Скачать презентацию IX Open economy oil shocks and disinflation policies Скачать презентацию IX Open economy oil shocks and disinflation policies

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IX. Open economy, oil shocks and disinflation policies (1973 -1985) IX. Open economy, oil shocks and disinflation policies (1973 -1985)

IX. 1 Open economy stabilization IX. 1 Open economy stabilization

Reminder: net export, aggregate demand real Ex. R • Open economy: AD = C+I+G+NX Reminder: net export, aggregate demand real Ex. R • Open economy: AD = C+I+G+NX – NX = net exports: export - import • In the short-run, export depends on foreign demand real exchange rate, import depends on domestic AD and real exchange rate – Real Ex. R = nominal Ex. R. (P*/P), appreciation of currency means lower numerical value of both real and nominal Ex. R, depreciation vice versa – Marshall-Lerner condition, i. e. net export depends on real exchange rate only • Standard asssumption: – Real appreciation (nominal appreciation and/or stronger foreign inflation than domestic one) less competitive domestic goods and services higher the current account deficit (NX drops) • And vice versa • AD: depends on domestic policy parameters (fiscal and monetary) AND real Ex. R

Reminder: Mundell-Fleming model • The efficiency of fiscal, monetary and trade policy differs according Reminder: Mundell-Fleming model • The efficiency of fiscal, monetary and trade policy differs according the exchange rate regime • Flexible exchange rate (float) – Fiscal policy very little efficient – Monetary policy very efficient • Fixed exchange rate – Fiscal policy very efficient – Monetary policy very little efficient

Policy goals in the open economy • Internal balance – full employment and price Policy goals in the open economy • Internal balance – full employment and price stability – Fiscal and monetary stabilization policies • External balance – definition: it does not have to coincide with zero current account – High CA deficit might be (very) desirable, when country is able to repay the debt financing (loans) in the future – High CA surplus might be a problem: • Too low domestic investment, given total domestic savings • Too many foreign claims, risk as to future payments • Target for protections from abroad – Assume “some desirable” CA deficit

Policy choices under B-W fixed Ex. R • Goal: simultaneous achievement of external and Policy choices under B-W fixed Ex. R • Goal: simultaneous achievement of external and internal balance • Under B-W, policy tools limited – Internal balance: monetary policy little efficient, fiscal policies only available – External balance: fixed Ex. R, devaluation options very limited • Four possible situation, away form both balances – I: over-employment and inflation, CA surplus too high – II: over-employment and inflation, CA deficit too high – III: underemployment and deflation, CA deficit too high – IV: underemployment and deflation, CA surplus too high • All four imply both Ex. R and fiscal adjustment

External balance, NX=NXX E I IV E II Internal balance, Yf Fiscal expansion External balance, NX=NXX E I IV E II Internal balance, Yf Fiscal expansion

Policy adjustment • If economy away from both lines, combination of both fiscal adjustment Policy adjustment • If economy away from both lines, combination of both fiscal adjustment and change of Ex. R is needed • Change in fiscal policy – expenditure changing – Changes the overall level of aggregate demand in the economy • Change in Ex. R (devaluation/revaluation) – expenditure switching – Switches demand between domestic output and imports • Policy dilemma at fix: fiscal policy too slow, Ex. R adjustment faster, but limited by B-W system

IX. 2 The End of Bretton-Woods System IX. 2 The End of Bretton-Woods System

1950 s • B-W system: – Countries limited in their monetary policies – Adjustment 1950 s • B-W system: – Countries limited in their monetary policies – Adjustment to disequilibria via international reserves (gold, but mainly USD) → need for keeping reasonable level of reserves • To keep reserves → limits of convertibility and of capital flows • Special position of US – USD as reserve currency, main task – keeping the USD price of gold (35 USD per oz. ) – Need to keep gold reserves enough – Potential constraint on US macroeconomic policy – when economies grow, will there be enough US gold reserves? • Confidence problem

1960 s • Gradual achievement of convertibility • Increase of international capital flows (despite 1960 s • Gradual achievement of convertibility • Increase of international capital flows (despite controls), more and more of speculative nature, because of expected devaluations • More frequent balance of payments crises, accompanied by losses of foreign exchange reserves • Devaluations, indeed (Britain November 1967) • Need for policies to achieve both internal and external balance • All this: crucially dependent on the performance of the US economy

