International Economics Chapter 12: The Global Macroeconomy

Introduction to International Macroeconomics

  • Definition: International macroeconomics is the study of large-scale economic problems within interdependent economies.

  • Macroeconomic Focus: The field concentrates on key economy-wide variables including:

    • Exchange Rates

    • Prices

    • Interest Rates

    • Income

    • Wealth

    • The Current Account

  • International Focus: Understanding of the global economy only emerges when connections and interdependencies among nations are fully considered.

  • The Coronavirus Shock: The coronavirus pandemic of 2019–20202019 \text{--} 2020 is cited as the biggest adverse global economic shock since World War II.

  • Key Features of the Global Macroeconomy:

    • The world consists of many different currencies rather than a single universal one.

    • Countries are financially integrated rather than isolated from one another.

    • Economic policy choices are made within this context of integration and currency diversity, though outcomes are not always optimal.

Foreign Exchange: Currencies and Behavior

  • The Exchange Rate: Defined as the price of foreign currency. A complete understanding of a country's economy requires studying how this price is determined and how it fluctuates.

  • Impact of Fluctuations: Because products and investments move across borders, exchange rate shifts significantly affect relative prices in three main categories:

    • Goods: Such as automobiles and clothing.

    • Services: Such as insurance and tourism.

    • Assets: Such as equities (stocks) and bonds.

  • Classification of Exchange Rate Behavior: Economists divide countries into two primary groups based on exchange rate regimes:

    • Fixed (or Pegged) Exchange Rates: Rates that are kept constant or within a narrow range against another currency.

    • Floating (or Flexible) Exchange Rates: Rates that fluctuate according to market forces.

  • Core Research Questions:

    • How are exchange rates determined?

    • Why do some rates fluctuate sharply in the short run while others remain constant?

    • What causes exchange rates to rise, fall, or stay flat in the long run?

Exchange Rate Crises and Macroeconomic Shocks

  • Economic Impact of Exchange Rate Changes:

    • International Relative Prices of Goods: Shifts make one country's goods more or less expensive compared to another's.

    • International Relative Prices of Assets: Changes in value affect the wealth of firms, governments, and individuals.

  • Exchange Rate Crises: A crisis occurs when a currency experiences a sudden, pronounced loss of value against another currency, usually following a period of stability or a fixed regime.

  • Statistical Prevalence: There were more than 3737 exchange rate crises recorded in the 21-year21\text{-year} period between 19971997 and 20182018.

  • Defining a Currency Crash: For analytical purposes, a crisis is defined as an event where a currency loses more than 30 %30\,\% of its value in U.S. dollar terms within a single year, provided it had changed by less than 20 %20\,\% in each of the previous two years.

  • Case Study: The Economic Crisis in Iceland (2008):

    • A severe crisis engulfed Iceland in 20082008 involving a collapse of the exchange rate, a financial crisis, and a government fiscal crisis.

    • Real output per person shrank by more than 10 %10\,\%.

    • Unemployment rose from 1 %1\,\% to 9 %9\,\%.

    • Economic output did not surpass its 20082008 level until 20152015.

Globalization of Finance: Debts and Deficits

  • Financial Globalization: This process began in economically advanced countries and has since spread to many emerging market countries.

  • The Balance of Payments: National indicators such as income, expenditure, deficit, and surplus are critical indicators of economic performance and the subject of policy debate.

  • Current Account (CA): This is the difference between a nation's income (Gross National Disposable Income) and its expenditure (Gross National Expenditure).

  • U.S. Current Account Historical Data (1990–20191990\text{--} 2019) (all values in billions of U.S. dollars):

    • 1990: Income =$5,966=\$5,966; Expenditure =$6,041=\$6,041; CA =−$75=-\$75

    • 1991: Income =$6,195=\$6,195; Expenditure =$6,187=\$6,187; CA =$8=\$8 (The last surplus for the U.S.)

    • 1992: Income =$6,509=\$6,509; Expenditure =$6,555=\$6,555; CA =−$46=-\$46

    • 1993: Income =$6,844=\$6,844; Expenditure =$6,924=\$6,924; CA =−$79=-\$79

    • 1994: Income =$7,264=\$7,264; Expenditure =$7,380=\$7,380; CA =−$116=-\$116

    • 1995: Income =$7,624=\$7,624; Expenditure =$7,730=\$7,730; CA =−$106=-\$106

    • 1996: Income =$8,055=\$8,055; Expenditure =$8,170=\$8,170; CA =−$115=-\$115

    • 1997: Income =$8,550=\$8,550; Expenditure =$8,680=\$8,680; CA =−$130=-\$130

    • 1998: Income =$9,020=\$9,020; Expenditure =$9,226=\$9,226; CA =−$205=-\$205

    • 1999: Income =$9,608=\$9,608; Expenditure =$9,887=\$9,887; CA =−$278=-\$278

    • 2000: Income =$10,231=\$10,231; Expenditure =$10,627=\$10,627; CA =−$396=-\$396

