Transcript No Slide Title

Balance of
Payments and
Exchange Rates
The Balance of Payments Account
• Meaning of the balance of payments
• The current account
The Balance of Payments Account
• Meaning of the balance of payments
• The current account
– trade in goods
UK balance of payments: 2001 (£ millions)
CURRENT ACCOUNT
1. Trade in goods
a) Exports
b) Imports
Balance on trade in goods
2. Trade in services
a) Exports
b) Imports
Balance on trade in services
+191 211
224 259
33 048
+77 076
62 373
+11 114
Balance on trade in goods and services
21 345
3. Net income flows (wages and investment income)
+11 151
4. Net current transfers (government and private)
Current account balance
7 246
–17 440
The Balance of Payments Account
• Meaning of the balance of payments
• The current account
– trade in goods
– trade in services
UK balance of payments: 2001 (£ millions)
CURRENT ACCOUNT
1. Trade in goods
a) Exports
b) Imports
Balance on trade in goods
2. Trade in services
a) Exports
b) Imports
Balance on trade in services
+191 211
224 259
33 048
+77 076
62 373
+11 114
Balance on trade in goods and services
21 345
3. Net income flows (wages and investment income)
+11 151
4. Net current transfers (government and private)
Current account balance
7 246
–17 440
The Balance of Payments Account
• Meaning of the balance of payments
• The current account
– trade in goods
– trade in services
– balance of trade in goods and services
UK balance of payments: 2001 (£ millions)
CURRENT ACCOUNT
1. Trade in goods
a) Exports
b) Imports
Balance on trade in goods
2. Trade in services
a) Exports
b) Imports
Balance on trade in services
+191 211
224 259
33 048
+77 076
62 373
+11 114
Balance on trade in goods and services
21 345
3. Net income flows (wages and investment income)
+11 151
4. Net current transfers (government and private)
Current account balance
7 246
–17 440
The Balance of Payments Account
• Meaning of the balance of payments
• The current account
– trade in goods
– trade in services
– balance of trade in goods and services
– income flows
UK balance of payments: 2001 (£ millions)
CURRENT ACCOUNT
1. Trade in goods
a) Exports
b) Imports
Balance on trade in goods
2. Trade in services
a) Exports
b) Imports
Balance on trade in services
+191 211
224 259
33 048
+77 076
62 373
+11 114
Balance on trade in goods and services
21 345
3. Net income flows (wages and investment income)
+11 151
4. Net current transfers (government and private)
Current account balance
7 246
–17 440
The Balance of Payments Account
• Meaning of the balance of payments
• The current account
– trade in goods
– trade in services
– balance of trade in goods and services
– income flows
– current transfers of money
UK balance of payments: 2001 (£ millions)
CURRENT ACCOUNT
1. Trade in goods
a) Exports
b) Imports
Balance on trade in goods
2. Trade in services
a) Exports
b) Imports
Balance on trade in services
+191 211
224 259
33 048
+77 076
62 373
+11 114
Balance on trade in goods and services
21 345
3. Net income flows (wages and investment income)
+11 151
4. Net current transfers (government and private)
Current account balance
7 246
–17 440
• South Africa also has a section on the
Current account for Net Gold Exports
• This is not included with goods
• It is a standalone section
• Do you know why?
