GEPI Notes PDF

GEPI ✸ Rodrik’s of the world economy Hyperglobalization: a world without political/cultural barriers to the location of the goods National Sovereignty: each government can pursue policies without limits imposed by other nations Democratic Politics: governments respect both individual liberty and...

GEPI ✸ Rodrik’s of the world economy Hyperglobalization: a world without political/cultural barriers to the location of the goods National Sovereignty: each government can pursue policies without limits imposed by other nations Democratic Politics: governments respect both individual liberty and political equality -​ all are valued but all cannot occur at the same time, only two at one Money: held based on confidence (credible convertibility to valuable alternatives), it provides economies of scale in its supply, creates positive network alternatives, has national/international consequences national money​ ​ ​ ​ international money 1- domestic payments​​ ​ ​ 1- international payments 2- stored as wealth​ ​ ​ ​ 2- stored as international reserves 3- unit of account​ ​ ​ ​ 3- exchange rates (balance of payments) identity: CA + F + E&O = change of R CA: current account F: financial capital E&O: errors and omissions change of R: change in reserves -​ net outflow of domestic goods=> money inflow -​ net outflow of financial assets=> money inflow ​ = increase in Central Bank (CB) monetary reserves BoP equilibrium -​ short-run perspective: if; net international flow of goods = net international flow of financial assets = external equilibrium is satisfied in the short run. (BoP) -​ longer (intertemporal) run perspective: if CA is balanced (no systematic loss of reserves or indebtment) (BoP ) 1 Exchange rates and trade (video example) Let’s say Turkey produces shirts and Italy produces cars. The prices are set in the currencies of exporting countries (producer price). These prices are sticky, they don’t adjust quickly to changes in demand and supply. -​ if TL falls, more TL is needed to buy Euro So shirts become cheaper in Italy and cars become more expensive in Turkey. TR would buy less cars from IT and IT would buy more shirts from TR. TL falls compared to the Euro. -​ TR’s trade balance: exports rise, imports fall (improves) -​ IT’s trade balance: exports fall, imports rise (deteriorates) ​ exchange rates don’t work in this way in the near term. Many internationally traded goods have fixed prices in USD (even if the US is not the trading country). USD is a key feature in international trade. Exporters use imported inputs which have sticky dollar costs, they have the incentive to price in dollars. Imports invoiced in USD is 4 times the amount of imports from the US, for exports it's 3 times. If the price of shirts and cars are invoiced in USD; TL-Euro exchange rate becomes irrelevant. What matters now is TL-USD and Euro-USD. If TL falls and more TL is needed to buy USD, TR would buy fewer cars from IT. BUT this doesn’t mean that IT will buy more shirts from TR. Because the exchange rate of TL is irrelevant. ​ Exports become more sensitive over time; as time passes TR’s export prices in USD adjust downward, and depreciation makes the pricing strategy affordable. Hence, both X and M contribute to the improvements in TR’s trade balance. Current Account imbalances It’s the difference between a country’s exports and imports. Deficits and surpluses are appropriate and healthy. They can be excessive leading to trade tensions and financial disruption which hurts global growth. The IMF assesses the imbalances. It conducts annual assessments of surpluses and deficits in the largest economies and alerts the global community of the potential risks that need countries to address together. the issue for BoP -​ we live in a closed global economy. Σ world exports = Σ world imports (goods, financial assets, money) (some countries exit, some enter) -​ important note: ​ ​ Σ world current accounts = 0 only N-1 out of N countries can independently pursue a national account target. the issue for exchange rates -​ only one independent exchange rate between two currencies A,B => B:A/B = 1/(B/A) -​ only two independent exchange rates between three currencies A,B,C => A/B and A/C imply B/C -​ in a world with N currencies, there are only N-1 independent exchange rates 2  -​ if countries issue national currencies, only N-1 out of N countries can independently pursue a national exchange rate target Due to the N-1 issue, there must be practical arrangements to make sovereign targets reciprocally consistent. Practical arrangements must cover; 1)​ payments and accounting (convertibility prices, fixed/flexible exchange rates) 2)​ store of value (official reserves) 3)​ adjustment in case of imbalances ✸ Gold Exchange Standard GES is the monetary system in which the standard economic unit of account is the fixed weight of gold. It was properly introduced in the 1870s and lasted until 1914 (with the end of Pax Brittanica*). The gold standard was the domestic monetary standard. Bimetallism (gold and silver) to imitation gold set the most successful economy. Pax Brittanica: strong British hegemony and peace between the great power countries The British “rules of the game”, (national gold standard) The official reserves are held in gold, private commercial banks keep their reserves in gold or convertible to gold. paper money ⇔ gold, convertible Bank of England issues paper money proportionately to Bank of England’s gold reserves = if bankofE has 2x gold = bankofE has 2x gold worth of paper money => 4x gold Reserves are gold because external equilibrium means not losing too much gold. Reserves are kept and stored. “Rules of the Game” countries abided by these principles; 1)​ convert their currency into gold upon demand to glod inflow/outflow 2)​ allow gold to flow freely across borders 3)​ adjust domestic monetary policies in response to gold inflow/outflow gold inflow: money supply rises, inflation rises gold outflow: money supply falls, inflation falls following these rules was critical to maintaining system stability. Bank of England balance sheet: BankofE Assets: Domestic assets (loans to domestic private bank and national government), Gold Reserves BankofE Liabilities: Deposits of national private banks, Currency in circulation(pound), Net worth The International Gold Standard -​ any country can participate under one condition; ​ fixing parity between paper money and gold (following the “rules of the game”) -​ no restrictions on international gold transactions -​ no need for international treaties -​ inflow/outflow of gold => automatic changes in stock paper money circulation -​ formal symmetry 3 Bank of Country A balance sheet: A’s CB Assets: Domestic assets (loans to domestic private banks and national government), Gold Reserves, Foreign assets (holding bonds in pound) A’s CB Liabilities: Deposits of national private banks, Currency A circulation, Net worth XIX century macroecon; internal equilibrium: -​ quantity theory of money; total value of transactions = amount of money x velocity of circulation: [P Y=M v] -​ money neutrality; money creation has no impact on the worth of income, only determines inflation rates [change of M/M = change of P/P] -​ prices and wages are flexible; provides market adjustment and severe but temporary unemployment external equilibrium: ​ ​ CA = X - M = Y - E suppose CA in deficit, CA decreasing imports, raising exports -​ the adjustments are automatic under “rules of the game” -​ change in M/M = change in Gold/Gold Automatic adjustment through times -​ Hume’s Price-Specie Flow Mechanism: explains how trade imbalances between countries naturally correct themselves in a world where gold is the primary form of money. ​ when a country exports>imports: trade surplus=> inflation (higher prices for goods and services) ​ when imports>imports: trade deficit => deflation As trade surplus countries’ goods become more expensive, they become less competitive; increasing X and decreasing M. This reduces trade surplus and trade deficit => rebalancing the flows of goods or gold. -​ Gold tends to move to producers of goods and services. This natural move ensures money is distributed aligning trade flows and supporting economic activity. (imperfect in reality; wage stickiness, political barriers, production differs) Example: if ⅘ of Britain’s money suddenly flowed to other countries (M>X); ​ domestic supply would shrink drastically ​ reduction in money leads to lower prices in Britain ​ foreign countries would flush Brits with gold, prices would rise, reducing their export competitiveness ​ over time, gold would naturally flow back to Britain as its goods became cheaper and attractive to foreign buyers. 