Econ 721 lec 1 - UMass Amherstpeople.umass.edu/econ721/Econ_721_lec 1_s_07.pdf · Raghuram G. Rajan...
Transcript of Econ 721 lec 1 - UMass Amherstpeople.umass.edu/econ721/Econ_721_lec 1_s_07.pdf · Raghuram G. Rajan...
What is financial globalization?
• The increasing importance and even dominance of international financial transactions in the global economy.
• This affects economic growth, stability and equality.
What has been the Impact of Financial Globalization?
• Economic growth• Inequality• Instability• Distribution of power – classes, nations• Trajectory of national economics and
world economy
What has been the impact on the ability of national institutions – the state to chart their own courses?
Distinction between open and closed
• NOT whether there are international flows of goods or finance, but whether these are dominated by international capitalist markets and institutions, as opposed to national capitalists states or other non-capitalist institutions
Block: Goals of US in post wwIIreconstruction
• To get other countries to adopt “open”economies
• Not just fighting communism but also national capitalist economies in europeand elsewhere
Eric Helleiner
• Over post-war period, finance makes a come back. Increase financial power over the period.
• Now, many argue that the power of finance supreme (Dumenil and Levy, Crotty)
Questions about Trilemma
• How do governments choose where on triangle to be?
• What are the role of class forces and coalitions?
• What is the role of underlying productive structre?
Questions about Trilemma
• What are the impacts of different choices in terms of income distribution, economic growth, class power?
• Where do IMF/World Bank push countries to be and why?
• Domestic capitalists? What are their interests?
Capital Mobility and Financialization
• Finance push for financial liberalization and capital mobility
• What are impacts?
Summary of Two Related Framework: Trilemma and policy Choice
• Trilemma• Stable Exchange
Rate• Free capital mobility• Autonomous
macroeconomic policy
• Conflicts• Capital – labor• Finance – industry• Center –periphery
(country’s location in the international economy and structure of corporate governance and financial markets)
Two other big frameworks of great relevance to understanding dynamics of international
finance
• I. International Monetary Regime– Organization of the International Monetary
System• 2. International Credit Regime
- organization of the supply, demand and enforcement of credit relations
International Trade Regime
• This is a third framework of key importance
• But we will not directly address this much in this class except where it clearly and significantly interacts with the other two
International Monetary Regime - It Involves:
• Exchange Rate Mechanism (fixed; floating; managed)
• Currency (ies) Used in various roles– Reserve currency– International medium (a) of exchange– International means of payment• N-1 Country• Mechanisms of coordination and monitoring
Which Countries can issue hard currencies
• Key divide in global economy (medium of exchange, and means of payment –dollars; pesos ?)
Key Currencies
• Store of value (reserves)• Medium of exchange (vehicle currency)• Intervention currency (intervene in foreign
exchange markets)• Means of payment (service debts)
International Credit Regime: Has Two Components Operating in Tandem
• Enforcement Regime: The institutions and policies implemented by creditors to punish non-payment and reward payment
• Repayment Regime: the institutions and policies implemented by debtors to credibly signal that they will repay
International Credit Regime has a Third Component Working in Tension with the
Other Two
• The Keynesian/Mynskian Imperative:Competition, behavioral aspects, and fundamental uncertainty: Excessive lending and bubbles
Enforcement Regime in Tension and Contradiction
• Enforcement Regime• Repayment Regime• Keynsian/Minskian Imperatives
Different Theories
• Walrasian: interest rates clear markets; exogenous enforcement of contracts; rationality and perfect information
• New Keynesian/Asymmetric Information: non-market clearing; non exogenous enforcement; principal-agent problems
• Power Laden: non exogenous enforcement (marxian, neo-marxian)
Different Theories: continued
• Keynesian/Minskyian: fundamental uncertainty; endogenous cycles
• Behavioral Finance: psychological departures from “rationality”
Types of financial flows:
• Debt-portfolio-banksEquity-portfolio-FDIDerivatives and other exotic transactions
Figure 1: Increasing Capital Account Openness
0
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1.5
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2.5
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1973 1974 1975 1976 1977 1978 1979 1980 1981 1982 1983 1984 1985 1986 1987 1988 1989 1990 1991 1992 1993 1994 1995
Cap
ital A
ccou
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penn
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High Income Countries
Upper Middle Income Countries
All Countries
Lower Middle Income Countries
Low Income Countries
Source: Jayadev and Lee, 2005
This Surge in Trading and Flows
• Relatively new
• During 1930’s, WWII, and early post-war period, tight regulations over forex trading and capital flows.
