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Chapter 4 - Money and Macroeconomymercoledì 5 giugno 201918:27This chapter will provide an overview of the important "management" functions performed by monetary authorities across the Atlantic. There emerges mutual help between western central banks (intervention of realignment of the US dollar in the 80s and of the euro in 2000). A key theme of this chapter is that the internal performance of the American and European economies has important implication for the international economy. In the nowadays global arena, international monetary affairs are run by countries which, through time, have accumulated significant international reserves, which enables their policy choices to be factored in. The Euro-American dominance of the system is, in fact, eroding. International finance is entering an age of multipolarity, like in the trade arena. The removal of national controls on the flow of international capital has been a key catalyst for the growth of a borderless international finance system. Global finance has also facilitated economic development in countries like China or Brazil. ??Although trade has formed the deepest area of interdependence between the EU and the US, their relationship has come to rivalry in terms of money and finance. The liberalization of financial markets and the development of technologies has enabled financial institutions to act globally and trade instantaneously. Investment banks and investors in general have become more and more powerful and able to influence national economies.?Important actors like private multinational companies, the Federal Reserve (US Central Bank; the Fed), China, etc.?The US dollar is the most popular reserve currency for the world's central banks. US firms are far less exposed to currency risk.???The Evolving role of the Euro?The euro challanged the dollar for the title of the world's currency.?History: the Bretton Woods system seemed to obviate the need for greater European efforts in the area, since it established a broad framework for monetary discipline and stability. Moreover, with extensive welfare states to protect and nurture, EC members were reluctant to accept the loss of fiscal and monetary control that would clearly flow from a common currency. This thinking changed by the 70s, as the Bretton Woods system crumbled.?Since German economy was growing to become the largest in Europe, the EC members decided to adopt the system of the "snake": the snake was essentially a pegged currency system where members agreed to assist each other in mantaining a given parity with the mark.?Stagflation of the 70s (toxic mix of inflationary growth and rising unemployment). Economic problems produced dissatisfaction with the Keynesian solutions. Instead, it was increasingly argued that tight monetary and fiscal discipline was needed to defeat inflation and keep public sector spending from "crowding out" private investment. UK Prime Minister Margaret Thatcher helped pave the way for a neo-liberal consensus necessery for the euro: the EC would gradually adopt neoliberal economics - based on deregulation, a reduction of the state's role in the economy and the control of monetary policy - and not corporatist welfare state policies as the basis for further integration.?During the 80s, West German Chancellor Willy Brandt catalysed the Franco-German discussions for the creation of a monetary union. The European Monetary System (EMS) mantained many of the features of previous managed currency system, particularly the use of fixed, but adjustable, parity rates manifest in the Exhange Rate Mechanism (ERM). Member states gradually joined in in the 80s; most of the EC economies were in by 1992. The system hinged on the willingness of Germany to take on the bulk of the asjustment costs of periodic intervention to defend a given parity. However, the ERM did not survive further international exchange rate turmoil in the early 90s: there was market expectations of greater divergence in economic performance in the mid-90s.?The Single Market Programme, and the resulting economic liberalism, catalysed the introduction of harmonized monetary relations and a common currency. At that time Germany was reluctant to keep shouldering the bulk of the costs of the managed EMS system. The euro would be launched in two stages: Stage One - it remained a mere unit of account; Stage Two - it would circulate in member states and would be overseen by the European Central Bank (the ECB). Stage One was vulnerable to market speculations. The Stability and Growth Pact (SGP) was a EMU-related provision, which was the necessary precondition fo German acceptance of the mark's demise. European monetary inegration cannot be understood separately from the collapse of the Bretton Woods system. The theory behind optimum currency area (OCAs) explains that once national economies enter a single currency, they give up domestic abilities to respond to external shocks via interest rates or budgetary policy. Many economists did not regard the Eurozone as an optimal currency area, as national economies remained sufficiently distinct so as to be asymmetrically vulnerable to external shocks.?The overly tight economic policies it seemed to require (based on the strict control of inflation via both the ECB's interest rate policies and national budgetary discipline) made it difficult for European economies to become consumers of last resort in the same manner as Americans. National govts. Have given up some of their ability to expand their economies through fiscal and monetary policies. The SGP makes it difficult to implement countercyclical fiscal policy (increased gov. Spending) in response to economic slowdowns.?Germany was the strongest advocate of the pact and succeded in getting its preferences for the monetary regime approved at the European Council in 1997. Germany had particular responsibilities as the "anchor" economy of the EC, being the deutschmark the key currency. The other member states were obliged to defend their currency parity vis-à-vis the mark. On the other hand, the Bundesbank was expected to intervene to assist other currencies against speculative attacks.?When the euro was first launched in 1999, there were high expectations it could rival the US dollar as the preferred instrument for international financial transactions. However, the currency steadily depreciated against the dollar in the first two years of its existence, due to the massive inflows of money in the US after the American productivity miracle of the early 2000s. By contrast, the Eurozone's productivity growth remained sluggish. In 2001, the euro had fallen so much that central bank intervention was used to stabilize its rate against the dollar.?Conversely, in mid-2000s, the euro had appreciated steadily against the dollar and had become much more widely used in international reserves.?The ECB's central objective was price stability, not the promotion of economic growth. The bank is required to keep Eurozone inflation below 1.5%; it has no other formal policy objective. Furthermore, a tight inflation target was felt