International finance: theory and policy

Cover......Page 1
Title Page......Page 4
Copyright Page......Page 5
Brief Contents......Page 6
Contents......Page 7
Preface......Page 14
1 Introduction......Page 22
 What Is International Economics About?......Page 24
  The Gains from Trade......Page 25
  How Much Trade?......Page 26
  Balance of Payments......Page 27
  International Policy Coordination......Page 28
  The International Capital Market......Page 29
 International Economics: Trade and Money......Page 30
 2 National Income Accounting and the Balance of Payments......Page 32
  The National Income Accounts......Page 34
   National Product and National Income......Page 35
   Gross Domestic Product......Page 36
   Investment......Page 37
   The National Income Identity for an Open Economy......Page 38
   The Current Account and Foreign Indebtedness......Page 39
   Saving and the Current Account......Page 41
   Private and Government Saving......Page 42
    Box: The Mystery of the Missing Deficit......Page 43
  The Balance of Payments Accounts......Page 45
   Examples of Paired Transactions......Page 46
   The Fundamental Balance of Payments Identity......Page 47
   The Current Account, Once Again......Page 48
   The Financial Account......Page 49
   Statistical Discrepancy......Page 50
   Official Reserve Transactions......Page 51
    Case Study: The Assets and Liabilities of the World’s Biggest Debtor......Page 52
  Summary......Page 56
 3 Exchange Rates and the Foreign Exchange Market: An Asset Approach......Page 61
   Domestic and Foreign Prices......Page 62
   Exchange Rates and Relative Prices......Page 64
   The Actors......Page 65
    box: Exchange Rates, Auto Prices, and Currency Wars......Page 66
   Characteristics of the Market......Page 67
   Spot Rates and Forward Rates......Page 69
   Futures and Options......Page 70
   Assets and Asset Returns......Page 71
    Box: Offshore Currency Markets: The Case of the Chinese Yuan......Page 72
   Risk and Liquidity......Page 74
   Exchange Rates and Asset Returns......Page 75
   A Simple Rule......Page 77
   Return, Risk, and Liquidity in the Foreign Exchange Market......Page 78
   Interest Parity: The Basic Equilibrium Condition......Page 79
   How Changes in the Current Exchange Rate Affect Expected Returns......Page 80
   The Equilibrium Exchange Rate......Page 82
   The Effect of Changing Interest Rates on the Current Exchange Rate......Page 84
    Case Study: What Explains the Carry Trade?......Page 86
  Summary......Page 89
 4 Money, Interest Rates, and Exchange Rates......Page 97
   Money as a Unit of Account......Page 98
   How the Money Supply Is Determined......Page 99
   Expected Return......Page 100
  Aggregate Money Demand......Page 101
  The Equilibrium Interest Rate: The Interaction of Money Supply and Demand......Page 103
   Equilibrium in the Money Market......Page 104
   Interest Rates and the Money Supply......Page 105
   Output and the Interest Rate......Page 106
   Linking Money, the Interest Rate, and the Exchange Rate......Page 107
   Europe’s Money Supply and the Dollar/Euro Exchange Rate......Page 110
   Money and Money Prices......Page 113
   The Long‐Run Effects of Money Supply Changes......Page 114
   Empirical Evidence on Money Supplies and Price Levels......Page 115
   Money and the Exchange Rate in the Long Run......Page 116
   Short‐Run Price Rigidity versus Long‐Run Price Flexibility......Page 117
    Box: Money Supply Growth and Hyperinflation in Zimbabwe......Page 119
   Permanent Money Supply Changes and the Exchange Rate......Page 121
    Case Study: Inflation Targeting and Exchange Rate in Emerging Countries......Page 124
  Summary......Page 127
 5 Price Levels and the Exchange Rate in the Long Run......Page 132
  The Law of One Price......Page 133
   The Relationship between PPP and the Law of One Price......Page 134
   Absolute PPP and Relative PPP......Page 135
   The Fundamental Equation of the Monetary Approach......Page 136
   Ongoing Inflation, Interest Parity, and PPP......Page 138
   The Fisher Effect......Page 139
  Empirical Evidence on PPP and the Law of One Price......Page 142
   Trade Barriers and Nontradables......Page 144
   Departures from Free Competition......Page 145
    Box: Measuring and Comparing Countries’ Wealth Worldwide: the International Comparison Program (ICP)......Page 146
   PPP in the Short Run and in the Long Run......Page 149
    Case Study: Why Price Levels Are Lower in Poorer Countries......Page 150
   The Real Exchange Rate......Page 152
   Demand, Supply, and the Long‐Run Real Exchange Rate......Page 154
    Box: Sticky Prices and the Law of the Price: Evidence from Scandinavian Duty‐Free Shops......Page 155
   Nominal and Real Exchange Rates in Long‐Run Equilibrium......Page 157
  International Interest Rate Differences and the Real Exchange Rate......Page 159
  Real Interest Parity......Page 160