4 The idealized international Gold Standard 1)​ exchange rate regime: fixed exchange rates based on their gold content (± gold points) ​ example: if 1kg gold is 10 pounds in UK and 20 dollars in US; the exchange rate between pound and dollar is 1:2. ​ gold points: The exchange rate can fluctuate slightly, within “gold points” a narrow band. this is determined by the cost of converting currency into gold. (transportation, insurance cost, shipping of gold) 2)​ reserve regime: gold as the basis. gold was the primary reserve asset. countries need to hold sufficient gold to back their currency. ​ The British pound became a credible substitute for gold in international trade due to Britain’s dominant economic position -> “sterling area”, other countries relied on the pound for trade and reserves. 3)​ adjustment regime: automatic adjustment, relied on price-specie flow mechanism to balance trade and capital flows between countries. 4)​ symmetric system: automatic adjustment for surplus and deficit countries. the gold standard adjustments impose both on surplus and deficit countries ​ deficit: losing gold due to trade deficits reduces the money supply, causing deflation, low prices, and more competitive goods ​ surplus: gaining gold increases the money supply, causing inflation, high prices, and less export competitiveness. = This symmetry makes both sides imbalances corrected leading to stable international trade. in short; 1- exchange rate: fixed rates based on gold 2- reserve regime: gold is the basis 3- adjustment regime: auto-adjustment relied on price-specie flow mechanism and “rules of the game” 4- symmetric system: both surplus and deficit countries experience auto-adjustment Britain’s current account (CA) surplus and international finance During the gold standard, the British CA surplus averaged 5.2% of GDP. Had massive foreign direct investment, and long-term lending to foreign countries. London was the international financial center. Had significant international financial integration (real finance -> intertemporal trade). There was financial instability in nearby CA deficit countries. International gold standard in practice -​ severe economic cycles causing heavy costs on workers *Rodrik’s trilemma + democratic consensus wasn’t an issue then -​ price instability (due to gold discoveries) -​ asymmetric position of gold producers (Russia, South Africa) -​ competition for attracting(getting) (existing) gold=> deflationary bias in gold standard countries 5  -​ formally symmetric regime: The pound informally became a reserve currency causing asymmetric features to the gold standard The End of the Gold Standard -​ economic progress came to an end in August 1914. -​ before 1870 most states except Britain were largely agricultural and self-sufficient. Trade was done mainly by local markets. -​ gold standard saw great expansion of trade and private investment flow -​ at the beginning of WW1 London financial institutions refused to extend credit for short-term debt repayment. This interrupted international finance and disrupted foreign exchange markets. Hence the gold standard ended. ​ The gold standard was abandoned due to its propensity for volatility(oynaklık), as well as the constraints it imposed on governments: by retaining a fixed exchange rate, governments were hamstrung in engaging in expansionary policies to, for example, reduce unemployment during economic recessions. Post WW1 -​ all countries adopted extraordinary monetary policies to finance an expensive war -​ normative theory by Gustav and Cassel and the purchasing power parity theory(PPP): The rate of exchange between two countries depends upon the relative purchasing power of their respective currencies. -​ new economic role of national gov: industrial policy -​ trying to rebuild the gold standard, which failed ultimately at the Genoa Conference 1922 -​ Rodridks trilemma. The golden straitjacket is too stringent for indebted countries (especially Russia and Germany) International collaboration in LoN (League of Nations): -​ creation of the International Labour Organization in 1919. (Remarkable international collab outcome of WW1) -​ ILO’s tripartite: structure, including trade unions, industrial unions, and govs. -​ The World Commission on the social dimension of globalization was established by ILO => to deal with no-global movements -​ ILO has a crucial role in decent work promoting Golden fetters, Gol Standard, and the Great Depression -​ Britain returned to the gold standard at pre-war parity(eşitlik) -​ restored international financial reputation -​ but caused deflationary consequences -​ Wall Street crash: quickly spread abroad. => Britain out of Gold Standard in 1931 Second enduring legacy of a turbulent period (Çalkantılı bir dönemin ikinci kalıcı mirası) -​ The US’ tendency to work outside of LoN favored the development of pragmatic collaboration among Central Bank (Dooming monetary reforms) -​ Creation of BIS (Bank for International Settlements), for implementing support for Germany with the payment for reparations 6 The need to practically implement the support for German reparations repayment led to the creation, in 1930, of BIS - Bank for International Settlements. -​ Germany is currently a key actor in Monetary and financial collab -​ Bretton Woods resolution 1944 => BIS should have been liquidated ASAP. ✸ Bretton Woods In principle and practice 1944 Bretton Woods conference was prepared by bilateral negotiations between the US and the UK. (White and Keynes as chief of delegations). -​ It aimed to establish post-war international economic system to promote currency stability, trade growth, and economic reconstruction. -​ It achieved this by creating institutions like IMF and WB and fixed exchange rate system. -​ These measures laid the foundations for the modern global financial system and economic cooperation among nations. Had two common goals (different visions of symmetry): 1)​ open economic systems Ended pre-war beggar-thy-neighbour* attitudes in external policies. Promotes international trade and financial flows for reconstruction. beggar-thy-neighbour: “Beggar” out of neighbouring countries. It’s a term used for a set of policies that a country enacts to address its economic woes that, in turn, actually worsen the economic problems of other countries. 2)​ GES with fixed exchange rates A system to stabilize currencies and prevent competitive devaluations, introduced fixed exchange rates pegged to USD (which was convertible to gold at 35 dollars/ounce of gold). main goals: -​ establish a stable international monetary system (fixed exchange rate pegged at usd) -​ promote economic growth and reconstruction (mechanisms for financial support and post-war recovery, and ensure long-term economic stability) -​ encourage international trade (remove trade barriers and create stable exchange rates, increase global cooperation to expand invesment) -​ prevent future economic crises (avoid economic distruptions, implement mechanisms to help countries with BoP difficulties) -​ create international institutions for economic cooperation (IMF for short term financial assistance for BoP difficulties, WB for long-term loans for post-war reconstruction, ITO(GATT) for facilitating global trade) New institutions and rules BW conference participants agreed on 3 new institutions: 1)​ IMF, International Monetary Fund 2)​ IBRD, The International Bank for Reconstruction and Development. (It is now part of the World Bank Group 3)​ ITO, (never ratified, but GATT was approved as a procedural agreement. It evolved into WTO) 7 The institutional system of BW: IMF Articles of Agreement Keynes's proposal of a supranational bank. Issuing supranational currency and bancor. (discarded in favour of the US’ idea of creating the IMF) [IMF: common pool of monetary resources (including gold and foreign exchange) provided by IMF member countries.] IMF is meant to provide temporary liquidity to single member countries in periods of difficulty with BoP equilibrium. Post WW2 GES Exchange rate regime: fixed rates ± 1% Reserve regime: gold and US dollars (US dollars convertible into gold at a fixed parity of 35USD per ounce of gold) ​ there’s a formalized asymmetry between the US and all other countries Adjustment regime: -​ temporary disequilibrium: IMF financing temporarily -​ Fundamental disequilibrium: the country can (unilaterally) redefine its parity with the US dollar. Required to inform IMF. = There’s a parity between Gold and USD. And there are exchange rates between USD and all other currencies. Keeping fixed exchange rates: -Central Bank intervention: buying or selling foreign exchange in