necessary as an insurance policy against the admission of member states such as Greece, with reputations of fiscal laxity. There was also an absence of ability to devalue the currency to mantain competitiveness.?By 2005, three economies in particular were causing concern:?Italy: Italy's economic growth fell in 2004. The industrial sectors (textile, footwear, etc) lost competitiveness to the Chinese.FranceGermany?Concern about the growth in the Eurozone countries had subsided somewhat in late 2006. The explanation for these more optimistic forecast was economic growth elsewhere in the world (in particular in Asia and in the Middle East). Germany's exports to China soared. Middle-Eastern states began to shift reserve assets out of US dollars and into euros.??The US economy: living on borrowed money??The US dollar weakness culminated in the "Nixon Shock" of 1971, which, in turn, resulted in rewriting the rules of the Bretton Woods system. In the 70s, the system of fixed exchange rates gave way to "managed" exchange rates, and the dollar was notable for its instability. US interest rates also had to fluctuate. In the early 90s the US economy began to expand at a spectacular rate, above 2%: jobs were created and firms enjoyed gains in productivity, lifted by the IT revolution?The growth of US economy had important implications for the transatlantic relationship: the explosion of consumer spending in the US made the dollar appreciate as foreign investment poured into America as firms sought returns that could not be gained in the "sclerotic" Eurozone; the result was a slump in the value of the euro, which pushed the ECB to attract money into continental European economies by increasing real interest rates. Plus, after 9/11, US airlines went bankrupt and manifactures ran up huge losses since enhanced security arrangements delayed shipments and added costs. The internet bubble burst due to conerns that these "new economy" companies were overvalued. The Federal Reserve cut interest rate aggressively, seeking to restart economic activity. By 2003 the US dollar was in decline against the Canadian dollar and the euro.?President Bush's measures in response to recession consisted in tax cuts ($2 trillion) in the mid-2000s. The US budget deficit was about $300 billion after the tax cuts and increased US military commitments. The US experienced a persistent deficit in merchandise trade as well. In 2006, the current account was in deficit of $800 billion (8% of GDP), which was financed by the foreign purchase of US debt securities (bonds) or assets.?In 2006, the US economy experienced weakness. Several factors contributed to it:?Inflation rose due to higher energy prices: higher oil prices damaged consumer confidence and added to manifacturing costsThe housing market stalled (house prices rose)Capital outflows into South-East Asia?As a result, demand for euros increased on the back of this trend.?By 2007, the Eurozone was undergoing a tentative recovery, led by Germany. Both Europe and America were more reliant on Asia than ever; Asian consumers helped European exports, while Asian purchases of US debt underpinned the US current account.???Managing the global economy?Global finance has loosened the rules on international monetary affairs, making it an area of light regulation: capital controls that constrained the flow of money frome one state to another were gradually removed during the 70s; major currencies moved away from rigid fixed currencies toward managed float systems of economic governance. The explosion of private financial flows was made it possible by technology (the development of computerized trading systems and telecommunication infrastructures). New financial products were born.?The most "politicized" monetary relationship the US now has is with China, not the EU, with which it remanains more technical. China is employing an export-led growth strategy, which is possible by keeping the yuan artificially low. Chinese firms undercut American ones in sectors like textile and apparel, furniture and intermediate manifacturing. The US imposed quotas on Chinese textile imports in 2005.?Chinese peg is worrysome also because China recycles its export earnings to buy US treasury bonds. In doing so, it accumulates US dollar balances that help keep the yuan peg. However, by recycling money, the Chinese domestic economy is penalized, since firms have less money to invest in new plant and new employees, while consumers have less money to spend on themselves. US and European firms investing in China (mostly in the automobiles sector) are adversely affected by this policy that depresses domestic demand.?London was becoming the financial centre of the world, with New York remaning dominant in the issuing of initial public offerings. Hong Kong and Shangai have emerged as key financial centres.??Competition and convergence in financial regulation?Even though many states did not formally adopt American rules on accounting or corporate governance, firms with any stake in the US market would have to adapt/adopt them. America's dominance on the world economy was reflected in its dominance of the regulatory agenda. However, European standards were gaining international acceptance. The Lisbon Agenda has provided a rationale for the pursuit of harmonization and liberalization of financial services regulation within Europe. The Single Market Programme helps this process.??From Bretton Woods to Plaza and beyond?Coordinaton of monetary policy was vital for the Bretton Woods system, in which the US dollar linked directly to gold while sterling, the franc and the deutschemark mantained their respective parities to the US dollar. The demise of the Bretton Woods system did not mean the end of the Euro-American cooperation and coordination on monetary policy; it meant the end of a formal, pegged currency system. The 1985 Plaza Accord helped catalyse a continued decline of the dollar and appreciation of the Japanese yen and, in so doing, protection pressure in the US congress.??The growing influence of China?In 2000 the US Congress granted China permanent, normal trade relations. American business was supportive of Chinese accession to the World Trade Organization in 2001, seeing China as a truly gigantic market of 1.2 billion consumers. The EU was in support of it as well, stressing also the disciplines that would be exerted on China.?In 2005, China's international reserves stood at $1 trillion, an amount far in excess of any requirement for mantaining the currency's value in international markets. It was estimated that China was spending $45 billion per quarter in 2007 to keep its currency from appreciating against the dollar.?The EU pusued a more active "China strategy" after 2000, seeing China as a "strategic partner" and making persistent attempts to develop new forms of economic as well as political dialogue with Bejing. Europe's trade deficit with China was about 60% of the US deficit in 2006.??Overview and conclusion?Explosion of international capital mobility of the past forty years.Lorenzo Tortu ................
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