Title: Globalization and Economic Policy
1Globalization and Economic Policy
- Fiscal Policy
- Monetary Policy
2- Globalization accelerated integration of
economies throughout the world through trade,
financial flows, the exchange of technology,
information and ideas and the movement of people - Outcome
- Trans-national mobility of factors of production
limit policy options for governments - Thus, govt have to carefully balance internal and
external pressures when formulating economic
policies
3Governments and States
- States are geographically defined
territoriality - Within this territory, govts are the sovereign,
i.e. have highest power and can impose policies
on citizens - State fullfills 4 functions
allocative distributive stabilizing regulatory
4Government and states
- From closed to open economies
- Ideological move away from Keynes to Neoclassical
with Thatcher Reagan in 1980s - Pressure by industry and business to abandon
capital controls - Finally, fall of Soviet Union was interpreted as
victory of American way of life, democracy and
free markets
5Policy in Open Economies
- Outcome
- liberalization deregulation of markets
- Increased mobility of factors of production
- Open economies imply that economic activity
expands beyond the territorial borders of single
economies - Thus, actions and decisions taken in one economy
can have significant trans-national spill-over
effects because of factor mobility - Remember
- GDP C I G (X-M)
- Oil shocks
6Fiscal Policy in Open Economies
- Taxation
- based on territoriality principle, i.e. govt
has right to determine tax institutions and
measures within its territory - But
- Mobile factors (mainly capital and skilled
labour) can vote with their feet over
implementation of fiscal policies - Problem
- By threatening exit option, mobile factors have
reduced tax base of govt! - Govt increasingly have to rely on immobile
factors (fixed capital unskilled) for taxation
or it has to borrow
7Fiscal Policy in Open Economies
- Hence race to the bottom? Is taxation still
possible with declining tax base? Is the welfare
state obsolete? - Empirical evidence suggest otherwise EU (most
integrated economies) have not experienced
decline in tax revenue or shift of tax burden to
immobile factors. - WHY? Because constituency ( mostly immobile
labour) puts pressure on govt to fulfil 4
functions. - Thus, fiscal policy has to comply to internal
external pressure
8Fiscal Policy in Open Economies
- Nevertheless, tax competition has increased.
- Lower corporate and lower income tax on high
income earners are supposed to attract companies
and skilled labour - Emergence of tax havens
- To stop process need for tax coordination among
the various governments
9Fiscal Policy in Open Economies
- Deficit Management
- With diminishing tax base, govt have to find
other options to raise money, like borrowing - But how sustainable is public debt?
- How it is financed?
- Economic growth to ensure solvency
- Debt-financing has become more risky as the
probability of default has risen. Thus, higher
risk premium????
10Fiscal Policy in Open Economies
Deficit Management -Exchange rate crises (Asian
crises) can impact on interest payments (higher
interest rates exchange rates) -Highly indebted
governments can face liquidity problems Consensus
reduce public debt to reduce risk of
insolvency i.e., reduce budget deficits manage
public debt in sustainable manner gtgtgtgt live
within your means Problem How to reduce debt?
11Fiscal Policy in Open Economies
- Deficit Management
- How to reduce debt
- Run primary surplus ?restrictive policy ? reduces
output and employment - 2) Improving Tax collection
- Privatization and paying off debt
12Fiscal Policy in Open Economies
- Competitive Fiscal Governance live within your
means - Govts have to use remaining revenues (resources)
in most efficient manner to fulfill 4 functions. - Reforms of expenditure revenue management to
ensure efficient and effective service delivery
according to best practice - Conclusion
- fiscal Policy decisions are a question of
equity, efficiency and feasibility
13Monetary Policy in Open Economies
Monetary policy affected by capital Mobility
14Monetary Policy in Open Economies
- Problem Trinity Impossibility
- A country cannot simultaneously have
- Freely mobile cross-border capital flows
- A fixed exchange or managed exchange rate and
- An independent domestic monetary policy, i.e.