US economy in 1960 s • Vietnam War, “moon racing” and Great Society program US economy in 1960 s • Vietnam War, “moon racing” and Great Society program of President Johnson → strong fiscal expansion → inflation → worsening of CA → monetary policy only temporary contracted, later eased → further inflation → expected rise in USD price of gold • Private speculators started to buy gold → two-tier gold market (private, where price of gold allowed to float; official, where fixed) → end of automatic constraint on worldwide monetary growth

US recession in 1970 • 1970: US recession with increase of unemployment, output falling, US recession in 1970 • 1970: US recession with increase of unemployment, output falling, CA deficit → need for real devaluation of USD vis-àvis major other currencies – Fall US prices – no way because of recession – Second option – nominal devaluation of USD, uneasy, as all other countries should be willing to peg their currency to USD at new (devalued) rate – August 15, 1971 – President Nixon stopped automatic exchange of gold for dollars and introduced import surcharge • Multilateral negotiation → Smithonian agreement in December 1971 – USD devalued by 10 % against foreign currencies, price of gold increased to 38 USD per oz. • Not the end of the story yet: because of continuing disequilibria, another speculative attack on USD in February 1973 → European currencies abandoned fix and by March 19, 1973 Japan and Europe floated their currencies against USD → end of B-W system

IX. 3 Oil shocks and stagflation IX. 3 Oil shocks and stagflation

IX. 3. 1 Stagflation • Stagflation: inflation + unemployment + low growth – US IX. 3. 1 Stagflation • Stagflation: inflation + unemployment + low growth – US as well as Europe • Trigger: oil shocks, 1973 and 1979 – In 1973 -4 and in 1979 -1982, two dramatic increases in price of oil: 1960: 100, 1972: 93, 1974: 135, 1982: 264 – Increase in oil price → substantial increase in P without a link to change in wages (and unemployment) • Economic policies were not able to react immediately → problems lasted till 1980 s

Main indicators, 1963 -2005 63 -72 73 -82 83 -92 93 -02 03 04 Main indicators, 1963 -2005 63 -72 73 -82 83 -92 93 -02 03 04 05 inflation USA 3. 3 8. 7 4. 0 2. 6 2. 3 3. 0 Europe 4. 4. 10. 7 5. 1 2. 4 2. 0 2. 2 2. 0 Japan 5. 6 8. 6 1. 8 0. 2 -0. 2 Unemployment USA 4. 7 7. 0 6. 8 5. 2 6. 0 5. 5 5. 4 Europe 1. 9 5. 5 9. 4 9. 6 8. 9 9. 0 8. 7 Japan 1. 2 1. 9 2. 5 3. 9 5. 3 4. 7 4. 5 per capita real GDP growth USA 2. 8 0. 9 2. 4 2. 1 2. 0 3. 3 2. 5 Europe 3. 9 2. 0 3. 0 2. 0 -0. 1 1. 9 Japan 8. 5 2. 9 3. 4 0. 7 2. 3 4. 3 2. 3

US data US data

What policies? • Stagflation: challenging framework for policy decisions • Keynesian: so far based What policies? • Stagflation: challenging framework for policy decisions • Keynesian: so far based on inflation vs. unemployment trade-off, no use • Monetarist: provided credible explanation what happened, but the advice for stable increase of money supply was not of much help either

Rational expectations and policy credibility • Anticipated policies → immediate adjustment towards new equilibrium, Rational expectations and policy credibility • Anticipated policies → immediate adjustment towards new equilibrium, consistent with natural values • Un-anticipated → new equilibrium, but not at natural values, i. e. with higher inflation or higher unemployment • Effective policy: must be credible, i. e. agents must believe that authorities will indeed pursue that policy that they announce

Difficult policy options after 1973 • Oil shocks: un-anticipated, economy reacted according new-classical theory Difficult policy options after 1973 • Oil shocks: un-anticipated, economy reacted according new-classical theory – Price increase, contraction, higher unemployment – Policy response: difficult, see Case study I bellow • Disinflation after 1979: mainly the problem of credibility – will the authorities hold monetary contraction? – See Case study II bellow

IX. 3. 2 Policies 1973 -1979 Monetary expansion IX. 3. 2 Policies 1973 -1979 Monetary expansion

Effect on prices • Oil and energy inputs more expensive → all prices oil Effect on prices • Oil and energy inputs more expensive → all prices oil importing countries up • Expectations: price increases will continue • Both in US and Europe – accumulated inflationary pressures via wage negotiations already from 1960 s • Speculative hoarding of commodities stocks

Effect on output • Sharp price increase → fall of AD → fall of Effect on output • Sharp price increase → fall of AD → fall of output • Sharp increase of unemployment • Stagflation: inflation with unemployment