The Balance of Payments Account
• Meaning of the balance of payments
• The current account
– trade in goods
– trade in services
– balance of trade in goods and services
– income flows
– current transfers of money
– Net Gold Exports
– balance on current account
UK balance of payments: 2001 (£ millions)
CURRENT ACCOUNT
1. Trade in goods
a) Exports
b) Imports
Balance on trade in goods
2. Trade in services
a) Exports
b) Imports
Balance on trade in services
+191 211
224 259
33 048
+77 076
62 373
+11 114
Balance on trade in goods and services
21 345
3. Net income flows (wages and investment income)
+11 151
4. Net current transfers (government and private)
5. Net Gold exports
Current account balance
7 246
0
–17 440
Current account balance as % of
GDP in selected countries: 1970–2003
Current account balance:% of GDP
5
4
3
2
1
0
-1
-2
-3
-4
-5
1970
1975
1980
1985
1990
1995
2000
Current account balance as % of
GDP in selected countries: 1970–2003
Current account balance:% of GDP
5
4
3
2
1
0
UK
-1
-2
-3
-4
-5
1970
1975
1980
1985
1990
1995
2000
Current account balance as % of
GDP in selected countries: 1970–2003
Current account balance:% of GDP
5
4
3
2
1
0
UK
-1
-2
-3
USA
-4
-5
1970
1975
1980
1985
1990
1995
2000
Current account balance as % of
GDP in selected countries: 1970–2003
Current account balance:% of GDP
5
4
3
2
Japan
1
0
UK
-1
-2
-3
USA
-4
-5
1970
1975
1980
1985
1990
1995
2000
The Balance of Payments Account
• The capital account
UK balance of payments: 2001 (£ millions)
CAPITAL ACCOUNT
5. Net capital transfers
+1 439
Capital account balance
FINANCIAL ACCOUNT
6. Investment (direct and portfolio)
a) Net investment in UK from abroad
b) Net UK investment abroad
Balance of direct and portfolio
7. Other financial flows (mainly short-term)
a) Net deposits in UK from abroad and
borrowing by UK residents
b) Net deposits abroad by UK residents and UK
lending to overseas residents
Balance of other financial flows
8. Reserves (drawing on +, adding to –)
Financial account balance
+1 439
+ 75 496
118 750
–41 254
+219 087
161 063
+58 024
+3 085
+19 855
The Balance of Payments Account
• The capital account
• The financial account
The Balance of Payments Account
• The capital account
• The financial account
– investment
The Balance of Payments Account
• The capital account
• The financial account
– investment
• direct
The Balance of Payments Account
• The capital account
• The financial account
– investment
• direct
• portfolio
UK balance of payments: 2001 (£ millions)
CAPITAL ACCOUNT
5. Net capital transfers
+1 439
Capital account balance
FINANCIAL ACCOUNT
6. Investment (direct and portfolio)
a) Net investment in UK from abroad
b) Net UK investment abroad
Balance of direct and portfolio
7. Other financial flows (mainly short-term)
a) Net deposits in UK from abroad and
borrowing by UK residents
b) Net deposits abroad by UK residents and UK
lending to overseas residents
Balance of other financial flows
8. Reserves (drawing on +, adding to –)
Financial account balance
+1 439
+ 75 496
118 750
–41 254
+219 087
161 063
+58 024
+3 085
+19 855
The Balance of Payments Account
• The capital account
• The financial account
– investment
• direct
• portfolio
– other financial flows (mainly short term)
UK balance of payments: 2001 (£ millions)
CAPITAL ACCOUNT
5. Net capital transfers
+1 439
Capital account balance
FINANCIAL ACCOUNT
6. Investment (direct and portfolio)
a) Net investment in UK from abroad
b) Net UK investment abroad
Balance of direct and portfolio
7. Other financial flows (mainly short-term)
a) Net deposits in UK from abroad and
borrowing by UK residents
b) Net deposits abroad by UK residents and UK
