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1Proprietary and Confidential - G-enovation, Inc. - © 2009
Macroeconomics:The Global Context
Robert A. Gough, Jr., Ph.D.
2Proprietary and Confidential - G-enovation, Inc. - © 2009
Macroeconomics
Is about the overall economic environment
…How it works as a whole …How:
(1) Output GDP = C + I + G + (Ex – M)
(2) Role of Money
(3) Expectations
…impact and determine Macroeconomic conditions
3Proprietary and Confidential - G-enovation, Inc. - © 2009
Macroeconomics
The Global Context is about…
• Trade flows• Income flows
• People flows
Tariffs…Quotas…Terms of trade…Dumping…Protectionism…Trade zones…Exchange rates…Balance of payments…
IMF…World Bank…World currency…Purchasing powerparity…Current account…Capital account…
4Proprietary and Confidential - G-enovation, Inc. - © 2009
International Finance
5Proprietary and Confidential - G-enovation, Inc. - © 2009
International Finance
Balance of Payments……a close cousin to GDP accounting
• GDP Account = reports a nation’s output and its component parts
• BOP Statement = records a nation’s cross-border transactions
6Proprietary and Confidential - G-enovation, Inc. - © 2009
International Finance
As in a GDP account…all numbers in aBalance of Payments Statement are flows…
…indicating the value of:
• Exports and Imports• Income Receipts and Payments• New Foreign Borrowing or Lending
…over a particular period oftime…like a year.
7Proprietary and Confidential - G-enovation, Inc. - © 2009
International Finance
A Balance of Payments Statement
Current Account
• Balance on Trade of Goods & Services
• Balance on Merchandise Trade (Goods)• Balance on Trade in Services
• Net Income (Net Factor Receipts)
• Net Unilateral Transfers
8Proprietary and Confidential - G-enovation, Inc. - © 2009
International Finance
A Balance of Payments Statement
Capital and Financial Account
• Net Capital Account
• Financial Account
• Net Foreign Direct Investment• Net Portfolio Flows• Other Capital Flows, Net• Change in Official Reserves
• Errors and Omissions (Statistical Discrepancy)
9Proprietary and Confidential - G-enovation, Inc. - © 2009
International Finance
A Balance of Payments Statement
…is very revealing…offers a unique window on a country’s cross border transactions…summarizes a country’s relationship to the global economy
• It tells a story……just like your personal checkbook…and your library
10Proprietary and Confidential - G-enovation, Inc. - © 2009
International Finance
11Proprietary and Confidential - G-enovation, Inc. - © 2009
International Finance
12Proprietary and Confidential - G-enovation, Inc. - © 2009
International Finance
13Proprietary and Confidential - G-enovation, Inc. - © 2009
International Finance
14Proprietary and Confidential - G-enovation, Inc. - © 2009
International Finance
15Proprietary and Confidential - G-enovation, Inc. - © 2009
International Finance
16Proprietary and Confidential - G-enovation, Inc. - © 2009
International Finance
A Balance of Payments Statement
Some explanations…Capital & Financial Account
“Financial Account”…
“Changes in official reserves” = reflect increases/decreasesin the government’s stockpile of gold and foreign currencies.
“Errors & Omissions” = residual category reflecting statisticaldiscrepancies in compiling BOP data.
17Proprietary and Confidential - G-enovation, Inc. - © 2009
International Finance
18Proprietary and Confidential - G-enovation, Inc. - © 2009
International Finance
Exchange Rates……strongly affected by:
(1) A country’s current account balance…trade balance
Logic:
• If consumer demand for foreign products rises…• A country’s current account balance deteriorates…• …and its currency depreciates• Because higher demand for foreign products bids up
price of foreign currencies needed to buy them
19Proprietary and Confidential - G-enovation, Inc. - © 2009
International Finance
Exchange Rates…
“Sustained current account deficits are moretypically associated with long-term currencydepreciation than with long-term appreciation.”
20Proprietary and Confidential - G-enovation, Inc. - © 2009
International Finance
Exchange Rates……strongly affected by:
(2) A country’s inflation…purchasing power parity
Logic:
• If a country experiences consistently higher inflation…• A country’s current account balance deteriorates…• …and its currency depreciates• Because…rising prices for a country’s products
reduces demand for those products.
21Proprietary and Confidential - G-enovation, Inc. - © 2009
International Finance
Exchange Rates…
Relationship between inflation and exchange ratesviewed through “purchasing power parity”….
• The Law of One Price• The “Big Mac Index” criteria
…A unit of currency ($) should always have the samepurchasing power in one country as another.
…Inflation undermines this parity.
22Proprietary and Confidential - G-enovation, Inc. - © 2009
International Finance
Exchange Rates……strongly affected by:
(3) A country’s interest rates…regarded by currency traders as the single most
powerful driver of exchange rates…in short run.
Logic:
• Higher interest rates attract foreign capital…• …driving up the value of a country’s currency
23Proprietary and Confidential - G-enovation, Inc. - © 2009
International Finance
Exchange Rates…
Regardless of other models and observations…Law of One Price – “uncovered interest rate parity”
A country’s currency tends to appreciate after arise in its interest rates…and to depreciate after a fall.
24Proprietary and Confidential - G-enovation, Inc. - © 2009
International Finance
Making Sense of Exchange Rates…
• It’s difficult…!
• Most important lesson: currency markets are unpredictable…
• …and irrational
“Ask 10 traders…likely get 10 different explanations!”
25Proprietary and Confidential - G-enovation, Inc. - © 2009
International Finance
Making Sense of Exchange Rates…
But…
…exchange rates are still subject to basicpressures of supply and demand.
• Exchange rate is the price of one currency in terms of another…like products!
• What raises the demand for a currency creates pressure for appreciation…and vice versa
26Proprietary and Confidential - G-enovation, Inc. - © 2009
International Finance
Making Sense of Exchange Rates…
Examples:
• Surge in American demand for foreign goods or financial assets…will weaken the dollar.
• Burst of European inflation…will weaken the euro…and strengthen the dollar.
• Unexpected increase in British interest rates…would strengthen the pound.
27Proprietary and Confidential - G-enovation, Inc. - © 2009
International Finance
Making Sense of Exchange Rates…
Reason why exchange rates are difficult to predict…
• Currencies are subject to a myriad of pressuresat the same time.
Ups and downs in aggregate demand…currencyinterventions by governments…interest rate
movements…inflation…financial panics…politicalcrises…oil shocks…new technologies…abrupt changes
in expectations…etc.
28Proprietary and Confidential - G-enovation, Inc. - © 2009
International Finance
Making Sense of Exchange Rates…
Upshot…Rules of Thumb…Best Predictors:
(1) Interest rates – for short-term movements…interest rate increases ► rapid
appreciation
(2) Inflation – for medium-term movements…high inflation ► depreciation
(3) Current account imbalances – for longer-termmovements
…deficits ► depreciation
29Proprietary and Confidential - G-enovation, Inc. - © 2009
Macroeconomics
Is about the overall economic environment
…How it works as a whole …How:
(1) Output GDP = C + I + G + (Ex – M)
(2) Role of Money
(3) Expectations
…impact and determine Macroeconomic conditions
30Proprietary and Confidential - G-enovation, Inc. - © 2009
Macroeconomics – The Global Context
Is about the global economic environment:
...How various forces
...Summarized by:
(1) Balance of Payments
(2) Exchange Rates
…impact and determine global economic conditions