Macroeconomics Quiz: Saving and Money Demand

Financial Globalization

• Financial globalization is not the same as trade globalization
• Measures of trade openness include tariffs and regulations on free trade, and (Exports + Imports)/GDP
• Measures of financial globalization assess the openness of cross-border financial transactions
• De Jure measures examine the restrictions on international capital movements, based on IMF reports
• De Facto measures quantify the amount of international trade in financial assets

Financial Assets

• Characteristics of financial assets facilitate transferring purchasing power across time periods
• Examples include: Portfolio investment (equity and debt), Foreign Direct Investment (ownership > 10%), other investments (bank loans, trade credit), and derivatives (futures, options).
• Reserves held by central banks are also considered financial assets.

Flows and Stocks

• Flows represent the value of assets traded in a given year.
• Stocks represent the total value of assets held in a given year, which are the cumulative flows.
• Measures of financial globalization, such as International Financial Integration measure, are calculated using Domestic assets + Foreign assets/GDP.
• Inflows/GDP and outflows/GDP reflect net purchases of assets by domestic and foreign investors.
• A negative capital flow indicates more financial assets are being sold than bought.

First Financial Globalization

• World capital markets were highly integrated in the late 19th century.
• A significant portion of British wealth was invested overseas. This was also true for France and Germany.
• Capital outflows from the UK primarily went to the 'New World' for natural resources (Canada, Australia, US, Latin America) and used in infrastructure projects (railroads, ports).
• Factors contributing to first financial globalization include transportation (telegraph) and global communication.
• The Solow growth model explains high returns to capital in capital-scarce countries.

Marginal Productivity of Capital

• Marginal productivity of capital (MPK) represents the additional output created by adding one more unit of capital, while holding other factors constant, like labor.
• MPK typically decreases as more capital is added. This is due to diminishing marginal returns.

Return on Capital

• Return on capital is the additional output produced by one more unit of capital.
• It is used to measure the contributions of capital to the production process and typically diminishes as more capital is added.
• The return on capital falls as more capital is added.

Capital Mobility Between Countries

• Capital flows between countries equalize returns when barriers to capital flow are removed.
• When capital freely flows, capital-abundant countries experience a reduction in capital stock and an increase in marginal productivity of capital.
• Capital-scarce countries experience an increase in capital stock and a decrease in marginal productivity of capital.
• Both countries converge to the same marginal productivity of capital, which corresponds to the world interest rate.

Financial Globalization Cases

• Washington Consensus promoted modernization, deregulation, and opening of economies in emerging markets in the early 1990s.
• Many emerging markets opened up their capital markets. Most developed countries had already opened their capital markets in the 1980s.

Expected Gains

• Intertemporal trades result in capital flowing from capital-rich (low returns) to capital-poor (higher returns) countries.
• Financial integration boosts global investment and growth.
• Smoothing of consumption occurs when countries borrow during downturns and save during booms.
• Diversification of risks occurs when countries access international financial markets.

National Accounting and Balance of Payments

• GDP measures the value of all final goods and services produced within a country's borders.
• GNI measures the value of all final goods and services produced by national factors of production.
• GNI = GDP + Net receipts of factor income from the rest of the world (ROW)
• Net receipts of factor income is the income domestic residents earn in the ROW minus the payments foreign residents earn in the domestic economy.
• The current account identity is: CA = (S + SG) - I = S – I (S = saving, SG = public saving, I= Investment)
• A positive current account indicates more exports than imports and the country can lend to the rest of the world.
• A negative current account indicates more imports than exports and the country borrows from the rest of the world.

The Balance of Payments

• The balance of payments records all transactions between a country and foreign economic agents.
• The balance of payments has three components: Current Account, Financial Account, and Capital Account.
• The current account includes transactions in goods, services, primary income (income earned from foreign investments), and secondary income (transfer payments).
• The financial account records transactions in financial assets between countries, such as foreign direct investment and portfolio investment.
• The capital account records capital transfers and certain transfers.
• By definition, BOP = 0 (Current account + Financial account + Capital Account).

The Foreign Exchange Market

• The nominal exchange rate (E) is the price of one currency in terms of another.
• Quotation types include how much of domestic currency to get one unit of foreign currency, and vice versa.
• Exchange rates are frequently quoted on the foreign exchange market or FOREX, using spot and forward rates.
• The foreign exchange market is decentralized across many financial institutions including interbank transactions.
• The US dollar is used in most transactions in interbank transactions with high liquidity.

Return on Assets (Assets and currencies):

• Interest rates and returns are considered in the value of assets.
• The riskier the asset or the currency, the higher the returned expected.
• A risk premium is needed to be compensated since assets have different risk levels.
• If the currency depreciates, the return from investing in the currency increases, and the opposite applies if the currency appreciates.

Exchange Rate and Output:

• A decrease in the real exchange rate improves competitiveness, increasing net exports and stimulating aggregate demand.
• Fiscal policy is less efficient in stimulating demand in open economies compared with when interest rates are raised.

Fixed Exchange Rates and Currency Unions:

• Many countries peg their exchange rates to a single currency or basket of currencies to maintain stability and control inflation.
• Maintaining a fixed exchange rate regime may require capital controls (restrictions on capital flows).
• There is a cost for maintaining a fixed exchange rate and that is a potential loss of monetary policy autonomy.

Currency Crises and Crises:

• Speculative attacks against a fixed exchange rate can occur.
• An unexpected currency crisis can lead to abrupt currency depreciation, reduced investor confidence, a tightening of credit markets, and economic downturn.
• Currency crisis mechanisms depend on the degree of capital mobility, the credibility of the authorities, and the extent to which a currency is pegged to another currency.

Test your understanding of key macroeconomic concepts related to saving, interest rates, and money demand. This quiz covers various factors influencing savings rates and their implications for economies, particularly in the context of China and emerging markets. Assess your knowledge of how these dynamics affect economic performance and valuation.