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“The Economic Way of Thinking” 11 th Edition. Chapter 19: National Policies and International Exchange. Chapter 19 Outline. Introduction Accounting for International Transactions Why Credits Must Equal Debits Equilibrium and Disequilibrium The Ambiguities of International Disequilibrium - PowerPoint PPT Presentation
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© 2006 Prentice Hall Business Publishing The Economic Way of Thinking, 11/e Heyne/Boettke/Prychitko
“The Economic Way of Thinking”
11th Edition
Chapter 19:
National
Policies and
International
Exchange
© 2006 Prentice Hall Business Publishing The Economic Way of Thinking, 11/e Heyne/Boettke/Prychitko 2 of 42
Chapter 19 Outline
• Introduction
• Accounting for International Transactions
• Why Credits Must Equal Debits
• Equilibrium and Disequilibrium
• The Ambiguities of International Disequilibrium
• Disequilibrium as a Disguised Policy Judgment
© 2006 Prentice Hall Business Publishing The Economic Way of Thinking, 11/e Heyne/Boettke/Prychitko 3 of 42
Chapter 19 Outline
• But Will it Go on Forever?
• Foreign Exchange Rates and Purchasing Power Parity
• The Bretton Woods System
• Fixed or Floating Exchange Rates?
• Nobody Knows
• The Trouble We’ve Seen
© 2006 Prentice Hall Business Publishing The Economic Way of Thinking, 11/e Heyne/Boettke/Prychitko 4 of 42
Chapter 19 Outline
• The Case for a Common Currency
• Private Interests, National Interests, Public Interests
• In Defense of Comparative Advantage
• Globalization and its Discontents
• The Power of Popular Opinion
© 2006 Prentice Hall Business Publishing The Economic Way of Thinking, 11/e Heyne/Boettke/Prychitko 5 of 42
Chapter 19 Outline
• The Power of Special Interests
• The Outsourcing Controversy: Soundbytes vs. Analysis
© 2006 Prentice Hall Business Publishing The Economic Way of Thinking, 11/e Heyne/Boettke/Prychitko 6 of 42
Introduction
• Adam Smith
– Believed exports and imports analysis caused absurd speculation.
• However
– Balance of Payments accounting does demonstrate effects of international transactions on national economies
• Balance of Payments always balances
© 2006 Prentice Hall Business Publishing The Economic Way of Thinking, 11/e Heyne/Boettke/Prychitko 7 of 42
Accounting for International Transactions
• Categories of Balance of Payment Transactions
– Exchange of merchandise– Exchange of services– Exchange of IOUs– Unilateral Transfers
© 2006 Prentice Hall Business Publishing The Economic Way of Thinking, 11/e Heyne/Boettke/Prychitko 8 of 42
Accounting for International Transactions
• The Balance of Payments
– Exports generate payments into a country or a balance of payment credit.
– Imports generate payments out of a country or a balance of payment debit
© 2006 Prentice Hall Business Publishing The Economic Way of Thinking, 11/e Heyne/Boettke/Prychitko 9 of 42
Why Credits Must Equal Debits
• Assume:
– Total dollar value of US imports (debits) exceeds the total dollar value of US exports (credits) for a year.
– There are no unilateral transfers.
© 2006 Prentice Hall Business Publishing The Economic Way of Thinking, 11/e Heyne/Boettke/Prychitko 10 of 42
Why Credits Must Equal Debits
• Assume:
– Americans owe (IOUs) the difference between imports (debits) and exports (credits) IOUs to foreigners.
– The value of the IOUs equals the difference between imports (debits) and exports (credits).
© 2006 Prentice Hall Business Publishing The Economic Way of Thinking, 11/e Heyne/Boettke/Prychitko 11 of 42
Why Credits Must Equal Debits
Imports (debits) = Exports (credits) + IOUs
© 2006 Prentice Hall Business Publishing The Economic Way of Thinking, 11/e Heyne/Boettke/Prychitko 12 of 42
Equilibrium and Disequilibrium
Disequilibrium implies that something will change.
© 2006 Prentice Hall Business Publishing The Economic Way of Thinking, 11/e Heyne/Boettke/Prychitko 13 of 42
Equilibrium and Disequilibrium
P
Q
DS
CeilingPrice
P1
Qs Qd
shortage
© 2006 Prentice Hall Business Publishing The Economic Way of Thinking, 11/e Heyne/Boettke/Prychitko 14 of 42
The Ambiguities of International Disequilibrium
• Since 1983, US merchandise and service imports have exceeded exports.
• When US imports exceed exports, the US exports IOUs.
• The US can export (sell) IOUs because people demand them (i.e., a market for IOUs).