Capital Controls
• Quantity based: prohibitions on trading of assets denominated in foreign exchange (forex). Examples: exchange controls, restrictions on buying or selling foreign assets
• Price Based: taxes on inflows or outflows of capital
Distinction Between De-jure and De-facto financial liberalization
• De-jure: legal restrictions (or the absence there-of)
• De-facto: quantity of flows
Uses of international financial system
• Transfer capital to those who have too much to those who have too little
• Help diversify risks
• Help smooth consumption• Help generate jobs (FDI)
Critiques of International financial flows
• Problem: most capital is flowing from the poorer countries to the richer countries (primarily the US)
• When capital does flow to poorer countries, it can (and often does) lead to financial instability and crisis.
Original Functions
• IMF, to help stabilize the international financial system and to help avoid the “deflationary bias” of the world Economy in the 1930’s
World Bank
• Medium to longer term lending for reconstruction after war and for developing countries
IMF
• Became more and more involved in longer term lending
• “structural adjustment”
• Interfering in operations of domestic economies
Pushed International financial Liberalization
Internal: free up domestic financial markets
External: reduce capital controls
“Washington Consensus”
• Financial Liberalization• Privatization• Trade Liberalization• Cut Budget Deficits
Washington Consensus
• Export led growth and free markets• Making countries attractive for
international investment
• These are the keys to economic growth
3 defining moments
• Third World Debt Crisis, 1982
• Asian Financial Crisis, 1997
• 9/11 – Iraq and the Election of “progressive” leaders in Latin America, opposed to Washington consensus
Figure 1: Increasing Capital Account Openness
0
0.5
1
1.5
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2.5
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3.5
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1973 1974 1975 1976 1977 1978 1979 1980 1981 1982 1983 1984 1985 1986 1987 1988 1989 1990 1991 1992 1993 1994 1995
Cap
ital A
ccou
nt O
penn
ess
High Income Countries
Upper Middle Income Countries
All Countries
Lower Middle Income Countries
Low Income Countries
Source: Jayadev and Lee, 2005
Third World Debt Crisis
• Background• Impacts• Led to neo-liberal globalization• Increasing role of IMF and structural
adjustment• Neo-liberalism and Washington
Consensus
International Financial Crises
• Third World Debt Crisis of 1982; defining moment in world economy
• Asian Financial Crisis of the 1990’s
Third World Debt Crisis
• Background• Impacts• Led to neo-liberal globalization• Increasing role of IMF and structural
adjustment• Neo-liberalism and Washington
Consensus
What happens when capital flows and then sudden stops
• Individuals, companies and governments build up debts
• Debts denominated in foreign currencies• Rely on future flows to service past flows
If debts in foreign currency
• When forex stops flowing in, creates problem
• If raise interest rates, problem worse• If exchange rate falls, problem becomes
worse –debts denominated in foreign currency becomes greater in domestic currency
Effect of depreciation on value of debt
• Exchange rate: 1 peso = 1dollar
• 100 dollars debt = 100 pesos debt• Exchange rate devalues (depreciates): 2
pesos = 1 dollar
• Now the country has 200 pesos worth of debt!!
Differences between trade in Goods and in Financial Assets
• Financial Assets are bets on the future; trade is production in the present
• Trade is based on newly produced goods—generates jobs.
• Finance ---already produced assets.• Creation of a financial asset necessarily
creates a debt.
Scepticism about Washington Consensus
• Post-Washington Consensus• More Policy space• Not all one size fits all• Capital controls?
Scepticism about Washington Consensus
• Post-Washington Consensus• More Policy space• Not all one size fits all• Capital controls?
Raghuram G. Rajan
• Economic Counselor and Director of Research
• “Has Financial Development Made the World Riskier?”
Risk: Spreading and Concentration: role of banks
• Securitization: selling assets (“plain vanilla” assets: financial commodities)
• Banks holding onto less liquid assets.
Implications for Systemic Risk?
• Incentives facing bank managers and investors – increasing systemic risk?
• Banks and other investment institutions have more incentive to take on risk:
Incentives to take on Risk
• Compensation: asymmetric: upside is compensated more than downside is penalized
• Performance judged relative to peers-incentive to take hidden risk-incentive to herd (ass covering)
Reinforce each other in boom-willing to bear low probablity TAIL RISK
Biggest Concern
• Will Banks be able to provide liquidity in the case of “tail risk” materializes
• In the past banks played that roleBased on their sound balance sheets
allowing them to attract liquidity in a crisis that they could on-lend
Illiquidity Risk?
• Banks today require liquid markets to hedge their bets, making them less able to provide the liquidity assurance they have provided in the past