    • 2001: Income =$10,567=\$10,567; Expenditure =$10,950=\$10,950; CA =−$383=-\$383

    • 2002: Income =$10,919=\$10,919; Expenditure =$11,362=\$11,362; CA =−$443=-\$443

    • 2003: Income =$11,448=\$11,448; Expenditure =$11,961=\$11,961; CA =−$513=-\$513

    • 2004: Income =$12,208=\$12,208; Expenditure =$12,833=\$12,833; CA =−$625=-\$625

    • 2006: Income =$13,784=\$13,784; Expenditure =$14,586=\$14,586; CA =−$802=-\$802

    • 2007: Income =$14,460=\$14,460; Expenditure =$15,170=\$15,170; CA =−$711=-\$711

    • 2008: Income =$14,753=\$14,753; Expenditure =$15,436=\$15,436; CA =−$683=-\$683

    • 2009: Income =$14,473=\$14,473; Expenditure =$14,845=\$14,845; CA =−$372=-\$372

    • 2010: Income =$15,069=\$15,069; Expenditure =$15,506=\$15,506; CA =−$437=-\$437

    • 2011: Income =$15,657=\$15,657; Expenditure =$16,122=\$16,122; CA =−$466=-\$466

    • 2012: Income =$16,318=\$16,318; Expenditure =$16,766=\$16,766; CA =−$448=-\$448

    • 2013: Income =$16,907=\$16,907; Expenditure =$17,276=\$17,276; CA =−$369=-\$369

    • 2014: Income =$17,659=\$17,659; Expenditure =$18,035=\$18,035; CA =−$376=-\$376

    • 2015: Income =$18,321=\$18,321; Expenditure =$18,745=\$18,745; CA =−$424=-\$424

    • 2016: Income =$18,792=\$18,792; Expenditure =$19,234=\$19,234; CA =−$441=-\$441

    • 2017: Income =$19,628=\$19,628; Expenditure =$20,095=\$20,095; CA =−$467=-\$467

  • Global Imbalances:

    • For approximately two decades, the U.S. current account deficit has represented roughly half of all deficits globally.

    • Offsetting surpluses are primarily found in Germany, China, Japan, smaller Asian economies, and oil-exporting countries.

External Wealth: Creditors and Debtors

  • Definition of Total Wealth (Net Worth): Assets (what others owe you) minus Liabilities (what you owe others).

    • Surplus/Saving: Buying assets or paying down debt leads to a rise in net worth.

    • Deficit/Borrowing: Taking on debt or spending savings leads to a fall in net worth.

  • External Wealth: This is a country's net worth from an international perspective. It equals Foreign Assets minus Foreign Liabilities.

  • Creditor vs. Debtor Nations:

    • Creditor Nation: A country with positive external wealth.

    • Debtor Nation: A country with negative external wealth.

  • Defaults and Risks: Research focuses on why nations default (fail to repay debt), the determinants of risk premiums (the extra interest charged for risk), and how these factors influence output, wealth, and exchange rates.

Government and Institutions: Policies and Performance

  • Policy Influences: Government decisions regarding exchange rates, macroeconomic policy, and debt repayment influence economic outcomes.

  • Regimes: Refers to the rules and norms within which policy choices are made.

  • Institutions: Refers to the broad legal, political, cultural, and social structures that influence economic and political actions.

  • Integration and Capital Controls: Trade growth has followed the reduction of trade barriers. Many nations now encourage capital movement by lifting restrictions on financial transactions.

  • Country Classifications:

    • Advanced Countries: High per capita income, well-integrated into the global economy.

    • Emerging Markets: Middle-income countries that are growing and becoming more integrated.

    • Developing Countries: Low-income countries that are not yet well-integrated.

  • Trends in Financial Globalization: Since the 1970s1970s, restrictions on international financial transactions have significantly decreased while the volume of transactions has grown dramatically, especially in advanced countries.

  • Exchange Rate Regimes and Monetary Organization:

    • Common Currency: Adoption of a shared currency with shared policy responsibility (e.g., the Eurozone).

    • Dollarization: Choosing to use a foreign currency over which the country has no policy control (e.g., El Salvador and Ecuador).

  • The Quality of Governance:

    • Better institutional quality (legal, political, social structures) is positively correlated with higher per capita income and lower income volatility.

    • Possible sources of institutional variation include the actions of former colonizing powers, types of legal codes developed, and natural resource endowments.

    • Poor governance typically results in a country being poorer, more susceptible to shocks, and unable to conduct consistent, reliable policy.