lending to overseas residents
Balance of other financial flows
8. Reserves (drawing on +, adding to –)
Financial account balance
+1 439
+ 75 496
118 750
–41 254
+219 087
161 063
+58 024
+3 085
+19 855
The Balance of Payments Account
• The capital account
• The financial account
– investment
• direct
• portfolio
– other financial flows (mainly short term)
– flows to and from reserves
UK balance of payments: 2001 (£ millions)
CAPITAL ACCOUNT
5. Net capital transfers
+1 439
+1 439
Capital account balance
FINANCIAL ACCOUNT
6. Investment (direct and portfolio)
a) Net investment in UK from abroad
b) Net UK investment abroad
Balance of direct and portfolio
7. Other financial flows (mainly short-term)
a) Net deposits in UK from abroad and
borrowing by UK residents
b) Net deposits abroad by UK residents and UK
lending to overseas residents
Balance of other financial flows
8. Reserves (drawing on +, adding to –)
Financial account balance
+ 75 496
118 750
–41 254
+219 087
161 063
+58 024
+3 085
+19 855
The Balance of Payments Account
• The capital account
• The financial account
– investment
• direct
• portfolio
– other financial flows (mainly short term)
– flows to and from reserves
– financial account balance
UK balance of payments: 2001 (£ millions)
CAPITAL ACCOUNT
5. Net capital transfers
+1 439
Capital account balance
FINANCIAL ACCOUNT
6. Investment (direct and portfolio)
a) Net investment in UK from abroad
b) Net UK investment abroad
Balance of direct and portfolio
7. Other financial flows (mainly short-term)
a) Net deposits in UK from abroad and
borrowing by UK residents
b) Net deposits abroad by UK residents and UK
lending to overseas residents
Balance of other financial flows
8. Reserves (drawing on +, adding to –)
Financial account balance
+1 439
+ 75 496
118 750
–41 254
+219 087
161 063
+58 024
+3 085
+19 855
The Balance of Payments Account
• The capital account
• The financial account
– investment
• direct
• portfolio
– other financial flows (mainly short term)
– flows to and from reserves
– financial account balance
• Overall balance of payments
UK balance of payments: 2001 (£ millions)
TOTAL CURRENT + CAPITAL + FINANCIAL ACCOUNTS
Total current account
–17 440
Total capital account
+1 439
Total financial account
Total current + capital + financial accounts
9. Net errors and omissions
Overall balance of payments
+19 855
+3 854
–3 854
0
UK balance of payments: 2001 (£ millions)
TOTAL CURRENT + CAPITAL + FINANCIAL ACCOUNTS
Total current account
–17 440
Total capital account
+1 439
Total financial account
Total current + capital + financial accounts
9. Net errors and omissions
Overall balance of payments
+19 855
+3 854
–3 854
0
The Balance of Payments Account
• The capital account
• The financial account
– investment
• direct
• portfolio
– other financial flows (mainly short term)
– flows to and from reserves
– financial account balance
• Overall balance of payments
• Assessing balance of payments figures
Exchange Rates
• The rate of exchange
– individual rates of exchange
– exchange rate index
Sterling exchange rates: 1980–2003
US
dollar
Japanese
yen
French
franc
German
mark
Italian
lira
1980
1981
1982
1983
1984
1985
1986
1987
1988
1989
1990
1991
1992
1993
1994
1995
1996
1997
1998
1999
2000
2001
2002
2.33
2.03
1.75
1.52
1.34
1.30
1.47
1.64
1.78
1.64
1.79
1.77
1.77
1.50
1.53
1.58
1.56
1.64
1.66
1.62
1.52
1.44
1.50
526
445
435
360
317
307
247
236
228
226
258
238
224
167
156
148
170
198
217
184
163
175
188
9.83
10.94
11.48
11.55
11.63
11.55
10.16
9.84
10.60
10.45
9.69
9.95
9.32
8.51
8.49
7.87
7.99
9.56
9.77
(9.96)
(10.77)
(10.55)
–
4.23
4.56
4.24
3.87
3.79
3.78
3.18
2.94
3.12
3.08
2.88
2.92
