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Capital flows, exchange rate, trade balances, and all that stuff

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Capital flows, exchange rate, trade balances, and all that stuff Outline Some very, very, very boring definitions and a little bit of theory What do the data say? – PowerPoint PPT presentation

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Title: Capital flows, exchange rate, trade balances, and all that stuff


1
Capital flows, exchange rate, trade balances, and
all that stuff
2
Outline
  • Some very, very, very boring definitions and a
    little bit of theory
  • What do the data say?
  • Why?
  • Policy implications

3
The Balance of Payment
  • The BOP keeps track of a country's payments to
    foreigners and receipts from foreigners
  • Transactions resulting into a payment to
    foreigners are entered in the BOP as a debit (-).
  • Transactions resulting into a payment from
    foreigners are entered in the BOP as a credit ().

4
The Balance of Payment
  • The BOP records two types of transactions
  • Transactions that involve exports or imports of
    goods and services or transfers are registered in
    the current account
  • When a Lebanese citizen buys a US made product,
    this is recorded as a debit in the Lebanese BOP
    and as a credit in the US BOP.
  • And viceversa
  • Transactions that involve the purchase or sale of
    assets are registered in the capital account
  • When a Lebanese company buys a US company
    (building, bond, ..), the transaction is recorded
    in the Lebanese BOP as a debit in the capital
    account and is recorded in the US as a credit in
    the capital account
  • And viceversa
  • Why debit? Because Lebanon is "importing" the
    Asset

5
The Balance of Payment
  • By double-entry bookkeeping, every transaction
    enters into the BOP twice, once has a credit and
    once as a debit
  • Example A US citizen buys hummus from Lebanon
    for USD2000 and pays with a check
  • Debit in US current account (import) credit in
    the Lebanese current account (export)
  • Credit in US capital account and debit in the
    Lebanese capital account (US sold a check to
    Lebanon)

6
The Balance of Payment
  • CAPITAL ACCOUNTCURRENT ACCOUNT0
  • So, what does a Balance of Payment deficit mean?

7
Current Account
(1) Exports Credit 200
(2) Imports Debit -700
(3) Uncle Walid from Montreal sends money to Karim in Beirut and Uncle Sam gives money to the Lebanese govt to fight drug dealers (remittances and aid are part of net unilateral transfer) Credit 150
(4) Current account balance (1)(2)(3) -350
Nonreserve capital account
(5) Change in domestic assets held abroad (increase -) Debit -250
(6) Change in foreign assets held domestically (increase ) Credit 200
(7) Nonreserve Capital Account Balance (5)(6) -50
(8) Errors and Omissions (shady figures take back some of the money they stashed in Dubai, it was a debit when they stashed the money) Credit 10
(9) Official settlement balance (4)(7)(8) -390
Official reserves transactions
(10) Change in official reserves held abroad (increase -) Credit 400
(11) Change in foreign official reserves held domestically (increase ) Debit -10
(12) Net Change in official reserves 390
8
Current Account
(1) Exports Credit 200
(2) Imports Debit -700
(3) Uncle Walid from Montreal sends money to Karim in Beirut and Uncle Sam gives money to the Lebanese govt to fight drug dealers (remittances and aid are part of net unilateral transfer) Credit 150
(4) Current account balance (1)(2)(3) -350
Nonreserve capital account
(5) Change in domestic assets held abroad (increase - ) Debit -250
(6) Change in foreign assets held domestically (increase ) Credit 200
(7) Nonreserve Capital Account Balance (5)(6) -50
(8) Errors and Omissions (shady figures take back some of the money they stashed in Dubai, it was a debit when they stashed the money) Credit 10
(9) Official settlement balance (4)(7)(8) -390
Official reserves transactions
(10) Change in official reserves held abroad (increase -) Credit 400
(11) Change in foreign official reserves held domestically (increase ) Debit -10
(12) Net Change in official reserves 390
CA deficit
BOP deficit
Trade balance (1)(2) -500 Capital account
balance (7)(12)(8) 350 Current account
balance
9
Some Theory(but not too much)
10
very complicated equations ahead!!!
11
No, not that complicated!!!
12
Neoclassical growth
  • Assumptions
  • Output (Y) is created by mixing capital (K) and
    labor (L)
  • Technology (A) determines the quantity of output
    generated by a given amount of K and L
  • If you like equations YAf(K,L)
  • If you believe in Cobb-Douglas YAKaL1-a
  • There is full employment (yeah, right!)
  • Growth (in per capita terms) is driven by
    investment (more K) or exogenous technological
    change (more A)
  • Since there are no unemployed resources, the only
    way to accumulate capital is to consume less
  • So, less consumption gt higher savingsgt more
    capitalgt more growth
  • It's a bit more complicated than this

13
Neoclassical growth
  • In an open economy, investment can be financed
    with foreign savings
  • Closed economy
  • YCGI
  • Since SY-C-G
  • We have SI
  • Open economy
  • YCIGEXP-IMPCIGCAB
  • Therefore SY-C-GICAB
  • And S-CABI
  • Capital inflows are often referred to as foreign
    savings

14
Implications
  • Poor countries are poor because have a low
    capital stock
  • Return to capital should be higher in countries
    with a low capital stock
  • ?Capital should flow from rich to poor countries
  • Developing countries that receive more capital
    should grow at a faster rate
  • ?Capital account liberalization should lead to
    higher growth

