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What’s Up with the Exchange Rate? 

What’s Up with the Exchange Rate? . Andrew K. Rose UC Berkeley, NBER and CEPR. The Basic Long-Run Issue. America’s Current Account Deficit 2006: $811.5 billion deficit (!) 6.2% of American GDP Implies annual Capital Inflows of $2700 per person annually (!)

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What’s Up with the Exchange Rate? 

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  1. What’s Up with the Exchange Rate?  Andrew K. Rose UC Berkeley, NBER and CEPR

  2. The Basic Long-Run Issue • America’s Current Account Deficit • 2006: $811.5 billion deficit (!) • 6.2% of American GDP • Implies annual Capital Inflows of $2700 per person annually (!) • 2007Q1: deficit of $192.6 billion • Almost all Goods (Services in surplus but small) • Small persistent income surplus Exchange Rates

  3. Causes • Some Dispute among Economists • Still, Low American Savings chief reason • Personal Savings very low lately, often negative • Public Sector also dis-saving (Federal deficits) • Lack of Investment outside US also possible issue Exchange Rates

  4. Current Account: Sustainable? • Size of Deficit unprecedented for America • Also unprecedented for “Anchor” country • US now taking over 75% of all global savings flows • Capital running “uphill” from poor to rich (!) • Growing US external debt Exchange Rates

  5. Adjustment must involve Prices • For current account to close, savings must rise (or investment fall, or both) • Symmetrically, exports must rise dramatically, while import growth slows • Exchange Rate one of the key adjustment mechanisms • So long-run depreciation of Dollar is likely Exchange Rates

  6. How Much? • Many Different Estimates, Little Consensus • Most expect at least another 15-25%, sometimes more • Exchange Rates often overshoot • Timing: almost impossible Exchange Rates

  7. Where will Effects be Felt? • Three Big Currency Zones in World: • Dollar, Asian-zone, Europeans • But exchange rate policy varies across world • Dollar floats freely against Many Currencies • Europeans (including UK, Norway) • Also Canada, NZ, Australia, etc Exchange Rates

  8. But Asia is Different • Asians take Exchange Rate Policy Seriously • Almost all East Asians manage currencies, will continue to do so • Part a Legacy of Asian Crisis of ’97-’98 • Part a Development Strategy … • Which Leads us to China Exchange Rates

  9. How to Think about the Yuan? • Chinese Communist Party Needs Growth to Survive Politically • Growth is Required to Absorb Massive Unemployment in Chinese Countryside • Agricultural Peasants Must Be Transformed Into Manufacturing Workers • Exports Provide Only Possible Outlet Exchange Rates

  10. Asian Paradigm for Development • Competitive (Cheap) Unemployed Labor Absorbed into Manufactured Sector • Example of key theory of W.A.Lewis (Nobel Laureate) Exchange Rates

  11. Implications for West • China has every incentive to maintain under-valued exchange rate • Under-valuation the key to rapid export growth • Right in theory • Effective in practice (past twenty years!) • Hence rapid accumulation of US$ reserves, as China maintains under-valued peg to US • Reserves act as “collateral”, encourage FDI Exchange Rates

  12. Special Role of USA • US is issuer of $, global reserve currency • East Asians fixes against US$ • US is largest, most open economy • US willing to handle large, persistent current account deficits Exchange Rates

  13. Special Role of USA, contd • American FDI high in Asia • High Returns on Asian Investments help protect against American Protectionism • China Importing Financial Services, since Domestic Financial Sector Weak • US also premier provider of collateral service (hence Asian pegs against $) Exchange Rates

  14. Where Does Europe Fit In? • No Direct Role • Still, Large Indirect Role • Euro floats against $ • Europe has powerful central bank with independent monetary policy Exchange Rates

  15. Dollar Depreciation Likely to be Mostly against Euro • Some Already Occurred • Dollar depreciated from .8$/euro to 1.4$/euro already • Worse for pound! • More likely to come! Exchange Rates

  16. Asia and the Euro • Crisis in Confidence Possible • American Current Account Deficits large • >6% GDP, highly persistent • Dollar Depreciation Resisted by Asians • But Euro Floats Freely! • Euro Likely to Continue to Appreciate Against Dollar over long Term Exchange Rates

  17. It isn’t Only China! • Other Asian Economies Waiting in Line behind China • India • Indonesia • Vietnam … Exchange Rates

  18. Historical Precedent • European Development in 1950s and 1960s • Export-Lead Growth to transfer under-employed Europeans from countryside to manufacturing • Revival of “Bretton Woods” regime, prevailed before 1971 Exchange Rates

  19. Conclusion • Dollar Decline likely to continue • Probably Most Dramatically Against Euro • Good argument for foreign diversification! Exchange Rates

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