Transcript Document

Mexico in the World Economy
Robert Mundell
Columbia University
Universidad Autónoma de Baja California
Tijuana, México
September 27, 2007
I. Global Megatrends
Global Megatrends
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
Globalization
IT Revolution
The Euro
Rise of China
US and Global Governance
Currency Areas, 2007
¥
Russia
Canada
₤
U.K.
Korea
Sweden
$
Taiwan
€
RMB
Hong Kong
A
India
Singapore
Brazil
A$
Mexico
Gulf
Countries
CFA
Latin American & Caribbean
Nigeria
$
The Euro Cycle
1.4
1.3
1.2
1.1
1.0
0.9
0.8
Dollar per ECU/Euro
0.7
Plaza Accord
Yen per Dollar
140
¥-$ Rate and the Asian Crisis
130
120
110
100
90
Asian Crisis
Should the RMB float?
• Wrong Question! An Oxymoron!
• Flexible Exchange Rate not a monetary
rule. It is the removal of a monetary rule.
Flexible rates are consistent with
hyperinflation.
• Correct Question: Should China’s fixed
exchange rate monetary rule be replaced
by an alternative monetary rule?
Choice of Monetary Rules
• Exchange Rate Target?
• Inflation target?
• Money supply target?
Which is better for China?
Observations
• Since 1997, China has achieved better
price stability by targeting the dollar
than any other major country by
“inflation targeting”.
• The major countries include the United
States, the Euro area, Chile, Mexico,
Brazil, U.K., or Russia.
China should not float
China’s policy of targeting the dollar has
given the Yuan an anchor, and policymakers a rudder for determining the best
policy mix. An adequate case has not
been made for changing that system. As
long as the dollar is stable in terms of the
US price level, China should maintain its
current policy.
Asian Currency
• Asia is considering the formation of an
Asian Monetary Area.
• Would help insulate the area against G-3
Instability.
• Would eliminate competitive devaluation
within the area.
• Would enhance Asia’s power in the world.
Asia Wakes Up, 2020?
India
Asian Currency Area
¥
Baht
Russia
$
RINGITT
YEN
P-Peso
15
RMB
€
WON
Africa
Rupiah
EURO
₤
HK$
Australia-NZ
Arab Bloc
What about Latin America?
Would a Latin-American
Dollar be Useful to the Region?
Conditions for a Latin American
Monetary Union
•
•
•
•
•
•
Criterion for Monetary Stability
Common Measure of Inflation
Lock Exchange Rates
Common Monetary Authority
Division of Seigniorage
Fiscal Stability
Larger union is Preferable to a
Smaller Union
• Should include:
• Brazil, Mexico, Argentina, Columbia,
Venezuela, Peru, Chile, Ecuador, Uruguay,
Paraguay, Bolivia, the Central American
Countries and the Caribbean.
•
First Steps
•
•
•
•
•
1. Latin American Monetary Fund
2. Choice of Anchor
3. Narrowing of Exchange Rates
4. Pooling of Reserves
5. Common Monetary Policy
World Currency Map: 2020?
India
¥
Russia
$
Euro Area
€
Africa
RMB
Latin $
₤
Dinar Area
Indonesia
Or Maybe…
2020?
India
Asian Currency Area
¥
Baht
Russia
$
RINGITT
YEN
P-Peso
15
RMB
€
WON
Africa
Rupiah
₤
HK$
Australia-NZ
EURO
Latin $
Arab Bloc
II. Macroeconomic Policy
Some of My Contributions to
Economic Theory
•
•
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The Mundell-Fleming Model.
Mundell-Tobin Effect
The Mundell-Dornbusch Model
The Theory of Optimum Currency Areas
Supply-Side Economics
Nobel Prize in 1999
• It was for the first and fourth of these
contributions that I received the Nobel Prize in
1999.
• The Academy of Science in Stockholm stated
that it was awarding me the Prize
• “for (my) analysis of monetary and fiscal policy
under different exchange rate regimes and his
analysis of optimum currency areas.”
