lecture 15 international macroeconomics

Lecture 15 International Macroeconomics

Econ 340

Econ 340, Deardorff, Lecture 15: Int Macro

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News: Mar 9-15• ECB QE begins -- WSJ: 3/10 | Proquest | FT: 3/10 | CTools

– Following last month's pledge by the European Central Bank to initiate Quantitative Easing, the Eurozone national central banks began buying sovereign debt, even at negative interest rates.

– The plan is to buy about €850bn of eurozone government debt, plus additional private sector debt. EU rules forbid the ECB from bailing out member governments, and this complicates but doesn't prevent the process.

– The purpose is stimulate the economy and to reverse or prevent deflation, which has begun in some of the countries. The eurozone's unemployment rate is over 11%.

• Euro falls close to parity with dollar -- WSJ: 3/14 | Proquest | NYT: 3/12 | Proquest | FT: 3/14 | CTools – The euro fell against the dollar on Friday to $1.0482, its lowest since 2003. – The reasons for the recent decline include both the ECB QE and the expectation that the Fed will raise interest rates

in coming months. – The fall in the euro is to be expected, and is part of the mechanism by which the ECB QE is expected to work: It will

make European goods cheaper and stimulate demand. • Tea Party divided on renewal of Export-Import Bank -- NYT: 3/10 | Proquest

– "The Export-Import Bank guarantees loans to overseas customers of thousands of American companies." It is an 81-year old institution that will disappear June 30 if not renewed by Congress.

– Some conservative Republicans oppose renewal, saying that it is "crony capitalism" mainly benefitting big companies like Boeing and Caterpillar. In fact it also benefits many small companies that export, including ones owned by Tea Party Republicans. So there is division among Republicans on whether to renew. Unlike some other issues, those opposed need not persuade any Democrats, as all they need to do is to not act.

– Is the Ex-Im Bank subsidizing exports? That's not clear: "The bank operates on fees it charges its users and, so far, has made money for the government."

http://www.wsj.com/articles/europes-central-bank-bets-big-on-stimulus-1425947453

http://search.proquest.com.proxy.lib.umich.edu/newsstand/docview/1661533903/EA7942FD377B4D0EPQ/1?accountid=14667

http://www.ft.com/intl/cms/s/0/e0c1a708-c63d-11e4-9bf4-00144feab7de.html%23axzz3Tzjoz9YY

https://ctools.umich.edu/access/content/group/795b9fe9-eb22-4031-9f0d-02ac2814fbbe/News/20150310%20-%20Central%20banks%20dive%20into%20ECB%20QE%20-%20FT.com.pdf

http://www.wsj.com/articles/euro-steadies-german-government-bonds-fall-after-weak-u-s-data-1426237658

http://search.proquest.com.proxy.lib.umich.edu/newsstand/docview/1663302891/2AE8A2E81B334E46PQ/1?accountid=14667

http://www.nytimes.com/2015/03/12/business/international/delight-or-dread-as-euro-falls.html?ref=todayspaper&_r=0

http://search.proquest.com.proxy.lib.umich.edu/newsstand/docview/1662356383/AD35DC22F0F24CEAPQ/1?accountid=14667

http://www.ft.com/intl/cms/s/0/d2eab8e4-c97c-11e4-a2d9-00144feab7de.html?siteedition=intl%23axzz3UIKZW8sM

https://ctools.umich.edu/access/content/group/795b9fe9-eb22-4031-9f0d-02ac2814fbbe/News/20150314%20-%20Quantitative%20easing%20and%20the%20decline%20of%20the%20euro%20-%20FT.com.pdf

http://www.nytimes.com/2015/03/10/business/smallbusiness/small-business-leaders-wage-counteroffensive-to-save-export-import-bank.html?ref=todayspaper&_r=0

http://search.proquest.com.proxy.lib.umich.edu/newsstand/docview/1661533060/A88829A7E179468DPQ/1?accountid=14667


5

News: Mar 9-15• ECB QE begins

– Following last month's pledge by the European Central Bank to initiate Quantitative Easing, the Eurozone national central banks began buying sovereign debt, even at negative interest rates.

– The plan is to buy about €850bn of eurozone government debt, plus additional private sector debt. EU rules forbid the ECB from bailing out member governments, and this complicates but doesn't prevent the process.

– The purpose is stimulate the economy and to reverse or prevent deflation, which has begun in some of the countries. The eurozone's unemployment rate is over 11%.


6

News: Mar 9-15• Euro falls close to parity with dollar

– The euro fell against the dollar on Friday to $1.0482, its lowest since 2003.

– The reasons for the recent decline include both the ECB QE and the expectation that the Fed will raise interest rates in coming months.

– The fall in the euro is to be expected, and is part of the mechanism by which the ECB QE is expected to work: It will make European goods cheaper and stimulate demand.


