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Lecture 3

Political Science 2j03 Week 3 Lecture 2.docx

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Department
Political Science
Course
POLSCI 2J03
Professor
Richard Mc Master
Semester
Summer

Description
Inflation:  Foreign exchange rate (FX) o Relative value of currency  Purchasing price parity (PPP) o Relative cost of goods and services  Appreciation: o Currency is more valuable relative to other currencies  Depreciate o Currency less valuable relative to other currencies  Inflation occurs with depreciation, a loss of PPP, and a loss of GX value What are the reasons for Inflation?  Too much capitol  Too much industry (controversial) o Goes back to Freidman and the monetary supply  Speculation o Looks at capitol flows in global economy, it’s the manipulation of other countries currencies o Investors try to cause a currency to depreciate, once value is really low, then they start buy all this currency back and profiting lots of money o Perception of depreciation (sell) o Depreciation then occurs (buy) Effects?  Increased prices  Loss of savings o Because of higher cost of living  Foreign investment drops  Decrease in exports o Less capitol available because its to expensive Inflation Rate  Seen as a percentage change in the consumer price index (CPI) of specific categories including: o Food/processed food/beverages/housing/clothes  Expressed as a typical cost to the consumer  What was Indonesia’s inflation rate between 2000-2007 o CPI for 2000 = 100 o CPI for 2007 = 188 o (188-100/100) x 100 = 88% o Usually % over 12 month or 1 month period  Prone to volatility (swings), but has potential to be managed o In Indonesias case, theres 30 years of relative stability, but in 1960’s you have a hike of almost 1000% (result of genocide, revolution against dictator etc) Response?  Interest Rates o 5 of the principle paid by the borrower o Set by national governments of national bank o Increase with inflation therefore they make money more expensive, restrict the capital mobility assuming that it’s the widespread availability thats causing the inflation, but if we draw money into banks then we will see a relative appreciation of currency, increase in PPP, and the decrease of prices of commodities. o Raises value of currency  Effects: o Diminishing investment within economies because of interest rates o Greater attraction to your currency o Economic stagnation (lack of business hiring people/no investment into companies) Mundell – Fleming Model  A state cannot do all three of theses things, they can just pick 2 of these and try to promote _____ : o Independence of national monetary policy  Ability of a state to printing money/setting interest rate o Stabilize exchange rates  By Pegging (the value of my currency, will not change between 2 and 3 quarters of a percentage of this currency) o Permit unrestricted inward and outward capitol flows  Global finance Balance of Payments:  The nations economic relationship with the rest of the world  Measured by Current and capital account balances (ability to invest capitol into other countries) Current account leads to two things, outputs (exports) and absorption (imports). Outputs leads to Surplus (outputs are high; you will have a positive balance of payments, exporting more than you import; you have greater ability to invest it elsewhere) and creditor (extend credit throughout the world. Absorption leads to Deficit (not have a surplus of capitol; more country money has to go to getting imports from other countries) and Debtor (you do not have capitol in your account to extend credit, you become a debtor and need someone else to pay for your credit) ^ Example, China has a positive balance of payment because of their power over industry. India is a debtor because their absorption is greater. Foreign Direct Investment  State max their comparative advantage by a country discerns what they can do relatively efficient and cheaper. However transnational corporations also do this. These corporations look at a countries things by looking at the FDI  FDI o Direct o Labor market and natural resources development  Portfolio FDI o Holding of shares o Invest into stock markets of other countries  Investment made outside the home country of investing company in which control over the resources transferred remains with the investor. Controversies:  Pros: o Additional resources o Increase tax revenue o Efficiency through competition  Open up untapped markets o Improve BoP  Greater investment coming in allows for greater ability to get output (they may change to creditor from debtor or at least reduce their reliance on others)  Cons: o Little high tech transfers o Incentive of low taxes  Ability for Gov. to get revenue from tax is limited o Worsen BoP  Make country dependent on some kind of economic activity from the country from which the FDI came o Affect the culture and politics around the world Part II – History of Global finance: Bretton Woods  Institution that was born out of Bretton woods, the IMF Keynesian economics:  Gov. wanted to embed economic decision making into society; didn’t like invisible hand  Paradox of thrift: o Job security/under consumption/crisis o When country needed money in it, free market fails because they would hold their money, however, this is the time when capitol needs to be injected  Requires the state to correct market failures  State must spend and invest when people will not  State uses power to protect the market Bretton Woods (trying to repair after WWII)  Having an institution that will be a lost resort money fund on an international level (Lender of last resort)  In order for IMF to give the money, the country must restructure their economy towards a more liberal paradigm o Stabilize foreign exchange rates (became volatile
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