the market keeps the exchange rate in ± 1% parity. This intervention implies a change in the money supply (according to the “rules of the game”). Example: to avoid depreciation: What to do: CB needs to buy domestic currency, and sell USD. What happens: The USD reserve of the CB falls and the money supply is reduced. Also, sterilization is possible. After foreign exchange intervention, the CB expands its money supply. The CB does open market operations (domestic credit expansion) to neutralize the monetary consequences of the fall in reserves. Country A’s CB exchange rate intervention: (excess demand for dollar) Country A’s CB Assets: domestic assets (loans to domestic private banks, loans to government), gold reserves, foreign assets(USD) -100. => The CB buys a domestic currency and sells USD Country A’s CB Liabilities: deposits of domestic private banks, currency in circulation -100, net worth => money supply is reduced Country A’s CB sterilized exchange rate intervention: (an excess demand for dollar) Country A’s CB Assets: domestic assets (loans to domestic private banks, loans to government) +100, gold reserves, foreign assets(USD) -100. => The CB makes loans to commercial banks 8 Country A’s CB Liabilities: deposits of domestic private banks, currency in circulation -100, +100, net worth => In the end, the money supply is unchanged Open macroeconomics in the BW era: Mundell-Fleming model -​ Keynesian short-run model -​ output tends to be demand-determined (short run) Y = (C + I+ G) + A; AD -> Y -​ prices adjust slowly, due to imperfect competition, and unemployment may happen -​ aggregate demand management to stabilize output and reduce unemployment -​ open economy: fixed E and sticky prices. Real exchange rates are also sticky Is internal equilibrium (Y*, i*, pi*) compatible with external equilibrium? -​ There’s no guarantee that Y*, i*, pi* are associated with external equilibrium in a fixed exchange rate regime ​ BP financing in SR may require i≠i* ​ CA equilibrium in LR may require Y≠Y* and/or pi≠pi* -​ Domestic monetary and fiscal policies are normally required for external adjustment in a fixed exchange rate regime Policies for internal equilibrium, its external effects and BoP ​ suppose y Y and i increase ​ Y and IMP increase => CA decrease ​ i increase => F(capital flows) increase (foreigners buy domestic assets) -​ F can increase in principle (finance). The CA deficit in the SR (new external debt); and intertemporal external disequilibrium will build up -​ Adjustment is required in LR, if not external debt becomes unsustainable. 9 LR external adjustment by expenditure policies -​ expenditure switching policies: domestic production replacing imports -​ possible macroecon tools: exchange rate depreciation or protectionism (both excluded by BW agreements) -​ these policy limitations were acceptable due to ambiguous effects of depreciation: foreign products become more expensive, import quantity decreases, value of imports increases (price elasticity of imports and exports matter) LR external adjustment by expenditure policies suppose desired domestic equilibrium is associated with the CA deficit. what can be done under BW rules: -​ expenditure-reducing policies; G decrease, T and i increase (restrictive macro policies: Y decrease) If Y and M decrease, CA improves These reducing policies are effective but they are painful and unpopular (Rodrik’s trilemma) LR external adjustment, giving up fixed exchange rate system Post WW2 open economy macroecon theory: Mundell and Fleming compare different exchange rate regimes from a Keynesian perspective. They highlight the role of financial integration across nations leading to the monetary trilemma: fixed exchange rates + international financial integration are incompatible with domestic monetary policy autonomy. In the BW period, alternative national policy options with international financial regulation were admitted. (ex. UK liberalized K flows, Italy restricted K outflows) Monetary Trilemma (Mundell-Flemming) This figure shows; three features that policymakers in open economies would prefer their monetary systems to achieve. at most two can co-exist, not three at the same time. the middles are consistent with the two goals that lies between them: the two which can co-exist together get the one in the middle. ​ The above is economic in nature, but also includes the political dimension. Application of the , pick two only two 1.​ autonomy in domestic equilibrium (output and employment, inflation rate) 2.​ fixed exchange rates (or a chosen exchange rate target) 3.​ freedom of international financial flows, both inward and outward -​ BW GES picked 1 and 2: national autonomy with fixed exchange rates However; as transnational financial integration increased (in the sixties) 1 and 2 became conflicting targets. Eventually, the BW system was doomed. 1944 BW for internal and external equilibrium 10 IMF lending: address temporary BoP disequilibrium -​ IN PRACTICE the IMF rules make exchange rate adjustments in case of fundamental disequilibrium. -​ IN PRACTICE the IMF rules make restrictive regulations of international financial flows: allowing national interest rates to differ from prevailing world interest rates BW in practice -​ Exchange rates were not adjusted even in case of fundamental disequilibrium -​ Financial regulations were adopted to restore monetary autonomy in pursuing domestic goals, which were quickly bypassed: -​ Countries often face disguised capital flows -​ Financial innovation accelerated, starting with the eurodollar market ✸ From GES to Dollar Standard to Flexible Exchange Rates BW over the decades: BW system was very successful in the 50s, sustaining reconstruction and promoting international integration, making “economic miracles”. US as the hegemonic power of the time. The US had a mutually consistent two-sided role: -​ provider of international liquidity (to dollars) on one side -​ net buyer of goods and, -​ supporter of export-led growth of other industrial countries on the other side In the 60s BW needed in the early years of BW, the US partners (Europe and Japan) became so successful in exports, that they accumulated massive USD reserves. Triffin’s dilemma* became a matter in 1960. Triffin’s dilemma: If the United States stopped running balance of payments deficits, the international community would lose its largest source of additions to reserves. De Gaulle’s problem: The international role of USD provided the US with an exorbitant privilege, as they could issue domestic currency to pay for international trade US foreign liabilities in USD exceeded US gold reserves in 1960. The US had liabilities to foreign monetary authorities in 1963 while the exchange rate parities were declared in 1958. Gold convertibility of USD, Triffin’s paradox As long as foreigners were willing to hold dollars US could finance its large balance of payments deficits by increasing foreign holdings of official assets (USD held by CB). Yet, the gold reserve of the US declined over the entire period, foreign central banks tendered their USD for gold. In 1964 external officials claimed that US gold exceeded the dollar gold backing, which questioned the credibility of the gold exchange standard. Political cooperation for BW survival There are two problems; 1- asymmetric role of international reserve currency in GES 2- Triffin’s Dilemma (liquidity vs confidence) -​ The BW international monetary system needed to be recast. 