15
Outline
  • Some very, very, very boring definitions and a
    little bit of theory
  • What do the data say?
  • Why?
  • Policy implications

16
Theory suggests that
  • ?Capital should flow from rich to poor countries
  • Without capital controls rich countries should
    run current account surplus and poor countries
    should run current account deficits (capital
    should go South)
  • ?Capital account liberalization should lead to
    higher growth

17
Countries liberalized capital flows
18
but capital is going North!
Current Account Balance ( of GDP)
Global imbalances
19
...still going
19
20
Current Account Balance ( of GDP)
21
Current Account Balance ( of GDP)
22
Current account Balance EMs ( of GDP)
23
But who is borrowing and who is lending?
  • Remember from our boring definitions
  • Current Account
  • Nonreserve capital account
  • Official reserves transactions 0

24
The balance of payment in EMs
The current account is positive (so DC dont need
capital) and yet the private sector is importing
capital. Therefore, the official sector needs to
export capital.
25
But who is borrowing and who is lending?
  • Remember from our boring definitions
  • Current Account
  • Nonreserve capital account
  • Official reserves transactions 0
  • The current account is positive (so DC dont need
    capital) and yet the private sector is importing
    capital. Therefore, the official sector needs to
    export capital.

26
Stock of Internat. Res. (EMs)
27
But who is borrowing and who is lending?
  • Large gross flows but no net inflows
  • The traditional channel (developing countries
    need capital) is not at work
  • This is strange, but maybe there are efficiency
    gains associated with foreign private capital
  • Foreigners are better at allocating capital
  • FDIs have positive spillovers
  • If this were the case, we should observe that CAL
    has a positive effect on growth
  • (the second prediction)

28
Capital account liberalization and economic
growth (IMF estimates)
29
Capital account liberalization and economic
growth (Rodrik and Subramanian)
30
Capital account liberalization and economic
growth (Rodrik and Subramanian)
31
Summing up
  • Theory
  • Capital should flow from rich to poor countries
  • The private sector should lend money to countries
    that need capital
  • Capital account liberalization should increase
    economic growth
  • Reality
  • Capital flows from poor to rich countries
  • The private sector lends money to countries that
    dont need it
  • (and governments of developing countries lend it
    back to governments of rich countries)
  • Capital account liberalization has no effect on
    growth

32
Outline
  • Some very, very, very boring definitions and a
    little bit of theory
  • What do the data say?
  • Why?
  • Policy implications

33
Why doesnt theory match the facts
  • Problems with the theory
  • Primacy of savings etc.
  • Yes, but not today
  • Problems with the international finanancial
    architecture
  • ILOLR does not work well and countries dont
    trust it
  • Lack of cooperation

34
ILOLR does not work well and countries dont
trust it
  • When did global imbalances start?
  • Yes, after the Asian crisis
  • Why?

35
ILOLR does not work well and countries dont
trust it
  • If the global insurer does not work well,
    countries will self-insure with international
    reserves

36
Lack of cooperation
  • Consider two countries
  • Country A has an inflation rate of 2 and an
    interest rate of 5
  • Real interest rate 3
  • Country B has an inflation rate of 8 and an
    interest rate of 11
  • Real interest rate 3
  • We expect that the currency of country B will
    depreciate
  • (if not country B will lose competitiveness and
    run larger and larger current account deficits)
  • By how much?
  • Approximately 6 per year
  • This is called uncovered interest parity (UIP)
  • This will also guarantee relative PPP

37
Lack of cooperation
  • We expect that the currency of country B will
    depreciate
  • But a smart investor can say
  • I can borrow at 5 in A and lend at 11 in B. If
    the XR does not move too much, I can make easy
    money
  • This is called CARRY TRADE
  • Note that carry trade pushes money from A into B
  • By creating demand for the currency of B it
    prevents a depreciation of B. In fact, B may even
    appreciate
  • Exchange rates will move in the WRONG direction
  • Of course, this cannot last forever.
  • Country B will keep losing competitiveness and
    run larger and larger current account deficits
  • At the end they will be a currency crisis in B,
  • But, it may last for a while, and the longer it
    lasts the worst the crisis

38
Outline
  • Some very, very, very boring definitions and a
    little bit of theory
  • What do the data say?
  • Why?
  • Policy implications

39
Reform the International Financial Architecture
  • Self-insurance is inefficient and trade
    agreements cannot survive with "exchange rate
    disagreements
  • We need to re-establish trust in the global
    insurer
  • The world economy needs a new code of conduct
    going far beyond the existing framework of
    international rules of trade policy as agreed in
    the World Trade Organization (WTO)
  • We need mechanisms to prevent wrong movements
    of the exchange rate
  • UNCTAD PPP and UIP rules

40
Reform the International Financial Architecture
  • This reform process may take time
  • In the meantime, protect yourself
  • If the risk taking behavior of financial
    intermediaries cannot be regulated perfectly, we
    need to find ways of reducing the volume of
    transactions What this means is that financial
    capital should be flowing across borders in
    smaller quantities, so that finance is primarily
    national (Keynes)
  • members may exercise such controls as are
    necessary to regulate international capital
    movements.. (IMF Articles of Agreements)

41
Capital flows, exchange rate, trade balances, and
all that stuff
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