the root of the problem. Explanation of low interest rates: Saving glut view: the fact that interest rates are low shows that there are ample savings. Money glut view: interest rates are low because inflation is low and because of accomodating monetary policy. Fed policy US monetary policy aims at attaining the natural rate of output Yn: highest possible level of output consistent with low inflation But at this output level, the exchange rate creates a current account deficit (excess demand for tradables) US macroeconomic policy According to the savings glut hypothesis The dollar appreciates against the intervening currencies. It is not easy for US to play against this. An overvalued US dollar creates excess demand for imports US CA deficit Given income and the exchange rate there is bound to be a CA deficit The internal counterpart of this deficit is an excess of spending over income or a shortage of savings. US spending grew faster than US income. US monetary and fiscal policy US monetary policy was expansionary Fiscal policy usually supported this US has no external constraint: it can borrow internationally in terms of its own currency Lax monetary and lax fiscal policy in US If not, a recession in US and around the world would be likely Emerging economies would have to boost up domestic demand Savings would have to decrease Indicators of lax monetary policy Indicators of lax monetary policy Results of lax monetary policy Increase in credit volume Increased demand for housing Increased demand for assets Bubble in housing market Asset bubble Indicators of lax monetary policy Direction of investments High availability of loanable funds Low nominal and low real interest rates Real cost of borrowing low Borrowing increasing A lot of loans extended by banks (with a lot of money coming from ‘shadow banks’) A shift into risky assets For example stocks, because the rate on risk-free assets (T-bills) is quite low. Demand increases for hedge funds and equity funds Equity funds: stocks Hedge funds: combination of stocks and derivatives and options to minimize risk exposure As demand for these rise Stock prices and prices of stock funds rise This blunts the expected and actual return Return: (price paid-price sold)/price paid As price paid inreases, % return decreases on a given price Risk spread Difference between the return on equity and risk free asset Spread is compressed for a given risk free rate