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Globalization and Economic Policy

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Trans-national mobility of factors of production limit policy ... cut interest rates, and impose a policy of reflation. Did the Malaysian gamble pay off? ... – PowerPoint PPT presentation

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Title: Globalization and Economic Policy


1
Globalization 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

3
Governments 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
4
Government 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

5
Policy 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

6
Fiscal 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

7
Fiscal 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

8
Fiscal 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

9
Fiscal 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????

10
Fiscal 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?
11
Fiscal 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

12
Fiscal 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

13
Monetary Policy in Open Economies

Monetary policy affected by capital Mobility
14
Monetary 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

15
Monetary 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

16
1997 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)
18
During the week of 20 October, 1997, Taiwanese
authorities decided not to defend the NT dollar
Source http//research.stlouisfed.org/fred2/categ
ories/158
19
Taiwanese 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.

20
October 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

21
Monetary 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


22
Monetary 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
23
Monetary Policy in Open Economies
Solutions??? Malaysia Capital Controls for 1
year (stabilize) Chile Tobin Tax??
24
IMF 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.

25
Two 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?

26
Capital 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.

27
Capital 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.

28
Financial market presure index (Jan. 19961)
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