1961 in a closed-door BIS meeting a gentlemen’s agreement was reached among CBs NOT to ask for USD to be converted into Gold (political decision) (doların altına çevrilmesini istemeyin) 11  -​ With the changed role of gold, it was rarely used for international settlements, (application of Gresham’s Law*) GES slowly became a pure exchange standard (de facto/in practice based on the USD) Gresham’s Law: “Bad money drives out good". For example, if there are two forms of commodity money in circulation, that are accepted by law as having similar face value, the more valuable commodity will gradually disappear from circulation. More exactly, if coins containing metal of different value have the same value as legal tender, the coins composed of the cheaper metal will be used for payment, while those made of more expensive metal will be hoarded or exported and thus tend to disappear from circulation. (yani diyor ki iki tip metalde circulate edilne para tipi varsa daha az maliyetli olan ödemeler için kullanılır ama pahalı olan dissappear olur) -​ BW's hegemonic regime evolved into an oligopolistic cooperation that led to a de facto USD standard. The Bank for International Settlements In 1930 the BIS was created. The BIS was established for the Young Plan (1930), which dealt with the issue of the reparation payments imposed on Germany by the Treaty of Versailles following the First World War. It is a hybrid organization; a business company and an international institution. Role: it is a bank for Central Banks, and also a club for central bankers of G10. (BIS survived the BW decision to suppress it) Discrete high level policy forum, pivotal in preserving post-BW international monetary system (started with 1961 gentlemen’s agreement) Current role of BIS: financial regulation and digital currencies The and international monetary system The Group of 10(G10): Belgium, Canada, France, Germany, Italy, Netherlands, Sweden, UK, US, Switzerland After the 1961 gentlemen’s agreement, G10 took the initiative to create a common Gold Pool to; -​ intervene in the private gold market, -​ creating a central bank’s currency swaps network, -​ repeated joint currency support arrangements (for example; to support the British pound and French franc) These measures helped prolong the lifespan of the BW system in a period of unprecedented (benzeri görülmemiş) economic growth, (the “golden thirty years” after the end of WW2). But couldn’t prevent the eventual end of the BW regime in 1971. The IMF response to the USD issue Cooperation became more difficult during the '60s for two reasons; 1- national policy priorities tended to diverge 2- global financial innovation Many requests were made to the IMF to address the USD liquidity/confidence problem. In 1969, the IMF created a new international reserve asset to supplement member countries’ official reserves: Special Drawing Rights. 12 Special Drawing Rights are an international reserve asset that provides non-USD-dominated international liquidity to be distributed among IMF members in proportion to their quotas in the Fund. -​ It’s an international reserve asset created by the IMF -​ It aims to support the foreign exchange reserves of member countries, provide liquidity, and enhance global financial stability -​ it is not a currency, but a basket of specific currencies (USD, EUR, CNY, JPY, GBP) -​ it’s a unit of account and a medium to exchange transactions between member countries. -​ Countries can exchange their SDRs for foreign currency with other members. -​ IMF periodically allocates SDRs to members in order to meet global liquidity needs. Countries receive SDRs based on their IMF Fund quotas. SDR nedir? -​ IMF tarafından oluşturulmuş uluslararası bir rezerv varlığıdır -​ amacı ülkelerin döviz rezervlerini desteklemek, liquidity sağlamak, global finansal istikrarı arttırmak -​ currency değildir, it’s a basket of specific currencies (USD, EUR, CNY, JPY, GBP) -​ IMF üyeleri arasında finansal işlemler için bir hesap birimidir ve değişim aracı olarak kullanılır. -​ üye ülkeler SDRlerini döviz karşlığında diğer üyelerle takas edebilirler -​ IMF dönem dönem SDR tahsisatı/allowance/allocates yapar, global liquidity need karşılamak için. Ülkeler IMF’deki kotalarına göre SDR receive eder. Roles of SDR: ​ reserve support: helps countries boost their foreign exchange reserves, making it easier to meet external financial needs ​ providing liquidity: during the economic crisis, SDR allocations lighten liquidity shortages ​ reducing exchange rate risk: provides a reserve tool independent of exchange rate fluctuations, contributing to stability +​ The most recent allocation of SDRs was to address the long-term global need for reserves and help countries cope with the impact of Covid-19. Global financial innovations in the 60s -​ BW rules: restrictive financial regulations could be used to pursue domestic objectives under fixed exchange rates -​ US: regulations for US based financial institutions -​ UK: regulations for pound transactions for domestic financial institutions – no regulation for transactions in USD in the UK -​ The “euro-dollar market”: it's for deposits and loans in dollars outside of the US, quickly developed, attracting clients for business (US multinationals outside the US) and for political reasons (Russia) -​ a transnational global financial market developed -​ BW countries found themselves back in the trilemma Eurodollar: USD that is held in foreign banks or at overseas branches of American banks 13 Eurodollar market: one of the world’s primary international capital markets. Unsecured funding is an attractive short-term source for corporations and financial institutions. Eurodollar loans can be cheaper than loans made elsewhere. Adjustment in dollar standard with Eurodollar market -​ Structural asymmetry between countries with CA surplus and CA deficit, CA deficit countries are more pressured to adjust -​ BW allowed exchange rate adjustments to be fixed but adjustable to Expected Return (ER). However, ER depreciation was seen as dangerous (in a financially integrated world) -​ Deficit countries avoided devaluations (değer kaybetme) even in fundamental disequilibrium because they feared further devaluations of self-fulfilling expectations ER: profit or loss an investor can anticipate from an investment BW in the 60s, no virtual exchange rate adjustments In theory: a devaluation can affect income levels and bring external equilibrium 3 potential features of devaluations 1- fight unemployment 2- improve CA 3- increase in official reserves ​ Currency devaluations can be used by countries to achieve economic policy. Having a weaker currency compared to the rest of the world can help; boost exports, decrease trade deficits, and reduce the cost of interest payments on government debts. This all depends on expectations over future exchange rates. When financial markets are integrated, expectations matter most. ​ If devaluation creates an expectation of future devaluation, the situation can worsen. What happens when : -​ monetary policy can transmit smoothly; -​ fewer entry barriers -​ better access to finance -​ lower interest rates Financial innovation in the BW era: BW agreements allowed countries to have restrictions on international capital flows to avoid clashes between domestic(like full employment) and external equilibriums. But transnational capital flows began to expand through loopholes in national financial regulations. London became the center of in the 60s. The sabotaged the technical applicability well before 1971, Nixon’s declaration on convertibility suspension. ​ domestic equilibrium: D=S balance within a country, full employment, stable inflation, sustainable growth ​ international equilibrium: D=S balance on external relations, sustainable trade balance, stable exchange rates ​ internal equilibrium: full employment, price stability within a country, domestic macroecon stability 14  ​ external equilibrium: sustainable balance of payments, current account=capital account over time without excessive borrowing or use of reserves 1971, the formal end of BW, -​ it is impossible to sustain cooperation between hegemon and other big countries because of diverging/splitting domestic policy objectives ​ Germany: imported inflation (due to fixed exchange rates) became unacceptable by the end of the '60s imported inflation: the rise in prices caused by an increase in the cost of imports ​ France: The US’ extreme privilege was politically unacceptable due to the conflicting political interests of Vietnam ​ US: “dollar is inconvertible to gold” was the solution to the conflict between domestic and foreign policy objective requirements -​ Hegemonic Stability Theory (HST): The international system remains stable when a single state is a hegemon. HST explains the rise of BW while its demise can be explained by hegemonic instability. In the 70s, exchange rate flexibility, and real shocks Since 1973, there were flexible exchange rates with CB exchange market intervention to avoid excessive fluctuations. -​ Money cooperation in Europe: the 1970 “snake” Werner Plan. limits fluctuations among European currencies ​ Werner Plan: institutional reform leading to fixing exchange rates and adopting a single currency within a decade without a Central Bank. With floating exchange rates the European snake was key for preserving common policies and budget. -​ 1973, 1979: oil shocks -​ Stagflation in many countries -​ Capital flights and growing financial interdependence. -​ The Werner Plan was never implemented due to the pressures of the US. Reforming the international monetary system -​ never-ending IMF negotiations until the Jamaica Agreement in 1976 leading to the Second Amendment of IMF Articles of Agreement: giving up “preserving a system of stable exchange rates”, unlike BW. ​ Exchange arrangements become each member's choice. The Fund oversees