7


8

News: Mar 9-15• Tea Party divided on renewal of Export-Import Bank

– "The Export-Import Bank guarantees loans to overseas customers of thousands of American companies." It is an 81-year old institution that will disappear June 30 if not renewed by Congress.

– Some conservative Republicans oppose renewal, saying that it is "crony capitalism" mainly benefitting big companies like Boeing and Caterpillar. In fact it also benefits many small companies that export, including ones owned by Tea Party Republicans. So there is division among Republicans on whether to renew. Unlike some other issues, those opposed need not persuade any Democrats, as all they need to do is to not act.

– Is the Ex-Im Bank subsidizing exports? That's not clear: "The bank operates on fees it charges its users and, so far, has made money for the government."


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Econ 340, Deardorff, Lecture 14: Pegging

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(From last time)Effects of Pegging

• Example: To see the effects of pegging versus floating, – Consider the Chinese foreign exchange

market (for $) – Suppose the US economy expands,

increasing US imports from China.– What will happen if

• The renminbi floats? Or, instead, if• The renminbi is pegged to the US dollar?


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Effects of US Expansion on China if Renminbi is Floating

• US expansion if renminbi is floatingEffects of US expansion:

– S$ shifts right (more US imports from China)

– Yuan appreciates (¥/$ falls)

– No change in China’s reserves or money supply

– Rising ¥ reduces US imports and increases US exports

S$

D$

Q$

E = ¥/$

E0

S’$

E1


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• US expansion if renminbi is peggedEffects of US expansion:

– S$ shifts right (more US imports from China)

– Yuan stays constant (no further effect on US trade)

– People’s Bank of China buys more $

• Reserves rise faster• Money supply expands

faster if not sterilized– May cause inflation in

China

S$

D$

Q$

E = ¥/$

E*S’$ΔR

ΔR’

Effects of US Expansion on China if Renminbi is Pegged


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Effects of Pegging

• Implication of Example:– Something always changes in the exchange

market when changes occur for trade, capital flows, or other transactions• Exchange rate changes if floating• Reserves (and maybe money supply) change if

pegged


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Outline: International Macroeconomics

• Recall Macro from Econ 102– Aggregate Supply and Demand– Policies

• Effects ON the Exchange Market– Expansion– Interest Rate

• Effects OF the Exchange Market– Depreciation via Trade– Depreciation via Net Wealth

• Effects THOUGH the Exchange Market


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Recall Macro from Econ 102

• Aggregate Supply and Demand DetermineY = GDP = Output = Income• This in turn implies level of Employment

P = Price level


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YYYN

P LRASSRAS

AD

Short-run Aggregate Supply

Long-run Aggregate Supply

Aggregate Demand

Natural Rate of Output

( = Output at Natural Rate of Unemployment)


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Recall Macro from Econ 102• Macroeconomic Policies

– Monetary Expansion = Increase in Money Supply (M)• Open market operations: purchase bonds• Reserve requirement: reduce it• Discount rate: reduce it• Usually indicated by Fed target for Federal Funds Rate

– Fiscal Expansion• Increase government purchases (G)• Reduce taxes (or increase transfers) (T)

– All of these have the effect of • Increasing aggregate demand• Shifting AD curve to the right

They differ in effects on interest rate (i):

• M>0 lowers i• G>0, T<0 raise i


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YN

P LRASSRAS

AD

AD′

Short-run change

Long-run change

M>0, G>0, or T<0,


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• Macroeconomic Policies– Contractionary policies (M<0, G<0, or

T>0) are just the opposite– All have only temporary effects on output and

employment, but lasting effects on price level– Policies can be useful (if done right) for

dealing with temporary problems such as a recession


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Effects ON the Exchange Market

• Non-Monetary Expansion

Y risesP risesi rises– We’ll always assume that the interest rate effect is

larger, because capital today is very mobile– Three cases to consider:

• Floating exchange rate• Pegged exchange rate at overvalued rate• Pegged exchange rate at undervalued rate

imports rise D€ shifts right

capital inflow S€ shifts right


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• US Non-Monetary Expansion: Floating Exchange Rate

S€0

D€0

Q€

E = $/€

E0

D€1

E1

G>0, T<0

S€1

Causes dollar to appreciate

(Due to Y>0, P>0)

(Due to i>0)


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• US Non-Monetary Expansion: Pegged Exchange Rate - Overvalued

S€0

I1

Q€

E = $/€

D€1

G>0, T<0

S€1

Less intervention (sells)

E*I0

D€0

(I1 < I0)


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• US Non-Monetary Expansion: Pegged Exchange Rate -

UndervaluedS€

0

I1

Q€

E = $/€

D€1

G>0, T<0

S€1

More intervention (buys)

E*I0

D€0


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• Summary: Non-Monetary Expansion– Results: Effects of non-monetary expansion