  Summary......Page 162
 6 Output and the Exchange Rate in the Short Run......Page 170
   Determinants of Consumption Demand......Page 171
   Determinants of the Current Account......Page 172
   How Real Exchange Rate Changes Affect the Current Account......Page 173
   The Real Exchange Rate and Aggregate Demand......Page 174
   Real Income and Aggregate Demand......Page 175
  How Output Is Determined in the Short Run......Page 176
   Output, the Exchange Rate, and Output Market Equilibrium......Page 177
   Deriving the DD Schedule......Page 178
   Factors That Shift the DD Schedule......Page 179
   Output, the Exchange Rate, and Asset Market Equilibrium......Page 182
   Factors That Shift the AA Schedule......Page 184
  Short‐Run Equilibrium for an Open Economy: Putting the DD and AA Schedules Together......Page 185
  Temporary Changes in Monetary and Fiscal Policy......Page 187
   Fiscal Policy......Page 188
   Policies to Maintain Full Employment......Page 189
  Inflation Bias and Other Problems of Policy Formulation......Page 191
   A Permanent Increase in the Money Supply......Page 192
   Adjustment to a Permanent Increase in the Money Supply......Page 193
   A Permanent Fiscal Expansion......Page 195
  Macroeconomic Policies and the Current Account......Page 196
   The J‐Curve......Page 198
   Exchange Rate Pass‐Through and Inflation......Page 199
   The Current Account, Wealth, and Exchange Rate Dynamics......Page 200
    Box: Understanding Pass‐Through to Import and Export Prices......Page 201
  The Liquidity Trap......Page 202
   Case Study: How Big Is the Government Spending Multiplier?......Page 205
  Summary......Page 207
 7 Fixed Exchange Rates and Foreign Exchange Intervention......Page 217
  Why Study Fixed Exchange Rates?......Page 218
   The Central Bank Balance Sheet and the Money Supply......Page 219
   Foreign Exchange Intervention and the Money Supply......Page 221
   The Balance of Payments and the Money Supply......Page 222
  How the Central Bank Fixes the Exchange Rate......Page 223
   Money Market Equilibrium under a Fixed Exchange Rate......Page 224
   A Diagrammatic Analysis......Page 225
  Stabilization Policies with a Fixed Exchange Rate......Page 226
   Monetary Policy......Page 227
   Fiscal Policy......Page 228
   Changes in the Exchange Rate......Page 229
   Adjustment to Fiscal Policy and Exchange Rate Changes......Page 230
  Balance of Payments Crises and Capital Flight......Page 231
   Perfect Asset Substitutability and the Ineffectiveness of Sterilized Intervention......Page 234
    Case Study: Can Markets Attack a Strong Currency? The Case of Switzerland......Page 235
   The Effects of Sterilized Intervention with Imperfect Asset Substitutability......Page 238
   Evidence on the Effects of Sterilized Intervention......Page 240
   The Mechanics of a Reserve Currency Standard......Page 241
   The Asymmetric Position of the Reserve Center......Page 242
   Symmetric Monetary Adjustment under a Gold Standard......Page 243
   Benefits and Drawbacks of the Gold Standard......Page 244
   The Gold Exchange Standard......Page 245
    Case Study: The Cost to Become an International Currency: The Renminbi Case......Page 246
  Summary......Page 249
 8 International Monetary Systems: An Historical Overview......Page 262
  Macroeconomic Policy Goals in an Open Economy......Page 263
   Internal Balance: Full Employment and Price Level Stability......Page 264
   External Balance: The Optimal Level of the Current Account......Page 265
    Box: Can a Country Borrow Forever? The Case of New Zealand......Page 267
  Classifying Monetary Systems: The Open‐Economy Monetary Trilemma......Page 271
  International Macroeconomic Policy under the Gold Standard, 1870–1914......Page 272
   External Balance under the Gold Standard......Page 273
   The Price‐Specie‐Flow Mechanism......Page 274
   Internal Balance under the Gold Standard......Page 275
    Case Study: The Political Economy of Exchange Rate Regimes: Conflict over America’s Monetary Standard during the 1890s......Page 276
   The Fleeting Return to Gold......Page 278
   International Economic Disintegration......Page 279
    case study: The International Gold Standard and the Great Depression......Page 280
   Goals and Structure of the IMF......Page 281
   Convertibility and the Expansion of Private Financial Flows......Page 282
   Speculative Capital Flows and Crises......Page 283
  Analyzing Policy Options for Reaching Internal and External Balance......Page 284
   Maintaining Internal Balance......Page 285
   Maintaining External Balance......Page 286
   Expenditure‐Changing and Expenditure‐Switching Policies......Page 287
  The External Balance Problem of the United States under Bretton Woods......Page 288
   Case Study: The End of Bretton Woods, Worldwide Inflation, and the Transition to Floating Rates......Page 289