the international money system to ensure effective operation and surveillance each member and its obligations. ​ SDR to become the principal reserve asset of the international monetary system (it did not work) ✸ Global finance and asset price determination -​ Moderate financial integration Financial flows tend to follow a predictable pattern ​ high national interest rates to attract financial inflows ​ low national interest rates to boost financial outflows BoP equilibrium can be observed when; ​ both income and interest rates are low: low imports require little need for financial inflows 15  ​ both income and interest rates are high: attracting foreign inflows allows financing high imports +​ This perspective is valid when current transactions of international payments are in similar magnitude with financial transactions. -​ Strong financial integration With interest rate differentiation, predicting financial flows became very limited. There is always something happening very fast in global financial markets which can disrupt the pattern. With high financial integration; ​ financial flows dominate the amount of daily international payments (BIS estimates early 2000: 60 dollars of financial payments for 1 dollar account payment ​ BoP equilibrium in the short run is totally dominated by financial decisions; and can be characterized by CA deficit/surplus/balance. ​ Short run exchange rate is determined by financial markets. Q: Is this SR equilibrium conducive also to LR equilibrium (“appropriate” exchange rate for Current Account adjustment)? Asset price determination Not determined as flows, but priced as stocks. The existing amount of any equity has to be held by the public. If most people like to sell it, the equilibrium price of that asset will decrease (irrespective of the amount of trades) Exchange rates are determined as asset prices. Example in the short run; Short run price of an equity of Flying Cars Co. Each agent has the alternative between: holding their wealth in the form of a safe bond that provides a fixed interest rate (r), OR holding a Flying Cars share (risky asset, variable stock prices are set in the Stock Exchange market) If agents are neutral about risk and only concerned about profitability; Equilibrium in the Stock Exchange market requires the equivalence between the yields of those two alternative forms of holding wealth: safe bond with fixed interest rate or company share. This leads to short-run stock price adjustments. A simple equation: -​ What is the expected yield of a “safe” bond”? The interest rate r expressed as a percentage. -​ What is the expected gain for holding one share of Flying Cars Co.? This gain includes two components: ​ the dividend, d ​ and the capital gain or capital loss due to changes in the share’s market value: change in q -​ The sum of the two components in percentage is (d + change of q) / q -​ The equilibrium condition that implies no buying and selling of Flying Cars Co. shares is: r = (d + change of q) / q 16 Economic implications of the equation r = (d + change of q) / q ​ This equation explains how q is determined. ​ Given r and d, the equation identifies the equilibrium level of the stock price q which is associated with the expectation change of q ​ That is: expectations about future changes in q determine today’s level of q ​ Thus, stock market prices are likely to be volatile/temporary, reflecting new information, forecasts, and investors’s sensibility that feeds change of q ​ Asset prices have a forward looking nature. Asset prices in the long run -​ The fundamental value of a share of Flying Cars Co. is related to the ability of this firm generating future profits; to be distributed as dividends or to be re-invested into the firm. -​ This fundamental value can be estimated as the present value of future profits, each appropriately discounted. -​ Therefore, SR and LR determinants of asset prices are based on different variables reflected in two different mental models: ​ Keynes's “beauty-contest” story ​ The real possibility of financial “bubbles” Column from The Economist: The spectacular fall of FTX token and Sam Bankman-Fried The company filed for bankruptcy after competing offshore crypto exchange, Binance, backed out of a deal to get it and users withdrew around 6 billion USD in funds. FTX’s Sam Bankman-Fried stepped down as CEO immediately. Rational bubble: a rational bubble is present whenever an asset price deviates progressively more quickly from the path dictated by its economic fundamentals. The growth of rational bubbles reflects the presence of arbitrary and self-confirming expectations about future increases in an asset's price. What is in a bubble? -​ An increase in share price q at time t is rationally motivated by an expected increase for time t+1 17  -​ If the share price increase observed at time t+1 justifies expected increases then in the future a formally rational bubble develops. But economists disagree on what “efficient” and “rational” means. Economists disagree Fama’s view: Describes many arguments for the existence of bubbles as “entirely sloppy”. Asset prices were based on the best info available which caused sharp changes in companies' information about prospects. Shiller’s view: In the late 1990s prices were driven up because of the expectations that they would rise further. He called this “irrational exuberance” (unnecessary hype), which makes the assets become overvalued. This statement became popular. Beliefs and Bubbles ✸ Exchange rate determination in SR and LR Exchange rates -​ nominal exchange rates are determined as asset prices. most currency transactions are short-term and interest-bearing (faiz getiren) -​ For “risk neutral agents”; the overall return of holding USD must be equal to holding Euro. Returns on holding currency has two components; ​ the interest rate of that currency ​ expected appreciation/depreciation of that currency (rise or fall) in LR and SR What determines the fundamental value of the exchange rate? - PPP PPP (Purchasing Power Parity): a theoretical exchange rate that allows you to buy the same amount of goods in every country, like comparing the price of BigMac everywhere. Government agencies use it to compare the output of countries that use different exchange rates. PPP determines the fundamental value of the exchange rate; exchange rate changes tend to reflect inflation rate differentials. 18 Exchange rate determination has a forward looking nature (ileriye dönük). This means that nominal exchange rates have short-run volatility(oynaklık). This is caused by; new information changing expectations about the future which immediately feeds into the equilibrium exchange level. +​ Medium run: exchange rate waves of overvaluations and undervaluations of currencies (aşırı ve düşük) LR and PPP Money neutrality implies that; money supply, price levels, and nominal exchange rates move in the same proportion over the long run. -​ 50% increase in money supply -​ 50% increase in prices (inflation) -​ 50% increase in price of foreign currency (domestic depreciation) SR and equalization of ER Overall returns of two currencies must be equal for short-run equilibrium. -​ r(euro) = r (usd) + USD expected appreciation -​ r(euro)= r(usd) - Euro expected appreciation -​ r(euro) + USD expected appreciation = r(usd) Example: Today, you can make financial transactions on the basis of the following information: r(€) = 3%, r($)= 5%, “spot”E($/€) = 1.10 A.​ Suppose you expect $ the to appreciate. Will you buy or sell dollars? Why? B.​ Now you expect $ to depreciate. Buy or sell? Why? C.​ Assume you are risk neutral. Will you buy or sell $, if you expect E^exp ($/€) =1.10 also for the future? D.​ Assume you are risk neutral; you expect E^exp ($/€) =1.10. What level of “spot” exchange rate would be associated to equilibrium? (no buying, no selling of currencies) Answers: The current level of E($/€) = 1.10, r(€) = 3% and r($)= 5% imply a 2% interest rate differential in favor of $ A.​ Buy $ and sell euro, because the $ overall rate of return is higher (2% plus expected appreciation) B.​ Buy $ only if $ the expected depreciation is below 2%; for expected $ depreciation above 2%, the euro has a higher return C.​ You expect neither $ appreciation nor $ depreciation, hence you buy $ and gain the 2% interest rate differential D.