Effect on CA • Oil importing developed countries: sharp decrease (deficit), later improvement (as Effect on CA • Oil importing developed countries: sharp decrease (deficit), later improvement (as spending on imports fell down) • OPEC countries: sharp increase (surplus), investing the revenues (“petrodollars”) in developed countries • Oil importing developing countries: mild deficits (lower energy intensity) • No problem how to finance deficits (out of petrodollars)

Policy options • Both internal and external disequilibria, need for action, options • Return Policy options • Both internal and external disequilibria, need for action, options • Return to fix? – Danger of speculative attacks • Monetary contraction to fight inflation? – It seemed as politically unfeasible • Monetary expansion to fight unemployment – Selected policy, consequences?

Monetary expansion • US immediately 1974, Europe much later (1978) • US: – – Monetary expansion • US immediately 1974, Europe much later (1978) • US: – – Output recovery, unemployment improved Further inflation, larger than Europe Depreciation, both nominal and real CA deficit: contrary to model, as depreciation helps exports; here domestic expansion fostered imports (despite that more expensive), due to continuing recession in Europe, no demand for exports → deterioration of the deficit

Crucial consequences for developed countries • Weak dollar – psychological impact on US population Crucial consequences for developed countries • Weak dollar – psychological impact on US population • Entirely different understanding about scarcity of energy resources • US – growth resumed and unemployment – at least partially – improved • Europe – growth resumed as well (not as in US), unemployment persistent

IX. 3. 3 Policies 1980 -1985 Disinflation IX. 3. 3 Policies 1980 -1985 Disinflation

The burden of inflation • Very high US inflation through 1970 s – Due The burden of inflation • Very high US inflation through 1970 s – Due to monetary expansion when fighting unemployment of 1970 s • Eroding the health of US economy • 1979: new FED’s chairman Paul Volcker – Strong commitment to monetary contraction to lower inflation – Credibility problem • January 1981: President Ronald Reagan – New economic policies, based on tax cuts, anti-inflationary policies and support to private business – Later (1983): fiscal expansion, mainly due to political reasons (military expenditures)

Supply side economics • Lower taxes ↔ incentives to private sector to increase both Supply side economics • Lower taxes ↔ incentives to private sector to increase both effort and productivity • Strategy: lower tax means higher budget deficit now, but stronger growth in the future and larger tax revenues with deficit improvement in the future • Supply side economic, Laffer curve Tax revenue 0% 100% Tax rate

The data 1980 1981 1982 1983 1984 GDP growth % -0. 5 1. 8 The data 1980 1981 1982 1983 1984 GDP growth % -0. 5 1. 8 -2. 2 3. 9 6. 2 Unemployment % 7. 1 7. 6 9. 7 9. 6 7. 5 Inflation – CPI % 12. 5 8. 9 3. 8 3. 9 Nominal interest % 11. 5 14. 0 10. 6 8. 6 9. 6 Real interest% 2. 5 4. 9 6. 0 5. 1 5. 9 Real Ex. R (73=100) 117 99 89 85 77 Trade surplus -0. 5 -0. 4 -0. 6 -1. 5 -2. 7 Budget surplus -1. 8 -2. 0 -3. 5 -5. 6 -4. 5

A detour: policies in large open economies • No longer small country assumption – A detour: policies in large open economies • No longer small country assumption – No prevailing world interest rate – Changes in inflation and output do influence inflation and output in other economies • Changes to policy effects compared to M-F model – Monetary expansion: domestic output up, domestic currency depreciates, foreign outputs ambiguous – Fiscal expansion: domestic output up (different from standard M-F model in Lecture XII), home currency appreciates, foreign output up

XVI. 3. 1 Reducing the inflation XVI. 3. 1 Reducing the inflation

The costs of disinflation • Sacrifice ratio: the amount of lost output during the The costs of disinflation • Sacrifice ratio: the amount of lost output during the period of reducing inflation • Keynesian view: sacrifice ratio large, due to price and wage rigidities • Monetarist view: – there is always some sacrifice ratio – Probably much lower than Keynesians believe – Depends on institutional adaptations and – mainly – how quickly people adapt their expectations (AEH) • New classical school (rational expectations) – If policies credible (anticipated) → sacrifice ratio might be close to zero – If policies not credible (un-anticipated) → sacrifice ratio might be substantial