2.75
2.48
2.48
2.26
2.35
2.84
2.91
(2.97)
(3.21)
(3.15)
–
1992
2287
2364
2302
2339
2453
2186
2123
2315
2247
2133
2187
2163
2360
2467
2571
2408
2789
2876
(2941)
(3180)
(3115)
–
(1.45)
(1.40)
(1.43)
(1.36)
(1.28)
(1.29)
(1.22)
(1.25)
(1.45)
(1.48)
1.52
1.64
1.61
1.59
2003Q2
1.62
192
–
–
–
1.43
Euro
Sterling
exchange
rate index
(1990 = 100)
124.4
127.9
123.2
115.6
111.4
111.3
101.4
99.4
105.4
102.3
100.0
100.7
96.9
89.0
89.2
84.8
86.3
100.5
103.9
103.8
107.5
105.8
106.0
99.1
Sterling exchange rates: 1980–2003
US
dollar
Japanese
yen
French
franc
German
mark
Italian
lira
1980
1981
1982
1983
1984
1985
1986
1987
1988
1989
1990
1991
1992
1993
1994
1995
1996
1997
1998
1999
2000
2001
2002
2.33
2.03
1.75
1.52
1.34
1.30
1.47
1.64
1.78
1.64
1.79
1.77
1.77
1.50
1.53
1.58
1.56
1.64
1.66
1.62
1.52
1.44
1.50
526
445
435
360
317
307
247
236
228
226
258
238
224
167
156
148
170
198
217
184
163
175
188
9.83
10.94
11.48
11.55
11.63
11.55
10.16
9.84
10.60
10.45
9.69
9.95
9.32
8.51
8.49
7.87
7.99
9.56
9.77
(9.96)
(10.77)
(10.55)
–
4.23
4.56
4.24
3.87
3.79
3.78
3.18
2.94
3.12
3.08
2.88
2.92
2.75
2.48
2.48
2.26
2.35
2.84
2.91
(2.97)
(3.21)
(3.15)
–
1992
2287
2364
2302
2339
2453
2186
2123
2315
2247
2133
2187
2163
2360
2467
2571
2408
2789
2876
(2941)
(3180)
(3115)
–
(1.45)
(1.40)
(1.43)
(1.36)
(1.28)
(1.29)
(1.22)
(1.25)
(1.45)
(1.48)
1.52
1.64
1.61
1.59
2003Q2
1.62
192
–
–
–
1.43
Euro
Sterling
exchange
rate index
(1990 = 100)
124.4
127.9
123.2
115.6
111.4
111.3
101.4
99.4
105.4
102.3
100.0
100.7
96.9
89.0
89.2
84.8
86.3
100.5
103.9
103.8
107.5
105.8
106.0
99.1
Sterling exchange rates: 1980–2003
US
dollar
Japanese
yen
French
franc
German
mark
Italian
lira
1980
1981
1982
1983
1984
1985
1986
1987
1988
1989
1990
1991
1992
1993
1994
1995
1996
1997
1998
1999
2000
2001
2002
2.33
2.03
1.75
1.52
1.34
1.30
1.47
1.64
1.78
1.64
1.79
1.77
1.77
1.50
1.53
1.58
1.56
1.64
1.66
1.62
1.52
1.44
1.50
526
445
435
360
317
307
247
236
228
226
258
238
224
167
156
148
170
198
217
184
163
175
188
9.83
10.94
11.48
11.55
11.63
11.55
10.16
9.84
10.60
10.45
9.69
9.95
9.32
8.51
8.49
7.87
7.99
9.56
9.77
(9.96)
(10.77)
(10.55)
–
4.23
4.56
4.24
3.87
3.79
3.78
3.18
2.94
3.12
3.08
2.88
2.92
2.75
2.48
2.48
2.26
2.35
2.84
2.91
(2.97)
(3.21)
(3.15)
–
1992
2287
2364
2302
2339
2453
2186
2123
2315
2247
2133
2187
2163
2360
2467
2571
2408
2789
2876
(2941)
(3180)
(3115)
–
(1.45)
(1.40)
(1.43)
(1.36)
(1.28)
(1.29)
(1.22)
(1.25)
(1.45)
(1.48)
1.52
1.64
1.61
1.59
2003Q2
1.62
192
–
–
–
1.43
Euro
Sterling
exchange
rate index
(1990 = 100)
124.4
127.9
123.2
115.6
111.4
111.3
101.4
99.4
105.4
102.3
100.0
100.7
96.9
89.0
89.2
84.8
86.3
100.5
103.9
103.8
107.5
105.8
106.0
99.1
Sterling exchange rates: 1980–2003
US
dollar
Japanese
yen
French
franc
German
mark
Italian
lira
1980
1981
1982
1983
1984
1985
1986
1987
1988
1989
1990
1991
1992
1993
1994
1995
1996
1997
1998
1999
2000
2001
2002
2.33
2.03
1.75
1.52
1.34
1.30
1.47
1.64
1.78
1.64
1.79
1.77
1.77
1.50
1.53
1.58
1.56
1.64
1.66
1.62
1.52
1.44
1.50
526
445
435
360
317
307
247
236
228
226
258
238
224
167
156
148
170
198
217
184
163
175
188
9.83
10.94
11.48
11.55
11.63
11.55
10.16
9.84
10.60
10.45
9.69
9.95
9.32
8.51
8.49
7.87
7.99
9.56
9.77
(9.96)
(10.77)
(10.55)
–
4.23
4.56
4.24
3.87
3.79
3.78
3.18
2.94
3.12
3.08
2.88
2.92
2.75
2.48
2.48
2.26
2.35
2.84
2.91
(2.97)
(3.21)
(3.15)
–
1992
2287
2364
2302
2339
2453
2186
2123
2315
2247
2133
2187
2163
2360
2467
2571
2408
2789
2876
(2941)
(3180)
(3115)
–
(1.45)
(1.40)
(1.43)
(1.36)
(1.28)
(1.29)
(1.22)
(1.25)
(1.45)
(1.48)
1.52
1.64
1.61
1.59
2003Q2
1.62
192
–
–
–
1.43
Euro
Sterling
exchange
rate index
(1990 = 100)
124.4
127.9
123.2
115.6
111.4
111.3
101.4
99.4
105.4
102.3
