1 Global imbalances and the adjustment mechanism HEINER FLASSBECK Director Division on Globalization and Development Strategies

2 PER CAPITA GDP GROWTH BY REGION AND ECONOMIC GROUP, (Per cent)

3 Is the international adjustment mechanism working? Is the RER relevant? What are the sources of divergence? Size (2006): US, -6.6%GDP, $870 bl, China: +10%GDP $240 bl, Japan: +4%GDP $170 bl. pattern: large surplus economies -> recurrent depreciations Japan, Germany, Switzerland and Malaysia deficit economies -> recurrent appreciations Euro area, Hungary, New Zealand UK, Australia, Turkey, India, South Africa. WIDENING OF THE GLOBAL IMBALANCES Size and pattern

4 CARRY TRADE: a “species” of a broader “genus” A source of imbalance for some economies. An amplifying factor in the divergent pattern of global imbalances. DESTABILIZING SPECULATION Interest rate differentials and relatively stable currencies induce short terms speculation as in the pre-90s crisis scenario. Floating exchange rates can move in the wrong direction Market price determination in the international capital markets "False pricing" in the international product markets Widening of the imbalances and worldwide financial fragility

5 YEN-CARRY TRADE ON THE ICELANDIC KRONA, US DOLLAR AND BRAZILIAN REAL, Note: A positive change in the exchange rate means an appreciation of the corresponding currency vis-à-vis the yen.

6 YEN-CARRY TRADE ON THE ICELANDIC KRONA, US DOLLAR AND TURKEY LIRA,

7 UNCOVERED INTEREST RETURNS, EXCHANGE-RATE CHANGES, INFLATION AND INTEREST RATE DIFFERENTIALS, LATIN AMERICA Interest rate differentials induced by anti-inflation monetary policies drive nominal appreciations + inflation differentials = real appreciations undermining international competitiveness in exchange rate sensitive exports.

8 UNCOVERED INTEREST RETURNS, EXCHANGE-RATE CHANGES, INFLATION AND INTEREST RATE DIFFERENTIALS, SUB-SAHARAN AFRICA Speculation opportunities are fading and appreciation trend leveled off, but volatility persist

9 UNCOVERED INTEREST RETURNS, EXCHANGE-RATE CHANGES, INFLATION AND INTEREST RATE DIFFERENTIALS, EASTERN EUROPE Speculation opportunities, appreciation trend and volatility persist despite the reduction in interest rates.

10 UNCOVERED INTEREST RETURNS, EXCHANGE-RATE CHANGES, INFLATION AND INTEREST RATE DIFFERENTIALS, ASIA Little speculation opportunities, moderate average appreciation and volatility.

11 REAL COSTS: EXCHANGE-RATE VOLATILITY AND REAL INTEREST RATE DIFFERENTIALS, (per cent) Real exchange rate changes and uncovered interest returns in selected economies, (per cent)

12 DOMESTIC POLICIES, OPEN CAPITAL MARKET AND EXCHANGE RATE MANAGEMENT: BEYOND STANDARD TRILEMMAS National policies to prevent speculation and overvaluation: Explore non-monetary anti-inflationary policies and resilience to depreciation Temporary measures to prevent speculative flows while moving towards structurally lower interest rates differentials Globally coordinated policies to reduce global imbalances: Floating and unilateral hard pegs "no panacea" Intermediate or regional cooperative schemes Code of conduct Multilateral oversight and negotiations Identification of the size of the deviation and enforcement of the necessary correction by a multilateral body Multilateral monetary system as necessary as the multilateral trading system

13 UNCOVERED INTEREST RETURNS, EXCHANGE-RATE CHANGES, INFLATION AND INTEREST RATE DIFFERENTIALS, BRAZIL

14 UNCOVERED INTEREST RETURNS, EXCHANGE-RATE CHANGES, INFLATION AND INTEREST RATE DIFFERENTIALS, TURKEY

15 UNCOVERED INTEREST RETURNS, EXCHANGE-RATE CHANGES, INFLATION AND INTEREST RATE DIFFERENTIALS, MEXICO

16 UNCOVERED INTEREST RETURNS, EXCHANGE-RATE CHANGES, INFLATION AND INTEREST RATE DIFFERENTIALS, CHINA

17 Asia: China, Hong Kong (China), India, Indonesia, Rep. Korea, Malaysia, Pakistan, Philippines, Singapore, Taiwan (Province of China) and Thailand. Latin America: Argentina, Bolivia, Brazil, Colombia, Dominica, Mexico, Uruguay and Venezuela. Eastern European Countries: Czech Republic, Hungary, Lithuania, Poland, Russian Federation and Bulgaria. Sub-Saharan Africa: Benin, Burkina Faso, Côte d'Ivoire, Guinea-Bissau, Kenya, Mali, Mauritius, Niger, Senegal and South Africa. SELECTED ECONOMIES PER REGION

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