Global imbalances

Lecture outline

 Global imbalances- definition and measures  Factors and sources of the imbalances  Resolution possibilities

Global imbalances-definition

 External inequilibria in systemically important economies, which pose risks to the functioning of the global economy  The risks: destabilization of the international monetary system, financial crises, protectionism

Global imbalances- elements

 Current account imbalances- majorly the difference between exports and imports  Net foreign assets imbalances- the difference between the value of the assets of a country abroad and the value of the domestic assets owned by foreigners

Source: Wikipedia

Measures of the global imbalances (1)  Current account = Net foreign assets – the value of central bank interventions  The current account deficit influences the foreign debt of the economy  deficit accummulation leads to increasing foreign debt levels  The value of the foreign debt depends on the valuation of assets and liabilities- exchange rate changes can influence the value of the debt!!!

Measures of the global imbalances (2)

 Current account imbalances- in a specific time period  International investment position- a measure of net foreign asstes in a specific time period  Foreign reserves- indirect measure of distortions

Measures of the global imbalances (3)

Source: ECB

The factors of the global imbalances

 Structural factors  Cyclical factors

Cyclical factors

 Short-term global demand  Asset prices- inluencing foreign debt levels  Business cycles induced by productivity shocks  investment increase  increased imports  current account deficit  Public savings  the fiscal stance influences short-term demand  Oil prices changes  higher prices lead to higher values of imports and exports

Structural factors

 Long-term trends  The Lucas paradox  The long-term decrease of savings  Market structures and the share in global production

The Lucas paradox

 Capital flows from developing countries to developed countries despite the fact that the second ones have higher levesl of capital per worker

The reasons for occurrence of the Lucas pradox

 Risk premium in catching –up countries  Capital flow restrictions  Underdeveloped financial markets in developing countries  FDI flows to emerging countries, portfolio investment flows to developed countries

Other structural factors

 The long-term decrease of savings business cycle moderation in the USA  The increased share of the USA in the global output due to productivity growth expectations of a continued faster growth drive the US current account deficit

The sources of the unequilibrium (1)  Competing theories  International financial integration  The concept of the Bretton Woods II system  Export oriented exchange rate policy strategies in Asian countries  Twin deficits  Production effectivity increase in the USA  Global savings glut

International financial integration

 International financial integration occurs if all market participants have equal access to the instruments traded and face the same set of rules while being active on the market  The liberalisation of capital flows enabled financial integration

Twin deficits

 The budget deficit in the USA is accompanied by the deficit of the current account  The increase of government spending causes the growth of demand and increases imports

Exchange rate policies

 Exchange rate policies supporting exports in Asian countries  Central bank interventions preventing currency appreciation  accumulation of large foreign reserves  The inflow of foreign savings to the American market  the decrease of American interest rates  fuelling American demand

Bretton Woods II

 Dooley et al. (2003; 2004; 2005)  The global economy can be portrayed as:  USA as a center  The trade region-Asia- fixed exchange rates,main market players are central banks and governments  The capital region- Europe, Canada, Australia, floating exchange rates, main market players are private investors- a neutral region in terms of imbalances

Bretton Woods II

 Underdeveloped financial market in China it is easier to allocate the Chinese savings abroad  The financing of the US deficit

ad infinitum

is profitable for China due to increased exports

Permanent increase of production effectiveness in the USA  Increase of effectiveness  higher rates of returns on the American asset market  FDI- net negative inflow and decreasing purchase of American stock counterdicts the hypothesis of increased effectiveness – it was only valid until the late 90-ties

Global savings glut

 USA as the consumer of last resort- competing explanation to the Bretton Woods II  Factors:  Restructuring of enterprises  profits increase -> increased savings in the sector of enterprises  The increase of oil prices- increased value of savings in oil exporting countries  A high propensity to savings in Asian countries and labour force migration  increased savings in the destination countries

A global savings glut?

Source: IMF Economic Outlook 2005

Potential resolution

 Setser,Obstfeld, Rogoff – the deficit can not be maintained

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 Maintainance of the Bretton Woods II

Maintainance of Bretton Woods II

 The credibility of USD- investors believe in maitaining of the current exchange rate policy i.e. large interventions of the Chinese central banks  No significant difference in the short term and long term interest rates reflects the expectations of the

status quo

 Maintainance of the Chinese exchange rate policy – long term cost of production restructuring  Reluctance to increase US savings

The collapse of Bretton Woods II

 Reluctance of Asian central banks to increase reserves  The cost of reserve maintainance- the appreciation of the remninbi increases the value of liabilities and decreases the value of the assets held in USD  The costs of interventions- high levels of reserves cause credit expansion and inflationary pressure despite sterilization  Cost for Chinese state-owned banks- the necessity to purchase low premium government bonds  the necessity to recapitalize banks  The Chinese manufacturing is to a large extent foreign-owned and its production is consumed dometically  The trade region is very differentiated- no common policies

Mitigation of the imbalances

 Exchange rate adjustments  Strenghtening of the supply-side of the deficit countries  Ajustment of the asset prices  International cooperation- a consensus has to be reached by the main market players

The global imbalances and financial stability

 The global imbalances impact negatively the financial stability  The international monetary system does not fulfill its functions properly i.e. impedement of the exchange rate stability function, liquidity provision function etc.

 The global imbalances are blamed as one of the reasons for the latest financial crisis

The role of the international currency

 “

Exorbitant Privilege

”  USD as the main reserve currency  Differences in the interest on US assets and liabilities  USA possess profitable assets in the form of FDI and stocks, US liabilities are low yield banking deposits and bonds

The need of cooperation

 The resolution can not be carried out by single countries- the need of global cooperation  The willingness to maintain the inequilibrium depends on the features of the economies  Income  Public balance  Foreign debt

Literature

 M. Rubaszek, Nierównowaga globalna: przyczyny oraz możliwe rozwiązania, Bank i Kredyt, 2006,  Adjustment of global imbalances in a finacialy integrating world, ECB Monthly Bulletin, 08/2007,  M. Xafa, Global imbalances and financial stability, IMF Working Paper, 2007  T. Bracke, M. Fidora, Global liquidity glut or global savings glut, ECB Working Paper, 2008.