Phelps the 2006 Winner
• My colleague and friend at Columbia
University, Edmund (“Ned”) Phelps won
last year.
• It is perhaps interesting that I was the last
solo winner of the 20th century, Phelps
was the first solo winner in the 21st century.
• The following are before and after pictures
of Phelps. They show the prize makes a
difference!
This one is before.
And this one is after!
Phelps Prize
• Phelps won his prize for his analysis of
‘intertemporal tradeoffs in macroeconomic
policy.’
• .
The Phillips Curve
• In the early 1950s, monetary policy was strongly
influenced by the idea of the ‘Philips Curve,’
named after a New Zealander Professor at the
London School of Economics.
• The Philips curve was a trade-off between
unemployment and inflation.
• The implication was that an increase in the rate
of monetary expansion would raise the inflation
rate and lower the rate of unemployment.
Inflation Expectations
• Around 1968, Phelps and Milton Friedman
independently made a critique of the Phillips
Curve, taking into account inflation expectations.
• They argued that the Philips curve assumed that
labor unions would be indifferent to the inflation
rate and not change their wage demands to
compensate for inflation.
• Their incorporation of inflation expectations into
the model reduced the effectiveness of inflation
as a stabilization policy.
• If wage rates rise with inflation expectations, real
wage rates would not fall and employment would
not increase.
When inflation increases the Phillips Curve theory implies
that equilibrium moves from A to B. But taking account of
inflation expectations, the Phillips Curve shifts to the right
and unemployment stays at the level indicated by C. .
л
B
C
A
Phillips Curve
л = rate of inflation; u = rate of unemployment
u
The Natural Rate of Unemployment
• Contrary to the Keynes model, the new
theory implies that there is an equilibrium
rate of unemployment independent of
monetary policy.
• This has been called the ‘natural rate of
unemployment.’
• Classical Economics was right after all!
‘The Natural’ Rate of Unemployment
л
B
C
A
The dotted red line gives
the equilibrium rate of
Unemployment
independently of the
inflation rate.
Phillips Curve
u
Blow to Keynesianism
• The Friedman-Phelps critique combined
with the application of rational
expectations to the problem by Lucas sunk
the idea that economic performance could
be improved by ‘surprise inflation.’
•
Not just “not better,” but worse
• The end result is that there would have
been no permanent reduction in
unemployment, whereas there would have
been a ‘permanent’ increase in inflation.
• The bottom line is that any short run gain
would be more than wiped out by the long
run loss.
III. Mexico in the World Economy
The International Monetary System
• No discussion of any country “in the world
economy” could be relevant without
considering the international monetary
system.
• The IMS shows how prices expressed in
different national currencies are connected
together to enable trade in goods and
services, capital and money to take place.
The World Economy Since
WWII
• The post-war international monetary system—
sometimes called the Bretton Woods system-that was set up after World War II, evolved out of
the international gold standard.
The International Monetary System in 1969
Soviet Union
¥
Canada
RMB
Sweden
₤
Korea
$
France
DM
India
Mexico
Latin American & Caribbean
CFA
Italy
8¢ Peso
• The Mexican peso was fixed to the dollar at the
exchange rate of $M12.5 = $US1.00.
• The Mexican peso was worth 8 US cents from
1954 until 1976.
• Throughout this period (or at least until 1971)
Mexico had both a stable exchange rate and a
pretty stable price level.
• How does the Friedman-Phelps Critique of the
Phillips Curve work in that period.
New Critique of the Model
• I want, however, to make a new critique of
both the Phillips Curve and the FriedmanPhelps Critique based on the fact that it
was based on a closed economy.
• In the 1960s the United States was not
only an open economy but an open
economy that was part of a fixedexchange rate international monetary
system.
Monetary Policy and Fixed
Exchange Rates
• Under fixed exchange rates, monetary
policy is not free to choose its own inflation
rate.
• With an international monetary system
such as existed under bimetallism, or the
gold standard, or in the dollar-based gold
exchange standard era from 1934 to 1971,
there is a common inflation rate shared by
all countries.