​ The current exchange rate level E($/€) must be lower than 1.10 by 2% in order to have equilibrium. In this case, the 2% interest rate differential in favor of the $ is balanced by the 2% expected appreciation of the euro. 19 Nominal exchange rate waves have real implications -​ if there are volatile exchange rates and sticky prices; the exchange rate fluctuates wildly in the short run -​ Market signals to firms and consumers are also volatile. -​ Foreign prices shown in domestic currency(cost of imports when converted into the domestic currency, which depends on the exchange rate) fluctuate and cause prices of foreign goods to rise or fall. This affects consumer choice and firm investment decisions. -​ Volatile exchange rates make international trade decisions uncertain. -​ Systematic risk increases by 15% ✸ Digital currencies and cryptocurrencies Preserving trust and stability of the value of money; historical solutions: pure commodity money, private money supply, centralized control over money issuing historical experience: money can be devaluated; when it's privately supplied competitively, and when supplied by a sovereign present common solution: independent and accountable CBs, who use money created in a public/private collab between CB and commercial banks (two-tiered system) Digital money ​ Central Bank and Digital Currency; Potentially a new form of digital Central Bank money that can be distinguished from reserves or settlement balances held by commercial banks at central banks. it is a central Bank liability, denominated in an existing unit of account which serves both as a medium of exchange and a store of value CBDCs are not crypto assets. ​ Financial inclusion; Individuals and businesses have access to useful and affordable Financial products and services that meet their needs such as transactions, payments, savings, credit, and insurance; and are delivered in a responsible and sustainable way. ​ Stablecoin; Crypto asset that aims to maintain a fixed value relative to a specific acid or a basket of assets. based on USD. like USDT. ​ Security Tokens; Crpto assets that meet the definition of a security in the jurisdiction where they're issued, marketed, transferred, exchanged, or stored ​ Decentralized Finance (DEFI); a set of alternative financial markets products and systems that use crypto assets and software known as smart contracts that are built using distributed ledger or similar technology; run by a community, public vote(generally) ​ Unbacked Crypto Asset; Crypto assets that are neither tokenized traditional assets nor stablecoins ​ Blockchain; A distributed ledger in which transaction details are held in blocks of information a new block is attached to the chain of existing blocks via a computerized process that validates transactions ​ Digital Assets; Digital instrument issued or represented using distributive Ledger or similar technology. This excludes digital representations of fiat currencies. ​ Distributed Ledger Tech (DLT); A means of saving information through a distributed ledger such as a repeated digital copy of data available at multiple locations. A database that's stored shared and synchronized on a computer network data is 20  updated by consensus among the network participants. Blockchain is one example but it doesn't necessarily maintain its record using the same chain of blocks architecture. ​ Crypto Asset: Also known as cryptocurrency, a private sector digital asset that depends primarily on cryptography, distributed ledger technology, and similar technology. ​ E-money; Stored monetary value or prepaid product in which a record of the funds or value available to the consumer for multi-purpose use is stored on a prepaid card or electronic device like a computer or phone and which is accepted as a payment instrument by other than the issuer (multi-purpose use). The stored value represents a claim and is enforceable against the e-money provider to repay the balance on demand and in full. ​ Utility Tokens; Crypto assets that give holders a right to access a current or prospective product or service from the issue or issuer or issuing network Distributed ledger technology -​ Decentralized record keeping -​ each user stores their own copy of the entire ledger (permissioned like BTC or not) -​ There are “miners” and “users”; they all verify all ledger updates, so there is an incentive for miners to add only valid transactions till there’s a consensus on whether validity is reached (energy-intensive process) -​ Miners receive fees for; ascertaining that a transfer was completed without double-spending (proof of work), and updating the ledger (which has a cost) double spending: bi kripto paranın iki kere kullanılmaya çalışılması, adam parayı iki kere harcayamaz ben onu tekrar satmaya çalışırsam satamam. ben onu sana satarkan fee ödendi, ben onu bvbaşkasına satmaya çalışırken sistem tekrar çalışıyo ama işe yaramıyo ama sistem çalıştığı için tekrar fee ödeniyo. A cryptocurrency requires; -​ a protocol: computer code specifying how participants make transactions (ağ, hash üreten sistem, cümle kurmanı sağlayan sistem gibi alfabe) -​ a ledger: storing the history of transactions (defter, cümleleri yazman için defter) -​ decentralized network of participants (it’s a digital currency that’s no one’s liability) it’s value derives from expectations that others will keep accepting this currency (yazmamız için transactiona ihtiyacımız var) -​ digital per-to-peer exchange: no central counterparty to execute the exchange (transaction yapması için insanlar lazım) Crypto model of trust requires: -​ honest miners (controlling the vast majority of computing power) when a miner finds a bitcoin, he hiding it and not adding it to the system => dishonest miner -​ users verifying the history of all transactions -​ a predetermined amount of token supply; but there are issues on “networking externalities”; ​ scalability of transactions (congestion) ​ scalability of total token issuance (inelastic supply) ​ trust in the finality of payments (possibility of “forks”) 21 The many opportunities for distributed ledgers -​ they work very well in niches -​ they allow significant abatement of transaction costs Examples; ​ WFP blockchain-based Building Block System, handling payments to Syrian refugees in Jordan (crypto-payments, centrally controlled by WFP) ​ could facilitate low-volume cross-border payment services (remittances{havaleler}), currently very expensive fees Crypto regulations 22 Emir’le çalışma notları: blockchain basically noter, biz bunu sanal ama yazılı hashleme zincirleme mantığı, devletin elinden alıyo merkeziyetsiz bi sissteme alıyor.dünyadaki son bilgisauar lapatılana kadar duruoy. cryptocurrency alt bi sistem; erc20 ağı etherium20 ağı, trc20 ağı tron 20, feesi düşük ve hızlı, kendi chainlerinin altında çıkartıkkları coinler. ✸ Debt, financial, and exchange rate crises; “fundamental” or “self-fulfilling” Debt crisis -​ Global finance in the 70s had; oil shocks, industrial countries in recession, eurodollar markets that recycle petro-dollars (receiving deposits(mevduat: faizle yatırılan paranın dönüşü) from Arabic countries, lending to countries with emerging economies (including oil exporting countries)) -​ new financial tools: “roll-over” and “syndicated loan” for euro-market lending to emerging economies. there was a scarcity of publicly available information on commercial lending to sovereign borrowers -​ there was a shift from Keynesian views to monetarist, neo-classical views. This caused a shift in national macroecon policies. (1979 Volker was at the Federal Reserve, 1980 Thatcher in the UK. -​ Sudden shifts like these have systematic effects, like strong rise in world interest rates. => The 1982 global debt crisis, involving all indebted emerging countries +​ Macroeconomics of large countries can produce policies that can create negative or positive systematic externalities 1982 debt crisis -​ Creditor (alacaklı) countries policies: providing support to domestic financial institutions who have a possible risk -​ Debtor (borç alan) countries: commercial lending (ticari kredilendirme) dried up for all emerging countries (negative reputation externally). there was only access to non-market loans (official lending (resmi kredilendirme) commercial lending: focuses on profit. driven by market forces and targeting private borrowers. profit official lending: focuses on development and humanitarian goals. provides favourable terms to governments in need. public good -​ Changing role of IMF: providing conditional loans not only for temporary difficulties but in fundamental disequilibrium situations too -​ IMF conditionality: requiring structural adjustment through restrictive fiscal and monetary problems, market-oriented reforms -​ The consequence was “the lost decade” for many countries Emerging v Low-income countries Successful emerging countries face private debt risk. This usually happens after a significant regime change, such as Mexico accessing NAFTA in 1994, or Greece accessing the Eurozone. 