International Economics Twelfth Edition CHAPTER S E V E N T E E N 17 International Economics Twelfth Edition The Income Adjustment Mechanism and Synthesis of Automatic Adjustments Buon capitolo, il migliore del libro Si faccia bene I capr. 3 e 4 delle 6 Lezioni e le dispense Dominick Salvatore John Wiley & Sons, Inc. Salvatore: International Economics, 12th Edition © 2016 John Wiley & Sons, Inc.

Learning Goals: Understand how the equilibrium level of income is determined in an open economy Understand the meaning of foreign repercussions Describe how the absorption approach works Understand how all the automatic adjustments work together in open economies Sinora aggiustamenti BdP via prezzi: a) o tasso di cambio (svalutazione esterna) o b) via svalutazione interna (deflazione) Questi aggiustamenti correggono tassi di cambio reali squilibrati dovuti a tassi di cambio nominali squlibrati (a parità di tasso di inflazione) o tassi di inflazione squilbrati (a parità di tasso di cambio nominale). Ora vedremo come all’origine degli squilibri vi possa anche essere un diverso andamento della AD nei due paesi (per cui la correzione potrà svolgersi oltre che nei modi visti, anche agendo sulla AD). Salvatore: International Economics, 12th Edition © 2016 John Wiley & Sons, Inc.

Keynes contribuì a questa confusione. 17.1 Introduction The automatic income adjustment mechanism relies on changes in the level of national income of deficit and surplus nations to adjust the balance of payments. The income adjustment mechanism is Keynesian, while the price adjustment mechanism is more traditional, or classical. NB per gli economisti convenzionali “classico” = neoclassico (o più precisamente,marginalista) Keynes contribuì a questa confusione. Salvatore: International Economics, 12th Edition © 2016 John Wiley & Sons, Inc.

17.1 Introduction Assumptions Deficit or surplus arises in the current account. All prices, wages and interest rates remain constant. Si ricordi che per Keynes i suoi risultati non dipendevano dall’assunzione di prezzi rigidi (per gli economisti mainstream sì) Nation operates under fixed exchange system. Nations operate at less than full employment (una bella ammissione, ma Keynes è considerato di breve periodo, nel lp full employment) Salvatore: International Economics, 12th Edition © 2016 John Wiley & Sons, Inc.

17.2 Income Determination in a Closed Economy (si vedano anche dispense e 6 Lezioni cap. 3). In a closed economy (no international trade) without a government sector, the equilibrium level of national income and production (Y) is determined by planned flow of consumption (C) plus planned investment (I): Y = C(Y) + I Desired saving is a function of income: S(Y) = Y – C(Y) Salvatore: International Economics, 12th Edition © 2016 John Wiley & Sons, Inc.

17.2 Income Determination in a Closed Economy Investment (I) is an injection (immissione) into the system because it adds to total expenditures and stimulates production. Saving (S) is a leakage (dispersione) out of the system because it represents income generated but not spent. The equilibrium level of income is where: S = I At equilibrium, leakages from the economy (S) must be balanced by injections into the economy (I). L’idea dell’investimento come immissione e del risparmio come dispersione risulta chiara guardando all’esempio numerico delle 6 Lezioni (e dispense) Salvatore: International Economics, 12th Edition © 2016 John Wiley & Sons, Inc.

FIGURE 17-1 National Income Equilibrium in a Closed Economy FIGURE 17-1 National Income Equilibrium in a Closed Economy. NB CA = 100 Salvatore: International Economics, 12th Edition © 2016 John Wiley & Sons, Inc.

17.2 Income Determination in a Closed Economy Since S = I at equilibrium, then: ΔI = (1/MPS)ΔY or ΔY = (1/MPS)ΔI where MPS = marginal propensity to save (change in desired savings with a change in income) If k = 1/MPS, then ΔY = kΔI k is the Keynesian (closed economy) multiplier. Any change in investment will induce a multiplied change in income as given by the above formula. I  S Si veda di nuovo l’esempio numerico. Si studi anche nelle 6 Lezioni il legame fra moneta endogena e moltiplicatore keynesiano: perché le banche non sono intermediarie di risparmio ma creano credito? Salvatore: International Economics, 12th Edition © 2016 John Wiley & Sons, Inc.

17.2 Income Determination in a Closed Economy Example: MPS = ¼ so k = 1/MPS = 1/.25 = 4 So an increase in investment of 100 leads to an increase in income of k(100) = 400. Income will increase by smaller and smaller amounts until total increase is 400. When income has increased by 400, induced savings will have increased by 100, and equilibrium national income (S=I) will again be achieved. Salvatore: International Economics, 12th Edition © 2016 John Wiley & Sons, Inc.