The World Economy
• If the Phillips Curve was applicable at all, it
was to the entire world economy, not to
the individual nations making it up.
• The same applies for the Friedman-Phelps
Critique.
Mexico’s Fixed Exchange Rate
• Let us accept the correctness of the
Phillips Curve critique of Friedman and
Phelps and see how it can be made
relevant to an economy like Mexico’s.
• From 1954 to 1976 Mexico had a fixed
exchange rate.
• The peso was 8 cents.
• The exchange rate was 12.5 pesos =
$1.00.
The Law of One Price
• In fluid markets, prices in one country
have to equal prices in other countries
after converting into the same currency.
• Thus p = ep* gives the equilibrium price ‘p’
of a good in (say) Mexican pesos where p*
is (say) the US price in dollars, and e is
the exchange rate, the price of the dollar in
terms of pesos.
•
Dynamics
• Differentiation of the equation p = ep* gives:
• π = π* + ε
• where πis the rate of inflation in Mexico, = π* is
the US rate of inflation, and ε is the rate of
depreciation of the peso against the dollar.
• If the exchange rate is fixed, equilibrium of the
Mexican price level requires the same rate of
inflation in Mexico as in the U.S.
л
The dotted red line gives
the equilibrium rate of
Unemployment
independently of the
inflation rate.
Л = Л* +ε
u
Variations around the Mean
• There are of course reasons why inflation rates
would differ even under fixed exchange rates.
• The price levels might not be in equilibrium.
• Differential changes in prices of domestic and
international goods .
• Blocks in information.
• Changes in trade impediments.
• Capital movements.
Mexico in the World Economy
• We have now brought the discussion into
the macroeconomic situation in Mexico.
Let’s now discuss Mexico in the world
economy.
II. Mexico and the World Economy
Flexible Exchange Rates
• In 1971, the U.S. took the dollar off gold, and the
European countries took their currency off the
dollar.
• This gave rise to floating exchange rates, but
nobody liked it so they went back to the dollar
after a few months.
• But this didn’t work out and generalized flexible
exchange rates came into being in 1973.
Inflation
• Flexible exchange rates mean that many
countries gave up their monetary discipline,
giving rise to generalized inflation in the
1970s.
• Mexico discovered oil in 1976 and
promptly moved toward inflation. The
dollar was devalued and then it floated.
Mexico floats and inflates; Europe
stabilizes within itself
• From 1976 until 1990 Mexico lost all monetary
discipline and had the greatest inflation in its
history. Floating rates so far had proved to be a
disaster because it was not associated with a
policy for controlling the money supply.
• Europe wanted fixed rates and so formed the
EMS (European Monetary System) and the ERM
(exchange rate mechanism).
Currency Areas October 1990 after
Britain’s Entry into ERM
Poland
Soviet Union
¥
Canada
Korea
Sweden
₤
$
Neth
Denmar
RMB
Belgium
DM
France
Hong Kong
India
Mexico
Latin American & Caribbean
Gulf
Countries
Italy
CFA Franc
Austria
Spain
Euro Creates a New Power Center in
1999
¥
Russia
Canada
₤
Korea
Sweden
$
RMB
€
India
Taiwan
Indonesia
Hong Kong
Mexico
Australia
Latin American & Caribbean
Brazil
CFA
Gulf
Countries
The Currency Reform
Flexible exchange rates in Mexico led to inflation
so drastic that by 1990 it became necessary to
have a currency reform, to lop off unnecessary
zeros.
De facto Mexico went back to almost fixed rates in
the 1990s with the US$ = $M 3.5 and Mexico
recovered monetary stability.
But political factors in the 1994 election combined
with undisciplined monetary policy, creating the
crisis of 1994-95, and the largest bailout in IMF
history.
Mexico 1995-2006
• Since 1994 the peso has depreciated and the
dollar has risen from $M3.5 to around or above
$M 10.00.
• Prices rose with the depreciated peso but the
rate of inflation has been kept below two digits in
recent years.
Remittances
• Mexico’s balance of payments has been
succored by emigrants’ remittances which in
recent years has come to be a leading element
in the receipts side of the ledger.