• Floating exchange rate appreciates• Pegging the exchange rate becomes easier

– If reserves were falling (overvalued case) they now fall less rapidly

– If reserves were rising (undervalued case) they now rise more rapidly


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• Monetary Contraction (i.e., rise in interest rate)

Y fallsP fallsi rises

– Assume again that the interest rate effect is larger– Same three cases

• Will only show floating case; others are similar

imports fall D€ shifts left

capital inflow S€ shifts right


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• US Monetary Contraction: Floating Exchange Rate

S€0

D€0

Q€

E = $/€

E0

D€1

E1

M<0

S€1

Causes dollar to appreciate

(Due to Y<0, P<0)

(Due to i>0)


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• Summary: Monetary Contraction– Assuming (always) that the interest-rate effect on

capital flows is larger than the income and price effects on trade

– Monetary contraction has essentially the same effects as a non-monetary (e.g., fiscal) expansion

– Reason: • Only the interest rate really matters, due to assumption that

capital flows dominate• And both fiscal expansion and monetary contraction raise the

interest rate


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Effects OF the Exchange Market

• Under a pegged exchange rate, the exchange market has little effect on the economy unless the pegged rate itself is changed– Exception: without sterilization, domestic

money supply is sensitive to trade and capital flows

• Under a floating exchange rate, movement of the exchange rate can matter a lot


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Effects OF the Exchange Market• Thus, in both cases, we want to know effects of

changing the exchange rate

• We’ll look only at an exchange depreciation

– (Usually called a “devaluation” when a pegged exchange rate is depreciated)


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• Two Major Effects of Exchange-Rate Depreciation– Trade Effect

• Depreciation makes country’s goods cheaper– Wealth Effect

• Depreciation makes country’s assets cheaper


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Effects OF the Exchange Market• Trade Effect of

Depreciation– E>0

• Stimulates exports (they are cheaper to foreigners)

• Retards imports (they are more expensive for domestic buyers)

• Thus depreciation increases aggregate demand (AD)

– Stimulates economyYN

P LRASSRAS

AD

AD′


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• Wealth Effect of Depreciation– If assets and liabilities are in same currency, then little

effect– If assets and liabilities are in different currencies, one

home and the other foreign, then BIG EFFECT


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• A common case of Wealth Effect, especially in • Developing countries in the past• Many countries in the recent financial crisis

– Countries have borrowed abroad to finance domestic investment• Assets are in home currency• Liabilities are in foreign currency

– Then depreciation causes a huge drop in net wealth


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• Example: Effect of 20% depreciation of Mexican peso (p): E=10p/$ → 12p/$– Case 1: Assets and liabilities both in pesos– Case 2: Assets in pesos but liabilities in $


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Case 1: Before E = 10 p/$

Assets

Liabilities

Net Wealth

in pesos in $in $

−900 p

1000 p = (100 $)

= (−90 $)

≈ 80 $

≈ −72 $

= (+10 $)100 p +8 $

After E = 12 p/$

Initial

20% loss of net worth

(in $)


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Case 2: Before E = 10 p/$

Assets

Liabilities

Net Wealth

in pesos in $in $

−900 p =

1000 p = (100 $)

−90 $

≈ 80 $

= −90 $

= (+10 $)100 p −10 $

After E = 12 p/$

Initial

Bankrupt!


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• Wealth Effect of Depreciation– This is exactly what happened to lots of

developing countries when they had an Exchange Crisis and their currencies suddenly depreciated

– The wealth effect overwhelms any beneficial effect that the country might otherwise feel from a boost in exports


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• Wealth Effect of Depreciation– It is also what happened in 2008 to

• Iceland• Latvia• Perhaps others in Eastern Europe

– They had liabilities denominated in euros, and then their own currencies fell.

– (It is not what is happened in 2010 to Greece. Their debt and assets were both in euros. They just borrowed more than they could repay.)


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2005

Jan

2005

Jun

2005

Nov

2006

Apr

2006

Sep

2007

Feb

2007

Jul

2007

Dec

2008

May

2008

Oct

2009

Mar

2009

Aug

2010

Jan

2010

Jun

2010

Nov

2011

Apr

2011

Sep

0.0000.0020.0040.0060.0080.0100.0120.0140.0160.018

Iceland Exchange Rate 2005-12


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• Another recent example: Brazil


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• Example of a different sort: Appreciation of the Chinese Yuan (aka renminbi)– For many years, the yuan was pegged to the US

dollar– On July 21, 2005, China

• Changed to pegging to a basket of currencies• The yuan appreciated by 2%• After that it rose by about another 20%• The increase stopped at the start of the financial crisis, in

July 2008– It rose slowly since then, for a while (as we saw in the

graph last time)


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• Effects of the Yuan Appreciation• (See reading by Stiglitz)