   The Mechanics of Imported Inflation......Page 291
   Assessment......Page 292
   Monetary Policy Autonomy......Page 293
   Symmetry......Page 294
   Exchange Rates as Automatic Stabilizers......Page 295
   Case Study: The First Years of Floating Rates, 1973–1990......Page 297
  Macroeconomic Interdependence under a Floating Rate......Page 302
   Case Study: Transformation and Crisis in the World Economy......Page 303
   Case Study: The Dangers of Deflation......Page 309
   Monetary Policy Autonomy......Page 311
   The Exchange Rate as an Automatic Stabilizer......Page 313
   The Problem of Policy Coordination......Page 314
  Are Fixed Exchange Rates Even an Option for Most Countries?......Page 315
  Summary......Page 316
 9 Financial Globalization: Opportunity and Crisis......Page 325
   Three Types of Gain from Trade......Page 326
   Portfolio Diversification as a Motive for International Asset Trade......Page 328
   The Menu of International Assets: Debt versus Equity......Page 329
   The Structure of the International Capital Market......Page 330
   Offshore Banking and Offshore Currency Trading......Page 331
   The Shadow Banking System......Page 332
   The Problem of Bank Failure......Page 333
   Government Safeguards against Financial Instability......Page 335
   Moral Hazard and the Problem of “Too Big to Fail”......Page 339
   The Financial Trilemma......Page 341
   International Regulatory Cooperation through 2007......Page 343
    Case Study: The Global Financial Crisis of 2007–2009......Page 345
    Box: Foreign Exchange Instability and Central Bank Swap Lines......Page 348
   International Regulatory Initiatives after the Global Financial Crisis......Page 344
   The Extent of International Portfolio Diversification......Page 351
   The Extent of Intertemporal Trade......Page 353
   Onshore‐Offshore Interest Differentials......Page 354
   The Efficiency of the Foreign Exchange Market......Page 355
  Summary......Page 359
 10 Optimum Currency Areas and the Euro......Page 364
   What Has Driven European Monetary Cooperation?......Page 366
    Box: Brexit......Page 367
   The European Monetary System, 1979–1998......Page 369
   German Monetary Dominance and the Credibility Theory of the EMS......Page 370
   European Economic and Monetary Union......Page 372
  The Euro and Economic Policy in the Euro Zone......Page 373
   The Maastricht Convergence Criteria and the Stability and Growth Pact......Page 374
   The Revised Exchange Rate Mechanism......Page 375
   Economic Integration and the Benefits of a Fixed Exchange Rate Area: The GG Schedule......Page 376
   Economic Integration and the Costs of a Fixed Exchange Rate Area: The LL Schedule......Page 378
   The Decision to Join a Currency Area: Putting the GG and LL Schedules Together......Page 381
   Other Important Considerations......Page 382
    Case Study: Is Europe an Optimum Currency Area?......Page 384
   Origins of the Crisis......Page 387
   Self‐Fulfilling Government Default and the “Doom Loop”......Page 393
   A Broader Crisis and Policy Responses......Page 395
   ECB Outright Monetary Transactions......Page 396
   The Future of EMU......Page 397
  Summary......Page 398
 11 Developing Countries: Growth, Crisis, and Reform......Page 403
   The Gap between Rich and Poor......Page 404
   Has the World Income Gap Narrowed Over Time?......Page 405
   The Importance of Developing Countries for Global Growth......Page 407
  Structural Features of Developing Countries......Page 408
   Box: The Commodity Supercycle......Page 410
  Developing‐Country Borrowing and Debt......Page 413
   The Economics of Financial Inflows to Developing Countries......Page 414
   The Problem of Default......Page 415
   Alternative Forms of Financial Inflow......Page 417
   The Problem of “Original Sin”......Page 418
   The Debt Crisis of the 1980s......Page 420
   Reforms, Capital Inflows, and the Return of Crisis......Page 421
  East Asia: Success and Crisis......Page 424
    Box: Why Have Developing Countries Accumulated Such High Levels of International Reserves?......Page 425
   Asian Weaknesses......Page 427
    Box: What Did East Asia Do Right?......Page 429
   The Asian Financial Crisis......Page 430
  Lessons of Developing‐Country Crises......Page 431
  Reforming the World’s Financial “Architecture”......Page 432
   Capital Mobility and the Trilemma of the Exchange Rate Regime......Page 433
   “Prophylactic” Measures......Page 435
   Coping with Crisis......Page 436
  Understanding Global Capital Flows and the Global Distribution of Income: Is Geography Destiny?......Page 437
   Box: Capital Paradoxes......Page 438
  Summary......Page 442
   An Analytical Derivation of the Optimal Portfolio......Page 447
   A Diagrammatic Derivation of the Optimal Portfolio......Page 448
   The Effects of Changing Rates of Return......Page 450
Index......Page 454
Credits......Page 466