© 2006 Prentice Hall Business Publishing The Economic Way of Thinking, 11/e Heyne/Boettke/Prychitko 15 of 42
The Ambiguities of International Disequilibrium
Does foreign investment in the US imply that the US economy is weak or
that it is strong?
© 2006 Prentice Hall Business Publishing The Economic Way of Thinking, 11/e Heyne/Boettke/Prychitko 16 of 42
Disequilibrium as a Disguised Policy Judgment
• The balance of payments reflects our situation, it does not cause it.
• If foreigners don’t invest in the US:
– Disequilibrium might occur and markets would have to adjust
© 2006 Prentice Hall Business Publishing The Economic Way of Thinking, 11/e Heyne/Boettke/Prychitko 17 of 42
But Will it Go on Forever?
• Claim of disequilibrium
– Prediction that things will change– Adjustments will occur
© 2006 Prentice Hall Business Publishing The Economic Way of Thinking, 11/e Heyne/Boettke/Prychitko 18 of 42
Foreign Exchange Rates and Purchasing Power Parity
• Foreign Exchange Rates
– Express the relative purchasing power of two currencies.
• Example
– $0.67 = 1 German mark– $0.0067 = 1 Japanese yen
© 2006 Prentice Hall Business Publishing The Economic Way of Thinking, 11/e Heyne/Boettke/Prychitko 19 of 42
Foreign Exchange Rates and Purchasing Power Parity
• Example
– Then $1.00, 1.5 marks and 150 yen will buy the same amount of goods in goods in the US, Germany, and Japan, respectively.
• Exchange rates adjust to create a purchasing power parity among national currencies.
© 2006 Prentice Hall Business Publishing The Economic Way of Thinking, 11/e Heyne/Boettke/Prychitko 20 of 42
Foreign Exchange Rates and Purchasing Power Parity
• An example:
– $1.00 = 150 yen– If 150 yen will purchase more in Japan than $1.00 will
buy in the US.– Dollar holder will want more yen to increase their
purchasing power.– Yen holder will exchange <150 yen for dollars.
© 2006 Prentice Hall Business Publishing The Economic Way of Thinking, 11/e Heyne/Boettke/Prychitko 21 of 42
Foreign Exchange Rates and Purchasing Power Parity
• The expectation that an asset will increase in value
– Causes its value to increase now
© 2006 Prentice Hall Business Publishing The Economic Way of Thinking, 11/e Heyne/Boettke/Prychitko 22 of 42
The Bretton Woods System
• Bretton Woods System (1944)
– Established fixed exchange rates– Each country was to buy and sell its currency to keep
it pegged at the official rate of exchange with the US dollar.
• Bretton Woods System
– US dollar was the benchmark currency– Dollar was pegged to gold
© 2006 Prentice Hall Business Publishing The Economic Way of Thinking, 11/e Heyne/Boettke/Prychitko 23 of 42
The Bretton Woods System
• International Monetary Fund (IMF)
– Attempted to provide foreign exchange reserves to help restore equilibrium.
– Divergent policies created disequilibrium.
© 2006 Prentice Hall Business Publishing The Economic Way of Thinking, 11/e Heyne/Boettke/Prychitko 24 of 42
Fixed or Floating Exchange Rates?
• Early 1970’s
– US abandoned fixed exchange rates.
• Exchange rates have adjusted (floated) to changing economic conditions.
• Since 1975:
– Global volume of trade increased more than twice as fast as global GDP.
© 2006 Prentice Hall Business Publishing The Economic Way of Thinking, 11/e Heyne/Boettke/Prychitko 25 of 42
Nobody Knows
• The Asian Crisis (1997)
– Fear of devaluation– Foreign investors withdrew funds– Governments and central banks buy own currency to
support value.– May run out of own currency
© 2006 Prentice Hall Business Publishing The Economic Way of Thinking, 11/e Heyne/Boettke/Prychitko 26 of 42
Nobody Knows
• Possible remedies
– Let the currency value fall– Raise interest rates
• And stop economic growth– Borrow from IMF
© 2006 Prentice Hall Business Publishing The Economic Way of Thinking, 11/e Heyne/Boettke/Prychitko 27 of 42
The Trouble We’ve Seen
• Assume
– IMF assistance delayed– The country devalues– A “capital flight” occurs– World-wide confidence in investments in foreign
countries falls– Capital begins to exit other countries
© 2006 Prentice Hall Business Publishing The Economic Way of Thinking, 11/e Heyne/Boettke/Prychitko 28 of 42
The Trouble We’ve Seen
• What if…
– The capital flight of the late 1990s slows world-wide economic growth
– The uncertainty created by the economic weakness in these countries reduces their ability to return to their recent prosperity.