100.0
100.7
96.9
89.0
89.2
84.8
86.3
100.5
103.9
103.8
107.5
105.8
106.0
99.1
Exchange Rates
• The rate of exchange
– individual rates of exchange
– exchange rate index
The weights of the currencies of various countries
in the sterling exchange rate index
Previous
Current
Previous
Current
–
0.6513
(Ireland)
0.0242
0.0308
(Germany)
0.2001
0.2249
(Finland)
0.0145
0.0141
USA
0.2044
0.1649
Canada
0.0190
0.0138
(France)
0.1175
0.1259
Denmark
0.0145
0.0138
(Italy)
0.0766
0.0827
Norway
0.0131
0.0119
Japan
0.0883
0.0700
(Austria)
0.0124
0.0119
(Netherlands)
0.0500
0.0571
(Portugal)
–
0.0084
(Belgium)
0.0525
0.0539
Australia
–
0.0048
(Spain)
0.0202
0.0385
(Greece)
–
0.0031
Sweden
0.0379
0.0345
New Zealand
–
0.0021
Switzerland
0.0548
0.0327
Euro
Exchange Rates
• The rate of exchange
– individual rates of exchange
– exchange rate index
• Determination of exchange rates
Exchange Rates
• The rate of exchange
– individual rates of exchange
– exchange rate index
• Determination of exchange rates
– the equilibrium exchange rate
Determination of the rate of exchange
2.20
$ price of £
2.00
1.80
1.60
1.40
1.20
1.00
0
Q of £
Determination of the rate of exchange
2.20
$ price of £
2.00
1.80
1.60
1.40
1.20
D by USA
1.00
0
Q of £
Determination of the rate of exchange
S by UK
2.20
2.00
$ price of £
b
a
1.80
1.60
1.40
1.20
D by USA
1.00
0
QD
QS
Q of £
Determination of the rate of exchange
S by UK
2.20
$ price of £
2.00
1.80
1.60
d
c
1.40
1.20
D by USA
1.00
0
QS
QD
Q of £
Exchange Rates
• The rate of exchange
– individual rates of exchange
– exchange rate index
• Determination of exchange rates
– the equilibrium exchange rate
– appreciation and depreciation
Exchange Rates
• The rate of exchange
– individual rates of exchange
– exchange rate index
• Determination of exchange rates
– the equilibrium exchange rate
– appreciation and depreciation
– shifts in currency demand and supply
Floating exchange rates: movement to a new equilibrium
S1
1.80
€/ £
1.60
1.40
1.20
D1
1.00
0.80
0.60
0
Q of £
€/ £
Floating exchange rates: movement to a new equilibrium
1.80
S1
1.60
S2
1.40
1.20
D1
1.00
0.80
0.60
0
Q of £
€/ £
Floating exchange rates: movement to a new equilibrium
1.80
S1
1.60
S2
1.40
1.20
1.00
D1
0.80
D2
0.60
0
Q of £
Exchange Rates
• The rate of exchange
– individual rates of exchange
– exchange rate index
• Determination of exchange rates
– the equilibrium exchange rate
– appreciation and depreciation
– shifts in currency demand and supply
• differences in interest rates
€/ £
Floating exchange rates: movement to a new equilibrium
1.80
S1
1.60
S2
1.40
1.20
1.00
D1
0.80
D2
0.60
0
Q of £
Exchange Rates
• The rate of exchange
– individual rates of exchange
– exchange rate index
• Determination of exchange rates
– the equilibrium exchange rate
– appreciation and depreciation
– shifts in currency demand and supply
• differences in interest rates
• differences in inflation rates
€/ £
Floating exchange rates: movement to a new equilibrium
1.80
S1
1.60
S2
1.40
1.20
1.00
D1
0.80
D2
0.60
0
Q of £
Exchange Rates
• The rate of exchange
– individual rates of exchange
– exchange rate index
• Determination of exchange rates
– the equilibrium exchange rate
– appreciation and depreciation
– shifts in currency demand and supply
• differences in interest rates
• differences in inflation rates
• relative investment prospects
€/ £
Floating exchange rates: movement to a new equilibrium
1.80
S1
1.60
S2
1.40
1.20
1.00
D1
0.80
D2
0.60
0
Q of £
Exchange Rates
• The rate of exchange
– individual rates of exchange
– exchange rate index
• Determination of exchange rates
– the equilibrium exchange rate
– appreciation and depreciation