Monetary restriction after 1979 • Strong, convincing commitment to monetary restriction, quick change of Monetary restriction after 1979 • Strong, convincing commitment to monetary restriction, quick change of expectations and quick impact: – Real interest ↑, Y↓, P ↓, real (and nominal) appreciation of USD – The credibility problem: most people did not believe that Reagan/Volcker team will be politically strong to reduce inflation quickly – Behaviour according rational expectation models: un-anticipated policy → decrease of output and increase of unemployment – Whenever credibility established → growth resumed and unemployment started to fall • Strong monetary contraction and subsequent volatility of macroeconomic parameters → impact on the position of USD • Originally, very strong commitment towards floating Ex. R without intervention (“benign neglect”)

Other countries’ reaction • Usually: appreciation of domestic currency seen as welcome by foreign Other countries’ reaction • Usually: appreciation of domestic currency seen as welcome by foreign countries (positive effect on exports) • Different attitude in 1980 -81: low US inflation relatively increased inflation in foreign (European) countries → additional inflationary pressure in European economy → monetary contraction in Europe (and Japan) as well – Technically, contraction as a result of intervention against USD’s appreciation → sale of USD assets (to undermine USD), i. e. money restriction

Effects of Monetary Contraction • 1980 -1982 – US economic development dominated by the Effects of Monetary Contraction • 1980 -1982 – US economic development dominated by the effects of monetary contraction • M. -F. model’s prediction: in case of flexible exchange rate monetary policy is efficient, see data: – Output contraction – Real appreciation of USD – Inflation sharply down • Remark: US is large economy, interest rate is not fixed on the “world” level

World recession after 2 nd oil shock Difficult coincidence: • Second oil shock • World recession after 2 nd oil shock Difficult coincidence: • Second oil shock • Monetary restrictions in all major parts of the world • Lack of forex policy coordination → deep recession worldwide, the most serious after Great Depression

Effects of Fiscal Expansion • After 1982 – stronger effect of fiscal expansion – Effects of Fiscal Expansion • After 1982 – stronger effect of fiscal expansion – Reagan: additional military expenditures • M. -F. model: fiscal policy less efficient, but here model’s predictions did not come true fully – There was a further appreciation of USD, in accord with M. -F. – There was a strong expansion of output, contrary to original version of M. -F. model • US is a large economy, interest rate is not fixed and appreciation is consistent with interest rate decrease → stimulation of AD and output

IX. 4 Exchange rate policies under floating IX. 4 Exchange rate policies under floating

Twin deficits and consequences • Increased military expenditures outweighed increased tax revenues due to Twin deficits and consequences • Increased military expenditures outweighed increased tax revenues due to faster growth – The budget deficit further deteriorated • Continuing USD appreciation slowed exports and increased imports – Trade deficit started to increase • Result: US economy started to mount both trade and budget deficits → the problem of twin deficits • Strong deficit and strong USD → calls for protectionism in the US, threat to overall world trading system → need for Ex. R adjustment, i. e. need for an intervention

Plaza Agreement • September 22, 1985: officials from US, UK, France and Germany announced Plaza Agreement • September 22, 1985: officials from US, UK, France and Germany announced a joint intervention to depreciate USD • Given strong commitment → change in expected Ex. R → drop of USD immediately next day • Accompanied by slight monetary expansion → continuous decline of USD in 1986 -87, US interest rates down relative to other countries • Second half of 1980 s: – – much stronger growth, world out of recession lower unemployment resumption of world trade macroeconomic stabilization

XVI. 4 Conclusions from oil shocks • Stagflation – a phenomena, neither known and XVI. 4 Conclusions from oil shocks • Stagflation – a phenomena, neither known and expected by both economists and public • Keynesian economics (and policies) on retreat • Disinflation policies of 1980 s opened a new era in economic policies – Success in reducing the inflation – International economics and coordination – The role monetary policies and of Central Banks • Twin deficits and period of weak USD

Open issues • Fix of float? – never ending story • Should there be Open issues • Fix of float? – never ending story • Should there be an international coordination on exchange rates policies? • Anti-inflationary policies emerged as a pivotal element in economic policy making • Expectations as a central notion both in economic theory and practice (see next Lecture) • The start of formation of the framework of macroeconomic policies for 21 st century (see the last Lecture)

Literature to Ch. XVI • Krugman, Obstfeld, ch. 19 • Snowdon, Vane, Modern Macroeconomics, Literature to Ch. XVI • Krugman, Obstfeld, ch. 19 • Snowdon, Vane, Modern Macroeconomics, Edvard Elgar, 2005 (part 5. 5. 3) • Romer, Ch. , Romer, D. , Reducing Inflation, The University of Chicago Press, 1997