control of domestic interest rates - Because capital flows respond to interest rate
differentials and these capital flows put
pressure on the exchange rate to adjust
15Monetary Policy in Open Economies
- Many central banks in developing countries have
dual goals in controlling inflation (domestic
price stability) and the maintenance of a stable
and appropriately valued exchange rate. - Financial liberalization phasing out of capital
controls - primary objective the achievement and
maintenance of financial stability - Recent goal Inflation targeting ONLY
161997 Asian Crisis and the Emerging Market crisis
- 1997 Loss of confidence in Thailand
- Capital flight ? Baht fixed to the Dollar
- Speculation ? Depreciation
- Loss of confidence spreads across to other East
Asian countries - Outcome High interest rates and depreciation
- Was Taiwan affected?
17(No Transcript)
18During the week of 20 October, 1997, Taiwanese
authorities decided not to defend the NT dollar
Source http//research.stlouisfed.org/fred2/categ
ories/158
19Taiwanese Experience
- 1997/71997/10 Central Bank intensively
intervened in the foreign exchange market
allowed market interest rates to rise financial
capital squeezed stock market falling - Short term (portfolio) investment lost confidence
in Taiwan ? Capital flight - The Central Bank tried to stabilize the financial
market by lowering bank reserve rates in
September and on October 16 . - ? NT DEPRECIATED 19.04 interest rates rose
(11 percent in early October) stock price index
dropped 16.41. Taiwan was influenced mildly
during the 1997 Asian Financial crisis.
20October 23, 1997 HKs Black Thursday The Hang
Seng index fell over ten percent
- Speculators sold more than US1 billion worth of
HK dollar in New York - Running down international reserves and raising
interest rates
21Monetary Policy in Open Economies
South Africa we had mini-crisis (1996) and
went through macroeconomic adjustment which
satisfied foreign investors of our resolve to
apply acceptable macroeconomic disciplines --
Chris Stals, Governor of the South African
Reserve Bank
22Monetary Policy in Open Economies
Was South Africa affected? The South African
financial markets, however, were in recent weeks
severely affected by these developments --
Chris Stals
23Monetary Policy in Open Economies
Solutions??? Malaysia Capital Controls for 1
year (stabilize) Chile Tobin Tax??
24IMF Bail Out
- Three of the worst affected countries (Thailand,
South Korea, and Indonesia) were forced to call
in the IMF and IMF-supported (designed) programs
to cope with the financial crisis. - In return for financial assistance from the IMF,
these countries committed to - float their exchange rates,
- raise interest rates,
- tighten fiscal policy (at least initially),
- open up their financial markets to foreigners,
- close troubled banks and financial institutions,
and - undertake a range of other structural reforms.
25Two paths
- Orthodox path Korea and Thailand,
- Malaysias path Instead of going to the IMF, the
Malaysian authorities imposed - sweeping controls on capital-account
transactions, - fixed the exchange rate at RM3.80 per US (a rate
of a 10 percent appreciation relative to the
level at which the ringgit had been trading
immediately before the controls), - cut interest rates, and impose a policy of
reflation. - Did the Malaysian gamble pay off?
26Capital Controls
- Malaysia has recovered nicely since the crisis,
but so have Korea and Thailand, two countries
that took the orthodox path. - can we say something more concrete about the
relative merits of the capital controls option as
a crisis-resolution strategy, at least in this
particular case? -- Kaplan and Rodrik - DID THE MALAYSIAN CAPITAL CONTROLS WORK?
Harvard University, John F. Kennedy School of
Government, February 2001.
27Capital Controls
- Did the controls help Malaysia recover
faster?--the prevailing view is that the answer
remains unclear - Kaplan and Rodrik (2001) find that the Malaysian
controls produced better results than the
alternative on almost all dimensions. - On the real side, the economic recovery was
faster, and employment and real wages did not
suffer as much. - On the financial side, the stock market did
better, interest rates fell more, and inflation
was lower.
28Financial market presure index (Jan. 19961)