• It is hard to separate drug money from the
remittance accounts. Combined the total now
comes to about $25 billion annually and will
probably increase in the next few years.
Remittances, Poverty and
Development
• Most of the person-to-family remittances are a
great benefit to Mexico from the standpoint of
alleviating poverty.
• They should not be relied upon, however, as a
tool of development.
• Most of the remittances probably go into
consumption rather than investment and
therefore do not contribute much to development.
Lessons from Mexico’s Monetary
History
• The fixed exchange rate system worked
well for Mexico in 1954-1976 in bring both
price stability and exchange rate stability.
• The fixed exchange rate system is a good
way of controlling the money supply if the
automatic mechanism is allowed to work.
Events of 1976
• But it was abandoned because of (1) IMF
pressure and (2) spendthrift fiscal policies.
• The Board of Governors of the IMF had failed to
find a way in the period 1972-74 to restore the
international monetary system.
• It passed a second amendment to the charter,
endorsing flexible exchange rates, which is the
absence of an international monetary system.
Flexible Exchange Rates and
Control of the Money Supply
• The IMF started to push the new
arrangement of flexible exchange rates,
and Mexico was one of its first victims.
• The movement to flexible rates in the late
1970s proved to be a disaster because
there was no control over the money
supply and Mexico moved into
hyperinflation.
Verdict on the 1994-5 Crisis
• The currency reform in 1990s brought back
monetary discipline and price stability along with
exchange rate stability.
• But it was allowed to break down because of the
political turmoil in the election year, and the
monetary policy of the Bank of Mexico, which
prevented the loss of dollars from reducing the
money supply.
• Instead of a “modest” depreciation of about 40%,
the peso depreciated as the dollar soared.
Recent Policy
• Recent policy in Mexico has been more
realistic than in the past. The floating rate
has been combined with monetary
discipline through inflation targeting. This
is a great improvement over the flexible
exchange rate period 1976-90.
Problem of Overvaluation
• Mexico has been using monetary policy to
control the inflation rate and to bring it down to
target levels.
• The experience of other countries is that this
method is successful at bringing about
disinflation, but it is achieved through
overvaluation of the currency.
• After the target inflation has been reached, the
currency is overvalued and there is either a
currency crisis or a pre-emptive devaluation.
Setting the new Exchange Rate
• An alternative stabilization policy is to use the exchange
rate as the instrument of stabilization.
• If inflation is currently, say, 10 per cent, and the target
inflation rate is 3 per cent, plans for stabilization at the
end of two years would require an exchange rate of
(10 – 3) x2 = 14 per cent below the current equilibrium.
• If, for example the current exchange rate is 10%
overvalued (because of the disinflation policy), the new
equilibrium exchange rate should be in two years 24%
below the current level.
Prerequisites of Stabilization
• It would be desirable in the long run to return to
a fixed rate, as in the period 1954-1976, and
most of Mexico’s earlier history with the silver
standard.
• But prerequisite of a successful stabilization are
at least threefold: (1) control over the budget, so
recourse to central bank finance is not needed;
(2) a substantial buildup of foreign exchange
reserves; and (3) consensus on that policy by
the top leaders of the government.
General Verdict
• The two worst monetary systems are as
follows:
• One is flexible exchange rates without
monetary and fiscal discipline. Mexico had
this between over the period 1976-1990.
• The other is fixed exchange rates without
monetary and fiscal discipline. Mexico had
this in 1974-76.
Benefits from Fixed Rates
• There are great benefits from fixed exchange
rates, especially for a country like Mexico that is
next to the supereconomy.
• It should be remember that the growth miracles
of Germany and Japan in the 1950s, and China
in the past fifteen years were all achieved with
export-led growth with fixed exchange rates and
substantial foreign direct investment.
Monetary Stability
• Mexico may be poised to follow in the
same direction but it requires careful
preparation and attention to the
prerequisites.
• Monetary stability is not everything, but
without it no country has ever been
prosperous in a sustained way.
Gracias!