– shifts in currency demand and supply
•
•
•
•
differences in interest rates
differences in inflation rates
relative investment prospects
change in aggregate demand
€/ £
Floating exchange rates: movement to a new equilibrium
1.80
S1
1.60
S2
1.40
1.20
1.00
D1
0.80
D2
0.60
0
Q of £
Exchange Rates
• The rate of exchange
– individual rates of exchange
– exchange rate index
• Determination of exchange rates
– the equilibrium exchange rate
– appreciation and depreciation
– shifts in currency demand and supply
•
•
•
•
•
differences in interest rates
differences in inflation rates
relative investment prospects
change in aggregate demand
speculation
€/ £
Floating exchange rates: movement to a new equilibrium
1.80
S1
1.60
S2
1.40
1.20
1.00
D1
0.80
D2
0.60
0
Q of £
Exchange Rates and Balance of Payments
• Exchange rates and the balance of
payments: no government intervention
– a floating exchange rate
• how rates are determined by dealers
– automatic balancing of overall balance of
payments
– current, capital and financial accounts may
not separately balance
Exchange Rates and Balance of Payments
• Exchange rates and the balance of
payments: government intervention
– reducing short-term fluctuations
• using reserves
• borrowing from abroad
• changes in interest rates
– maintaining a fixed rate of exchange over
the longer term
• deflation / reflation
• supply-side policies
• import controls
Fixed versus Floating Exchange Rates
• Advantages of fixed exchange rates
– certainty
– no speculation (if rate is absolutely fixed)
– prevents 'irresponsible' government policies
• Disadvantages of fixed exchange rates
– conflicts with other macro objectives
– danger of competitive deflations
– problems of international liquidity
– difficulties in adjusting to shocks
– speculation
Fixed versus Floating Exchange Rates
• Advantages of free-floating rates
– automatic correction
– no problem of international liquidity
– insulation from external events
– less constraint on domestic macro policy
• Disadvantages of free-floating rates
– possibly unstable exchange rates
– speculation
– uncertainty for business
• but use of forward markets
– lack of discipline on economy
$ / £ exchange rate and £ exchange rate index: 1976-2003
$/£
$2.40
150
$2.20
140
$2.00
130
120
$1.80
110
$1.60
100
$1.40
90
$1.20
80
$1.00
1976 1978 1980 1982 1984 1986 1988 1990 1992 1994 1996 1998 2000 2002
70
$ / £ exchange rate and £ exchange rate index: 1976-2003
$/£
$2.40
150
$2.20
140
$2.00
130
120
$1.80
110
$1.60
100
$1.40
90
$1.20
80
$1.00
1976 1978 1980 1982 1984 1986 1988 1990 1992 1994 1996 1998 2000 2002
70
$ / £ exchange rate and £ exchange rate index: 1976-2003
$/£
Index
1990=100
$2.40
150
$2.20
140
$2.00
130
120
$1.80
110
$1.60
100
$1.40
90
$1.20
80
$1.00
1976 1978 1980 1982 1984 1986 1988 1990 1992 1994 1996 1998 2000 2002
70
$ / £ exchange rate and £ exchange rate index: 1976-2003
$/£
Index
1990=100
$2.40
150
$2.20
140
$2.00
130
120
$1.80
110
$1.60
100
$1.40
90
$1.20
80
$1.00
1976 1978 1980 1982 1984 1986 1988 1990 1992 1994 1996 1998 2000 2002
70
The Origins of the Euro
• Post-war regulation of exchange rates
– the Bretton Woods system
– its collapse in the early 1970s
– dirty floating
• The ERM
– features of the ERM
– the 1980s
– crisis in the ERM
• events of 1992
• events of 1993
– a return of calm
The Origins of the Euro
• The Maastricht Treaty
– the timetable for EMU
– the convergence criteria
•
•
•
•
•
inflation
interest rates
budget deficits
general government debt
exchange rates
• Birth of the euro
– meeting the convergence criteria
– role of the European Central Bank (ECB)
European Economic and Monetary Union
• How desirable is EMU?