23 Least developed countries tend to access only official capital flows, like the “gift dimension” (low interest rates, long-term payments). Even so, repaying debt can be hard for LDCs. If needed, they can access Paris Club negotiations for debt reduction and scheduling. +​ LDC crises and emerging countries may be connected Systematic global effects of the 1982 Debt Crisis -​ Low-income countries (LIC) debt structure: no commercial debt. can have a mix of ODA grants and concessional loans (low rate long term repayment) -​ Low amounts of absolute LIC debt, but low GDP: high debt over GDP ratios, tending to grow (financial vulnerability): LICs can have low total debt but their low GDP makes their debt-to-GDP ratio disproportionately high=> this leads to financial vulnerability. -​ Creditor countries meet in “Paris Club” to agree on specific LIC debt management, like rescheduling -​ Systematic shock due to higher interest rates hit LICs due to financial vulnerability. this shock requires multilateral action: 1996 Highly Indebted Poor Countries Initiate (HIPC) by WB+IMF -​ Jubilee 2000: debt cancellation procedures for “least developed countries”, conditional on a national Poverty Reduction Strategy Paper HIPC Initiative: designed to ensure that the LICs are not overwhelmed by unmanageable or unsustainable debt burdens. It reduces the debt of countries meeting strict criteria. Of the 39 countries eligible or potentially eligible for HIPCI assistance, 36 are now receiving full debt relief from the IMF and other creditors Role of IMF -​ indispensable multilateral loans -​ IMF conditionality ​ structural adjustment, reducing debt and restoring internal stability, external equilibrium and reputation) ​ controversial pro-market orientation of microecon policy (opening international trade, privatization, reducing public sector) -​ internal implementation of IMF conditionality ​ applying measures that hit marginal interest groups with little voice to preserve political consensus (oybirliği) Typical roots of debt crises in emerging countries Consider a successful emerging country attracting significant foreign capital inflows: -​ domestic investment (I)> domestic savings (S) -​ government spending (G) > tax (T) => government budget deficit -​ If I>S and G>T, we observe CA deficit by definition: X it’s a boom, income growth, and price inflation (demand-pull inflation). foreign capital keeps flowing in and foreign debt increases Servicing the external debt The emerging country needs to borrow abroad to serve foreign debt. -​ Debt increases; new financial inflows allow financingof the deficit. In SR the local currency appreciates or depreciates less than implied by inflation differentials (PPP) 24  -​ real exchange rate appreciates; consequence of local inflation + exchange rate stability or appreciation. Real appreciation worsens the CA (lower competitiveness of local product) -​ CA fundamental deficit + mounting foreign debt => unsustainable path Typical form of emerging country debt crisis there is a contrast between SR exchange rate strength and LR expectations of unsustainable foreign debt example: SR optimistic equilibrium overlooks the conditions for fundamental equilibrium. this is a typical “beauty contest” story. ​ Which kind of expectations prevail in the market, and for how long? ​ What can trigger the capital flow reversal? - Anything can. Crisis unfolds With capital outflow the country finds itself unable to finance its CA deficit by accessing foreign capital. Emergency finance is needed with conditions attached. (from IMF or from a group of multilateral lenders like Troika for Greece) CA adjustment is necessary, a surplus is needed to repay debt even if the debt is rescheduled or trimmed (restructured) 25 26 ✸ Fundamental versus self-fulfilling exchange rate crises Also look at textbook chapter 19 Transformation and crisis in the world economy and chapt 20 The global financial crisis of 2007-2009. Internal and external equilibrium clash: fundamental crises -​ domestic policies aimed at pursuing internal equilibrium can clash with external equilibrium example; expansive money supply and above average inflation, with fixed exchange rates -​ exchange market intervention to preserve the exchange rate, reduces official reserves to a triggering crisis point -​ it is difficult to predict the timing of a crisis but it is obvious to expect a depreciation of the local currency -​ speculators “bet against the CB”: by selling local currency they create future depreciation, but “they will end up losing the bet” Self-fulfilling crises Imagine one country’s domestic policies are aligned with external equilibrium. This can be associated to domestic policy authorities that accept a voluntary sacrifice of internal equilibrium (income is kept lower and higher unemployment to adjust a CA deficit) This is financial crisis. BoP crisis with exchange rate targets and expected devaluation: capital flights -​ capital flights reduce official CB reserve -​ capital flights actually make the country vulnerable to more future capital flights -​ it’s an example of “self-fulfilling expectations” 27 Self-fulfilling crises example: Suppose the market agents fear the country wont respect the self-imposed restrictive domestic policies in the future. They expect a relaxation of policies and subsequent depreciation of the currency. -​ They can put a test the intentions of the country’s policy makers, market agents sell the country’s currency because its perceived to be vulnerable -​ CB intervention ot counter this wave of speculation will reduce official reserves, making the country’s policies even more restrictive and worsening the internal ballance. The country becomes even more vulnerable. -​ Agents have even better reasons to doubt the country’s perseverance in pursuing restrictive policies -​ Self-reinfrcing circle of speculative attacks may bring about a crisis, driven by adverse expectations Economists disagree They disagree about the existence of financial bubbles and self-fulfilling crises example: 1997 South Asian crisis most economists agree that Indonesia was in a fundamental disequilibrium, other neigbouring countries have no evident of macro disequilibrium, but were involved nonetheless. They were vulnerable to contagion(bulaşma). They had some internal vulnerability (exp: excess investment in South Korea) C. Kindleberger elaborates on H. Minsky’s hypothesis -​ financial crises are not an accident, they are endogenous(içsel) to the financial system -​ Minksy: pro-cyclical increases in supply of credit in good times, and decline in supply of credit less cheerful economic times=> lead to increased fragility in the financial system -​ exogenous shocks trigger a systemic financial crisis because of the intrinsic fragility of the system Hyper-financialization and the 2007-2008 crisis -​ before the 2007-8 crisis: unregulated finance (self-regulated, according to “Basle Rules” -​ GDP growth, very high inequalities across countries -​ limited transfer of resources to developing countries, and important increases in their official reserves (uphill financial flows) -​ increasing prevalence of OTC markets and “shadow” banking -​ an enormous increase in leverage -​ serious risk of losing systematic trust (Minsky hypothesis at work) ✸ Exchange rate regimes for the 21st century Fixed/Flexible exchange rates ​ PROS -​ exchange rate changes may be needed for adjustment to inflation, for the differential between home and world inflation -​ fixed rate regimes tend to be asymmetric (reserve currencies play a big role) -​ changes may be required after a REAL shock (like a change in energy prices). especially if domestic prices and wages are slow to adjust. -​ monetary policy can be used with domestic policy targets 28  -​ negative impact of exchange rate waves overshoots real decisions -​ higher uncertainty implies real costs requiring expensive insurance activities ​ CONS ​ examples: Britain returning to pre-war parity with gold => leading to the Great Depression; and the unchanged price of USD in the 60s shows real over-valuation, US inflation higher than other big countries -​ fixed exchange rate regimes can endure speculative crises=> become self-fulfilling. it depends on the credibility of the CB and other real and financial vulnerabilities. (exp: degree of indebtedness, debt/GDP) +​ fixed exchange rates have micro benefits (efficacy/international integration) but have macro costs (giving up domestic monetary policy autonomy) Intermediate to Extreme exchange rate regimes Keeping a fixed exchange rate is almost impossible in a globalized financial market. speculative attacks are