© 2006 Prentice Hall Business Publishing The Economic Way of Thinking, 11/e Heyne/Boettke/Prychitko 29 of 42
The Case of a Common Currency
• Fixed rates are the ideal system with ideal governments.
• Floating exchange rates are the ideal system when economic polices diverge
• January 1, 1999 – Euro
– Common currency– European Monetary Union– 11 nations
© 2006 Prentice Hall Business Publishing The Economic Way of Thinking, 11/e Heyne/Boettke/Prychitko 30 of 42
Private Interests, National Interests, Public Interest
• Why does trade occur?
• Who benefits from trade?
• Who benefits from trade restrictions?
– Protection from foreign competitors makes life more comfortable.
© 2006 Prentice Hall Business Publishing The Economic Way of Thinking, 11/e Heyne/Boettke/Prychitko 31 of 42
In Defense of Comparative Advantage
• The political process may be the greatest barrier to free trade.
• Who has the louder voice?
– Those who expect to gain from restrictions.– Those who expect to lose from restrictions.
© 2006 Prentice Hall Business Publishing The Economic Way of Thinking, 11/e Heyne/Boettke/Prychitko 32 of 42
In Defense of Comparative Advantage
• Comparative advantage demonstrates that:
– Exchange creates wealth.– A country cannot become wealthy by exporting more
than it imports.– One country cannot be more efficient than another in
the production of everything.
© 2006 Prentice Hall Business Publishing The Economic Way of Thinking, 11/e Heyne/Boettke/Prychitko 33 of 42
In Defense of Comparative Advantage
What are the arguments for trade barriers?
© 2006 Prentice Hall Business Publishing The Economic Way of Thinking, 11/e Heyne/Boettke/Prychitko 34 of 42
Globalization and Its Discontents
• Some believe
– Large corporations are in a global quest to help the “have-nots” of the world.
• Others say
– Large corporations will “roll over” the poor in searching for profits.
© 2006 Prentice Hall Business Publishing The Economic Way of Thinking, 11/e Heyne/Boettke/Prychitko 35 of 42
Globalization and Its Discontents
• Evidence suggests globalization achieves positive changes:
– Lifts up the poor from miserable poverty.– Environmental quality improves.– Workers better off.
• Income • Working conditions
© 2006 Prentice Hall Business Publishing The Economic Way of Thinking, 11/e Heyne/Boettke/Prychitko 36 of 42
The Power of Popular Opinion
• Strong opinions are not the same as valid arguments.
• Popular opinion often focuses on the consequences of public policy.
• Exchange and production emerges from globalization.
– Usually a marked pattern of improvement.
© 2006 Prentice Hall Business Publishing The Economic Way of Thinking, 11/e Heyne/Boettke/Prychitko 37 of 42
The Power of Popular Opinion
• Productivity increases sourced from
– Labor skill improvements.– Technological knowledge increases.– Improvements in economic organization.
• Globalization brings all from
– More developed world to– Less developed world
© 2006 Prentice Hall Business Publishing The Economic Way of Thinking, 11/e Heyne/Boettke/Prychitko 38 of 42
The Power of Special Interests
• Politics exhibit a short-sightedness in economic decision making.
– Concentrated benefits bias– More so in non-democratic governments that are not
secure.
© 2006 Prentice Hall Business Publishing The Economic Way of Thinking, 11/e Heyne/Boettke/Prychitko 39 of 42
The Outsourcing Controversy:Soundbytes vs. Analysis
• Number of jobs lost in the US due to outsourcing of jobs to foreign workers
– Miniscule compared to size of US economy
• Law of comparative advantage works
– Trade between nations is positive-sum
© 2006 Prentice Hall Business Publishing The Economic Way of Thinking, 11/e Heyne/Boettke/Prychitko 40 of 42
Once Over Lightly
• Balance of payments (credits = debits)
• Disequilibrium in balance of payments implies credits and debits are not equal.
• Foreign exchange rates link relative prices in nations with separate currencies.
• Exchange rates can be set arbitrarily by governments.
© 2006 Prentice Hall Business Publishing The Economic Way of Thinking, 11/e Heyne/Boettke/Prychitko 41 of 42
Once Over Lightly
• Fixed exchange rates reduce uncertainty and promote trade but presuppose compatible economic policies.
• The Asian Crisis
• Floating exchange rates
• The Euro as a common currency
• Debate over globalization
© 2006 Prentice Hall Business Publishing The Economic Way of Thinking, 11/e Heyne/Boettke/Prychitko 42 of 42
End of Chapter 19