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GlobalEconomics_002 Capital Mobility. CAPITAL GOES GLOBAL The rapid rise in international financial flows is often blamed for making financial markets.

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Presentation on theme: "GlobalEconomics_002 Capital Mobility. CAPITAL GOES GLOBAL The rapid rise in international financial flows is often blamed for making financial markets."— Presentation transcript:

1 GlobalEconomics_002 Capital Mobility

2 CAPITAL GOES GLOBAL The rapid rise in international financial flows is often blamed for making financial markets less stable. The blame is undeserved. Lots of gloomy pessimists, of course. It is easy to see the down-side. Is there an up-side?

3 Benefits Saving & investment allocated more efficiently Poor countries or countries with large investment needs can get capital more readily Rich countries or countries with high savings find outlets Risk is allocated & diversified

4 International Financial Flows How is it supposed to work? INLAND OUTLAND rhrh rfrf (S + T) h (I + G) h (S + T) f (I + G) f rwrw CAPITAL EXPORT CAPITAL IMPORT Outland has a high saving rate and/or high tax rates relative to Inland. Inland may have a higher investment rate or high government spending. Hence, Inland imports capital. The world interest rate rules in both countries

5 Market Power Capital flows measured by current account: CA = - KA. But in developed countries, CA as % of y (and therefore KA as % of y) is not unusually large. Also, S + T & I + G curves follow each other, in general, thereby minimizing the difference between them.

6 Market power Has not gone as far as expected. Current account surpluses & deficits should be huge, but if saving & investment follow each other, so must x & m.

7 Unequal Returns In a fully integrated capital market, shouldn’t comparable assets bear comparable yields? Investors must regard comparable assets as perfect substitutes. Expected ER changes must equal expected inflation differentials. Real interest rates must be equal. But, are they?

8 Unequal returns. §Among industrial countries, divergences from covered interest rate parity are small. §Full integration of capital markets => expected rates of return on bonds should be equalized. Hence, expected movements of exchange rates = expected difference between interest rates. §More strictly, real interest rates should be equal. Assets must be perfect substitutes.

9 Reassessing the Risks Under capital controls, fiscal policy => interest rate changes & monetary policy => inflation changes. Under capital mobility and pegged ER, fiscal policy is powerful but monetary policy is muted. Under mobility & floating ER, monetary policy is more powerful. Pegging dominates monetary policy.

10 Reassessing the Risk §Asset price volatility is not greater. §Major change in relative power of monetary & fiscal policy.


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