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Why do PIIGS matter to the price of corn in Indiana?. Philip Abbott. Euro Crisis. Unsustainable sovereign debt for Portugal, Italy, Ireland, Greece , Spain (PIIGS) 166% of GDP in Greece High interest rates (risk premiums) for PIGS European banks exposed to defaults

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euro crisis
Euro Crisis
  • Unsustainable sovereign debt for Portugal, Italy, Ireland, Greece , Spain (PIIGS)
    • 166% of GDP in Greece
    • High interest rates (risk premiums) for PIGS
    • European banks exposed to defaults
  • Slow economic growth in Europe
    • Recession throughout Euro zone?
  • Weak, volatile currency
    • Euro may not survive crisis
outline
Outline
  • Critical Issues of Euro crisis
    • Exchange rates – Devaluation
    • Monetary Policy – The ECB is not the Fed
    • Interest rates – Foreign capital flows to a safe haven, Investment
    • Fiscal Policy – Austerity
    • Financial Crisis – more severe than recession
  • Does this matter to the US? to agriculture?
  • Solutions and consequences
exchange rates devaluation
Exchange rates – Devaluation
  • Devaluation is the primary “cure” for a structural adjustment crisis
    • Improves export competitiveness
    • Inflates down debt in domestic currency
    • Greece can do neither of these
  • Fixed exchange rate countries cannot implement independent monetary policy
    • Weak dollar and commodity booms
    • Weak dollar from loose US monetary policy
monetary policy the ecb is not the fed
Monetary Policy – The ECB is not the Fed
  • ECB mandate is just to limit inflation
    • Fed’s includes unemployment
  • No Euro bonds equivalent to treasury bills
    • Which country’s interest rates to control?
    • Buying government bonds by ECB is controversial
  • Inflation and monetizing debt
    • Printing Euro’s or financing from Germany, France
      • Politically unacceptable in Germany
    • Stabilization Fund
  • Bank regulation – there are central banks in each Eurozone country
interest rates foreign capital flows to a safe haven
Interest rates – Foreign capital flows to a safe haven
  • Historically, different interest rate policies by ECB versus Fed have been important to exchange rates
    • Influence investment, capital flows sooner than trade
    • ECB raised, but is now lowering short term rates
  • Foreign capital flows as important as trade flows in transmitting economic shocks across borders
    • US dollar strength as safe haven
    • Low interest rates on US treasury bills also due to safe haven/ “risk off”
  • IMF and Europe
    • IMF resources to increase stabilization fund, loans to Greece
    • European leaders asked for help from non-European nations (China, Brazil, but not US)
fiscal policy austerity
Fiscal Policy – Austerity
  • Austerity also part of the IMF structural adjustment cure - conditionality
    • Brought lost decade to Latin America, protests
    • Contradicts Keynesian prescription
  • Confidence of investors versus stimulus of government spending
  • Severe austerity in Europe has evidently slowed economic growth
    • Even US super committee fallback did a better job of timing deficit reduction
    • Solution should be to stimulate growth in short term with a commitment to reduce spending in long run
  • Tax revenue strongly related to business cycles
    • Austerity  recession lower tax collections  debt increases, deficit targets not met
  • Euro zone does not have common fiscal policy
    • Social protection varies across countries
    • Deficit targets and spending cuts
financial crisis more severe than recession
Financial Crisis – more severe than Recession
  • Financial crisis and recession not the same thing
    • Recession without financial crisis, more severe recession, or depression with financial crisis
      • Fed, US treasury policy motivated to avoid financial crisis
      • Euro rescue package – recapitalize European banks
    • Bank failures with defaults on sovereign debt
      • US affected by CDS, Swaps – guarantees on debt
  • Financial crisis in 2008/09 brought trade collapse
    • World trade in 2009 fell 23% relative to 2008
    • Short term effects more severe in 2008QIV and 2009QI
does this matter to the u s economy t o agriculture
Does this matter to the U.S. economy? to agriculture?
  • Exchange rates, inflation and agricultural prices
    • Historically a weak dollar and inflation have brought higher agricultural prices, growing farm income
    • Is inflation “contagious”
  • Recession spillovers?
    • Exports to Europe
    • Worldwide recession
    • Food is income inelastic
  • Financial crisis and trade collapse
    • CDS and US bank exposure
    • Agricultural trade not immune to crisis
prices up in 2008 2011 but export demand volume is inelastic at least in short run
Prices Up in 2008 & 2011, but Export demand (volume)is Inelastic, at least in short run

Price does affect trade value significantly, and

Dec 2008 corn futures fell from nearly $8 in July to almost $3 in December,

With much of that fall after Lehman Brothers failed.

slide20
GDP has influenced trade volume, including agricultural trade, more so than pricesWorld total exports:
u s agriculture somewhat more resilient to recession than overall trade inelastic demand
U.S. Agriculture somewhat more resilient to recession than overall trade – inelastic demand
  • From 2008III to 2009II, US trade declines were
    • Imports 35% Ag Imports 11% Oil imports 57% (6% in Q)
    • Exports 26% Ag Exports 19%
    • Ag trade back to peaks in 2011

www.bea.gov

some solutions
Some solutions?
  • Disorderly break-up of Eurozone
    • Export competitiveness with devaluations
    • Recapitalizing PIGS banks – Debts remain in Euros
    • Financial crisis likely
  • Monetizing PIGS debt
    • ECB buys PIGS bonds – prints Euros
      • Inflation in Germany
    • Stabilization Fund -- is it big enough, will it substitute for ECB bond purchases?
  • Severe austerity
    • Budget limits in EU treaty
      • Do differences in social protection persist?
    • Recession more likely, more severe
    • Tax collections fall with recession
    • Social Unrest
  • Rescuing European banks
    • Voluntary “Haircuts” on Greek bonds – why doesn’t this trigger CDS?
    • Liquidity, loans from Fed to ECB
    • Increased capital requirements
closing thoughts
Closing Thoughts
  • U.S. stimulus measures should have meant weak dollar
    • Would have brought higher commodity prices
    • Weak Euro due to crisis counteracted this
    • Euro austerity more likely to bring recession
      • European countries have not delayed budget cuts
  • Euro crisis has already influenced corn, soybean prices
    • Exchange rates, recession, financial crisis
    • Longstanding problem, but actual crisis would have dramatic effects
  • Biggest risk is European financial crisis
    • Severe austerity means worldwide recession?
    • But bank failures and financial collapse may again have big effects on trade, including agriculture
      • ECB/ Fed moves to provide banks liquidity had most dramatic effects on markets
      • Fed policy to rescue banks based on fear of financial crisis