– Advantages of a single currency
•
•
•
•
•
eliminating conversion costs
increased competition and efficiency
elimination of exchange-rate uncertainty
increased inward investment
lower inflation and interest rates
– Disadvantages of EMU
• political arguments
• adjustment to shocks
– problem of asymmetric shocks
• EU12 may not be an optimal currency area
• regional problems
Fluctuations between the euro and the dollar
1.15
6
5
1.05
4
1.00
3
0.95
2
0.90
0.85
1
0.80
0
1999
2000
2001
2002
2003
Interest rate
US$ / euro
1.10
Fluctuations between the euro and the dollar
1.15
1.10
5
1.05
4
1.00
3
0.95
2
0.90
0.85
1
0.80
0
1999
2000
2001
2002
2003
Interest rate
US$ / euro
6
US interest
rate
Fluctuations between the euro and the dollar
1.15
1.10
5
1.05
4
ECB
interest rate
1.00
3
0.95
2
0.90
0.85
1
0.80
0
1999
2000
2001
2002
2003
Interest rate
US$ / euro
6
US interest
rate
Fluctuations between the euro and the dollar
1.15
$/€
5
1.05
4
ECB
interest rate
1.00
3
0.95
2
0.90
$/€
0.85
1
0.80
1999
0
2000
2001
2002
2003
Interest rate
US$ / euro
1.10
6
US interest
rate
Globalisation and the Problem of Instability
• Interdependence through trade
– international effects of changes in
aggregate demand
– vulnerability of open economies
• Financial interdependence
– size of international financial flows
– international effects of changes in interest
rates
Globalisation and the Problem of Instability
• The need for policy co-ordination
– the search for policy co-ordination
• G7/G8 meetings: attempts at harmonisation
• but lack of convergence
• Difficulties in achieving harmonisation
– differences in budget deficits and debt
– interest rate divergence
– different internal structures of economies
– politicians more concerned with domestic
issues
Debt and Developing Countries
• The debt problem
Debt ratios: average of all developing countries
1974 1980 1982 1984 1986 1990 1993 1995 1998 2000 2002
Ratio of debt
to GNY (%)
15
18
Ratio of debt
to exports (%)
80
85 124 147 213 171 176 151 153 119 113
Ratio of debt
service
to exports (%)
12
13
31
20
34
22
36
27
31
18
39
18
43
23
44
27
41
22
41
19
Debt ratios: average of all developing countries
1974 1980 1982 1984 1986 1990 1993 1995 1998 2000 2002
Ratio of debt
to GNY (%)
15
18
Ratio of debt
to exports (%)
80
85 124 147 213 171 176 151 153 119 113
Ratio of debt
service
to exports (%)
12
13
31
20
34
22
36
27
31
18
39
18
43
23
44
27
41
22
41
19
Debt ratios: average of all developing countries
1974 1980 1982 1984 1986 1990 1993 1995 1998 2000 2002
Ratio of debt
to GNY (%)
15
18
Ratio of debt
to exports (%)
80
85 124 147 213 171 176 151 153 119 113
Ratio of debt
service
to exports (%)
12
13
31
20
34
22
36
27
31
18
39
18
43
23
44
27
41
22
41
19
Debt and Developing Countries
• Origins of the debt problem
– borrowing to finance development
– the 1973/4 oil shock
– the 1979/80 oil shock
• world recession  fall in export earnings
• fall in commodity prices (exports)
• high interest rates  cost of servicing debt
• Rescheduling debt
– rescheduling official loans
– rescheduling commercial bank loans
Debt and Developing Countries
• Dealing with debt
– structural reforms
– IMF structural adjustment programmes
•
•
•
•
tight fiscal policies to reduce budget deficits
privatisation and market liberalisation
open trade policy
hardship from IMF programmes
– debt forgiveness
• HIPC initiative
– successes / failures to date
• pressure to cancel debts