Theory Lecture 1 Flashcards
Definition of Globalization
the development of an increasingly integrated global
economy marked especially by free trade, free flow of capital, and the tapping of cheaper foreign labor markets (Merriam-Webster.com)
Key trends and developments of the global economy and financial markets
Globalization came in waves.
1) International trade has grown remarkably in the last couple of centuries, relative to total output
2) The second half of the 20th century saw increasing trade across the world, some disparities remain
3) Financial globalization followed similar long-run trends (Stocks of foreign financial assets to GDP)
4) International trade and financial openness go hand in hand
5) Recently, financial integration outpaced real (trade) integration
Note: Financial globalization has mainly happened among advanced economies
6) Financial markets exhibit larger degree of returns co-movement now compared to pre-1914
Larger co-movement of asset markets has implications for international diversification
7)Global Imbalances: Countries accumulated large external debts or surpluses
These imbalances are very persistent and cause policy concerns (and political criticisms).
8) Labor mobility has also increased
9) Integration of all three markets (goods trade, finance and labor) goes hand in hand
Theoretical benefits of global capital markets
Efficient investment - Channel the savings to their most productive use globally (CA=S-I)
International risk sharing (or risk diversification) - Trade financial assets between countries to reduce cross-sectional fluctuation of consumption in case of temporary drop in income at a given time.
Discipline effect on policies - Constrain the government from running unsound macroeconomic or corporate policies
Examples of “bad” policies with respect to businesses / households:
(Discipline effect)
a. Asset “tunneling” by company management or value-destroying M&As.
b. Poor domestic political institutions.
c. Preferential treatment of individual companies, industries at the expense of other stakeholders.
d. Ad hoc nationalization of companies.
-> Financial and trade openness (globalization) may provide the discipline effect on policies.
What does the “interest group” theory of financial development explain?
(Discipline effect)
The bad examples of policy could be be improved by financial and trade openness as it would have a discipline effect on policies.
In the interest group theory the authors “interest group theory” stresses the role of trade and financial openness in reducing the influence of interest groups that oppose financial development.
In a closed economy, incumbents benefit from financial repression and the resulting low financial development because it denies potential competitors the financial resources to enter the market. Increasing both trade and capital account openness undermines this status quo. Foreign entry in the domestic goods markets reduces rents and creates more investment needs for incumbents to counter competition and take advantage of new opportunities.
- > The ideal scenario: Small economy close to a large and open country/region.
- > RZ: Financial integration is beneficial because (in combination with trade openness) it weakens the opposition to pro-business policy.
What are the two view on inflation?
- Center-left (incl. Modern Monetary Economics school): no worries, it is a temporary reaction to supply-demand disbalance.
- “Traditional” neoclassical view of last 40 years: infl expectations will rise and feed into real inflation.
Households/ small businesses may escape such repressive policies by
- > operating in “shadow economy” (Examples?);
- > Larger firms may adopt “best practices” from global markets (various ways)
Macro policy trilemma
The policy trilemma is about macroeconomic policies
A government cannot simultaneously follow 3 policy goals:
1) open capital markets (Capital Mobility)
2) pegged exchange rates
3) independent monetary policy (Monetary Autonomy)
-> Only two of these three options are possible.
-> Government’s hands are tied to choose carefully.
What are the three Feasible policy mixes?
A) Floating Exchange rate & Monetary Autonomy
B) Pegged Exchange rate and Capital Mobility
C) Pegged Exchange rate & Monetary Autonomy
Which are the two policy options left now?
One of the two policy options left
- Fixed exchange rates (mix B)
- Influencing interest rates (mix A)
“Global financial cycle”
Financial globalization and activities of global banks result in co-movements in asset prices, commodity prices, leverage, and capital flows
Trilemma becomes a “dilemma”
Monetary Autonomy is not an option any more regardless of the choice of exchange rate regime.
We choose between Capital mobility and Fixed exchange rate
With “global financial cycle” monetary autonomy is possible if and only if the capital account is managed. But how?
a) targeted capital controls;
b) limit credit growth & leverage at boom;
c) stricter limits on leverage for all fin intermediaries.
What are the costs of globalisation with regarding to Advanced economies?
• Financial stability and race to the bottom in financial regulation
Basel Committee on Banking Supervision (now Basel III accord)
Financial stability board (BIS)
• Taxing global profits (“tax heavens”)
Min corporate profits tax 15%
• Illicit money flows: global tax evasion, money laundering, terrorism financing, and corruption.
What are the costs of globalisation with regarding to Emerging markets and LMICs?
• Volatility of capital flows, “sudden stops”, especially since after GFC,
• Transmission of financial shocks via the global financial cycle
IMF’s “institutional view” on capital controls (2012) and Integrated Policy Framework (2020) for LMICs
• Inability to borrow in own currency, vulnerability from dollarization of liabilities
• Sovereign debt and default