– Change was gradual, rising only about 6% per year

– Wealth effect• For US, negligible, since our debt is in dollars• For China, there was some decline in yuan value

of their dollar assets


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• Effects of any Yuan Appreciation – Trade effect

• Effects on prices– US goods become cheaper to China– Chinese goods become dearer to US

(But note, from Stiglitz: Chinese exports to the US have 70-80% import content; thus yuan matters little)

• Helps US sales, hurts Chinese sales


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• Effects of the Yuan Appreciation – Other effects

• Helps China fight inflation and excessive monetary expansion and credit growth

• Permits increased consumption in China


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Effects OF the Exchange Market• Are these the actual reasons for the yuan

appreciations of 2005-12?– No– US had been

• Pressing China for years to stop holding down the value of the yuan

• Threatening increased protection against Chinese exports– Idea was that appreciation would reduce the Chinese

bilateral trade surplus with the US, & thus reduce the US deficit

– China refused to be bullied, but perhaps it was


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• Will a further Yuan Appreciation Change the US Trade Balance?– Probably not

• To do so, it would have to change US saving and investment• It’s not clear why an appreciation would do that

– One possibility (see Stiglitz, writing in 2005)• Chinese spending increasesThey stop financing the US current account deficitUS interest rates riseUS housing bubble burstsUS spending would fall

(First 2 didn’t happen; second 2 did.)


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• Most recently, the Chinese yuan depreciated suddenly, instead of appreciating, as it has been doing for years.


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US$/Yuan

2.7%


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• Most recently, the Chinese yuan depreciated suddenly, instead of appreciating, as it has been doing for years.

• This was done deliberately by the Chinese central bank

• Purpose was, apparently, to discourage those who had been bringing funds into China


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• Another Example: The Depreciation of the US Dollar– Quite aside from what happened to the yuan,

the US dollar depreciated over the last several years (until its more recent rise)• Mann and Plück, writing in 2005, say that it fell by

25%• It fell more until 2011-12• But has risen recently

– What were the effects of the fall?


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2000

2002

2004

2006

2008

2010

2012

2014

020406080

100120140160

Exchange Value of the US Dollar (2002=100)

CanadaChinaEuroJapanMexico


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• Effects of the Dollar Depreciation – Did this help the US trade balance? No!– For more reasons see Mann and Plück

• Lots of US imports come from countries whose currencies didn’t appreciate (China, Thailand), or even depreciated (Mexico)

• “Pass-through” is low in the US market: 10% fall in $ only causes 2.5 - 4.0% rise in import prices


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Effects OF the Exchange Market• Effects of the Dollar Depreciation

– Note that the dollar depreciated less vis a vis China than vis a vis Canada.

– Krugman argues that China should have appreciated more, so that • $ would depreciate more• US would export more and import less, stimulating

the US economy• He wants US to threaten a tariff on China’s

exports, to push them to appreciate. (Bad idea, unless the threat alone is enough.)


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• Effects of the Dollar Depreciation – Perry, in contrast to Krugman, thinks that the

US benefits from the failure of the Chinese currency to appreciate• Consumers, especially low-income, benefit from

cheap imported consumer goods.• US firms that use imported inputs from China also

enjoy lower costs.• It’s like we are getting goods free. (He ignores that

we are borrowing to accomplish this, and may need some day to pay it back.)


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Effects THROUGH the Exchange Market

• The issue here: – Do macroeconomic effects get transmitted to other

countries, and if so how?– i.e., does an expansion, for example, in one country

cause an expansion or a contraction in other countries?


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– The answer: Although many exceptions are possible,

it is usually true that changes in one country cause changes in the same direction in others:• Expansion here → expansion there• Inflation here → inflation there• High interest rates here → high interest rates there


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• Example: How a recession in US can cause recession Canada– Fall in aggregate demand in US (due to non-

monetary contraction such as a fall in investment) leads to• Fall in US income, leads to• Fall in Canadian exports to US, leads to• Fall in Canadian income

– To see these links in more detail…


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US Investment Falls

US Income Falls

US Interest Rate FallsUS Imports Fall

US Dollar Depreciates

US Imports Fall More

Canadian Exports Fall

Canadian AD Falls

Canadian Income Falls


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• We’ve seen some of this dramatically during the last few years:– Crisis started in US– Effects were transmitted to the world– Exception: US dollar did not depreciate

immediately; it appreciated at first. (Due to flight to safety.)


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Next Time

• Fixed versus Floating Exchange Rates– Who uses them– What experts recommend– Pros and cons of

• Floating rates• Pegged rates

– Alternatives– The Problem of Undervalued Currencies

lecture 15 international macroeconomics

Documents

ecb qe

european central bank

sovereign debt

bn of eurozone government

overview lecture

renewal of exportimport

additional private sector

proquest nyt