the new normal. -​ intermediate exchange rates (crawling pegs, official target zones) -​ countries wishing to contrast domestic inflation: pegging/fixing to a foreign currency = importing external monetary policies -​ Different forms: soft pegs, currency boards, dollarization/euroization.. -​ regional approaches to monetary cooperation, with parallel preferential trade agreements towards creating a common currency (monetary union) costs and benefits of a common currency Provides an integrated area with micro benefits and macro costs:​ basic benefit: reduces transaction costs ​ has increasing returns to scale, but it would take a world currency to maximize these benefits basic cost: losing macroecon policy instruments ​ losing control over domestic interest rate, no domestic exchange rate, not aligning with globalized finance Euro history of monetary cooperation in the EU EU countries in and out the snake during the early exchange rate fluctuation period 1979 European Monetary System, grid of bilateral parities with margins of fluctuations Adjustable parities, 11 realignments made between 1987-1979 Anti-inflation credibility in national policymaking, fixed exchange rates importing German credibility Formal symmetry: N currencies + ECU (than named Euro), de facto asmmetric role of Germany in economic policymaking The transition from flexible -> fixed -> signal currency In 1989, Jacques Delors presented the blueprint for the European Economic and Monetary Union, in Maastricht Treaty. It was imagined as a process of progressive convergence of policies. Move towards the single market based on “mutual recognition”. Capital controls in international transactions remained until 1990 in weak countries. To make doing business across borders easier, 12 countries signed the treaty in 1992. 29 Euro was introduced in 1999. Countries discontinued their own currencies and monetary policies, giving control to the European Central Bank. EU now had a unified monetary policy, with many domestic fiscal policies which is the main reason for the debt crisis. monetary policy: controls the money supply and interest rates for borrowing money fiscal policy: controls how much a government taxes and spendings, gov has to spends on tax. anything above has to be borrowed = deficit spending. Before Greece entered the EU, it paid high interest rates with a limit on the amount because lenders didn’t trust it. Now that it’s part of the EU, it can access more. Small countries suddenly had access to credit they never had before. Lenders now believe if the small countries cannot repay, big countries like Germany will step in and pay for them because the same new currency binds them. Countries like Greece, Portugal and Italy created high deficit spending proggrammes, which they paid for the borrowed money with more borrowed money. As long as the borrowing continued so did the spending, and the unbalanced fiscal policies continued untill 2008. The monetary union needs to match the fiscal union, fiscal union can prevent excessive borrowing and spending. Maastricht Convergence Criteria and the Stability and Growth Pact Maast Treaty required EU countries to satisfy several macroecon convergence criteria, prior to admission to EMU. Criteria; 1.​ last year’s inflation rate must be no more than 1.5% above the average rate of three EU member states with the lowest inflation 2.​ maintained a stable exchange rate within the ERM without devaluing its initiative. 3.​ public-sector deficit no higher than 3% of its GDP 4.​ public debt below/approaching a reference level of 60% of its GDP. EU financial crisis 1992: trilemma at work -​ 1989 and beyond: end of CW and German reunification -​ Internal equilibrium requires German interest rates to rise and attract funds from abroad -​ German interest rates are the monetary benchmark: free capital mobility, interest rates rise in other countries, challenging internal equilibrium -​ Speculative attack on countries with fundamental diequilibrium and vulnerability -​ Systematic exchange rate crisis in September 1992 ​ British pound sterling had a major decrease which marked a turning point for the UK economy and its place on the world stage. Reprecussiosn were far and wide. ​ This day exposed the vulnerabilities of the exchange rate mechanism is a system to stabilize European currencies but proved to be flawed and unsustainable under a market pressures. it revealed the limits of a governments ability to defy market forces. After a flood of selling the pound on foreign stock exchanges, Britain was forced to leave the ERM (European exchange rate mechanism) in 1992, less than two years after joining. This day became known as 'Black Wednesday', costing the UK Treasury £3.3 billion. ​ The crisis exposed the risks of fixed exchange rate systems especially in the face of speculative attacks and diverging economic fundamentals. speculative attacks: sudden selling of untrustworthy assets by previously inactive speculators This highlighted the need for more flexible and adaptive economic policies. 30  ​ EMU was created in 1992 to coordinate economic and fiscal policies with the common money euro. 1991:fixing irrevocable parities between national currencies and Euro. 2002: Euro materially starts circulating Fiscal policies Regional asymmetries suggest a pre-caution in creating a MU from a preferential trading area. Cross-country differences become a problem in asymmetric shocks, requiring national policies. Common fiscal rules; Debt of one country has negative spills in all of the Monetary Union. National debts raise interest rates in the whole MU. Fiscal rules are very difficult to enforce. Financial policy and monetary union Designing a financial regulation and supervision with a common monetary policy; -​ micro-prudential, macro-prudential dimensions -​ cross-country banking and finance -​ hard path between CB credibility and need for lending last resort in financial distress -​ urgent matter in time of crisis -​ two different experiences in two different crisis (financial/pandemic..) -​ The OCA(optimum currency area) don’t send clear signals. ​ the EU is not a perfect OCA, it may function but it’s at a cost -​ OCA criteria tells us where the costs will arise ​ labour market and unemployment ​ political tensions in asymmetric shocks ​ protectionist tendencies in deep negative symmetric shocks Optimal Currency Areas (OCAs) It’s a criteria for common currencies to be desirable.These criteria allow cost-benefit analysis for joining countries. But, cost and benefits modify over time and change optimally. -​ higher international integration between countries; = higher efficiency gain for joining and higher macroecon cost (autonomy loss). +​ macro costs can be important in asymmetric shocks, requiring different policies in different countries 31 6 criteria for an OCA: 1)​ Factor mobility across national borders (Mundell) ​ labor mobility: lowering administrative barriers like visa-free travel, cultural barriers, language, welfare, etc. (is costly across national borders) ​ capital mobility: price, wage, and flexibility 2)​ Production diversification (Kenen) ​ countries with widely diversified exports and countries with similar production structures have similar structures and face few or small asymmetric shocks. 3)​ Openness (McKinnon) ​ open to trade with countries and countries who trade a lot with each other ​ exchange rate doesn’t effect competitiveness in a small price-taker economy. if all goods are traded domestiic prices must be flexible 4)​ Fiscal transfers ​ transfers within national borders; either implicit (national welfare system) or explicit (in federal states). countries agree to compensate each other for negative shocks 5)​ Homogeneous macroecon preferences ​ to commonly deal with shocks. helps for both symmetric and asymmetric shocks, a better understanding of the partner’s actions. 6)​ Commonality of destiny ​ In a MU, countries will always face temporary conflicts of interest. ​ Commonality of destiny (kader ortaklığı) needs accepting economic costs for a higher purpose Real impact of a common currency -​ MU and national competitiveness: giving up managing the nominal exchange rate, each country faces real exchange rate changes -​ productivity and inflation differentials matter, with LR growth sustainability of a country. ✸ Debt and financial governance Current challenges for global finance governance -​ after the debt pandemic in low-income countries, who is dealing with sovereign financial distress? -​ the new role of G20 -​ IMF?, Paris Club? -​ DeFi, decentralized finance: a radical innovation with many risks and opportunities -​ financing the green transition 32