17.3 Income Determination in a Small Open Economy The import function relates imports to national income. M(Y) = M0 + mY where M0 is the level of imports when income = 0, and m is the marginal propensity to import The marginal propensity to import (MPM) is the change in imports associated with a change in income. MPM = ΔM/ΔY The average propensity to import (APM) is the ratio of imports to income, M/Y. MPM/APM = income elasticity of imports, ηY. Salvatore: International Economics, 12th Edition © 2016 John Wiley & Sons, Inc.

FIGURE 17-2 The Import Function. Salvatore: International Economics, 12th Edition © 2016 John Wiley & Sons, Inc.

Qui prima di affrontare la più complessa esposizione di Salvatore, si veda il moltiplicatore del commercio estero nelle dispense e la questione del vincolo estero nel cap. 4 delle dispense. Sono domande d’esame. M = mY E = E* Nel lungo periodo la bilancia commerciale deve essere in pareggio, per cui: M = E*. Da cui si ottiene: mY = E*, ed infine

17.3 Income Determination in a Small Open Economy Countries such as the U.S. that are less dependent on international trade have lower APM and MPM than most countries. For the U.S., APM = 0.15, MPM = 0.27, so , ηY = 1.8. Germany, APM = 0.33, MPM = 0.50, so , ηY = 1.5. United Kingdom, APM = 0.29, MPM = 0.64, so , ηY = 2.2. For a small open economy, exports are assumed to be independent of income (horizontal when plotted against income). Salvatore: International Economics, 12th Edition © 2016 John Wiley & Sons, Inc.

17.3 Income Determination in a Small Open Economy The equilibrium condition relating injections and leakages in the income stream is now: (Injections = Leakages) I + X = S + M or X - M = S – I Ricavabile da Y = C+I+X-M Y-C = I+X-M  S-I = X-M (v. anche slides su BdP  sectoral balances), ovvero I+X = S+M (immissioni=dispersioni) A surplus in the nation’s trade balance (X-M) must be accompanied by an equal excess of saving over domestic investment at the equilibrium level of national income. (Per memoria: col governo: I+X+G = S+M+T) Salvatore: International Economics, 12th Edition © 2016 John Wiley & Sons, Inc.

17.3 Income Determination in a Small Open Economy (non vi confondete, abbiamo denominato foreign trade multiplier, sopra e ora qui, due cose vicine ma diverse). Per questo ftm si veda la formula (più completa col settore pubblico) nelle dispense.   Salvatore: International Economics, 12th Edition © 2016 John Wiley & Sons, Inc.

Sostituendo DS=(1-c) DY e DM=mDY Attenzione abbiamo due nozioni di foreign trade multiplier: slide 12 e slide 16. Più correttamente quello qui sotto è open market multiplier La formula di DS p. 149 k’=1/(s+m) la si ricava dall’uguaglianza immissioni/dispersioni: DI+DX=DS+DM Sostituendo DS=(1-c) DY e DM=mDY Per l’esercizio di pp. 149-50 si può naturalmente utilizzare questa formula DY = 1 (DI + DM) 1 - c – m Nell’esercizio della figura che segue X aumenta da 300 a 500. Per l’esame svolgere primi 8 esercizi p. 164.

FIGURE 17-3 National Income Determination in Small Open Economy FIGURE 17-3 National Income Determination in Small Open Economy. Nota: M=Mo+mY è qui M=150+0,15Y (per cui se Y=1000, M=300).La S= So+sY=-100+0.25Y). Se Y=1000, imm=disp (sopra), ovvero X=300=M=300 (sotto). Con X=500 c’è surplus BdP (sotto). SE ad aumentare è I, es. DI=+200, invece di X, si avrebbe deficit BdP (doppio vantaggio delle exp, vedi eserczio p. 150)

17.4 Foreign Repercussions: questo qui sotto non è il caso più interessante, fare solo caso relative all’equazione 17.12 con dimostrazione e con commenti seconda parte pag. 154 In a two-nation world, an autonomous increase in exports in Nation 1 is equal to an autonomous increase in imports in Nation 2. If Nation 2’s imports replace domestic production, income falls, inducing Nation 2’s imports to fall, neutralizing part of the initial increase in imports. This induces foreign repercussions on Nation 1, neutralizing part of the initial increase in exports, and as a result, the foreign trade multiplier for Nation 1 is smaller than corresponding trade multiplier without foreign repercussions. Salvatore: International Economics, 12th Edition © 2016 John Wiley & Sons, Inc.

17.4 Foreign Repercussions – questo qui sotto non è il caso più interessante, fare solo caso relative all’equazione 17.12 con dimostrazione e con commenti seconda parte pag. 154   Salvatore: International Economics, 12th Edition © 2016 John Wiley & Sons, Inc.

17.4 Foreign Repercussions. Business cycles are propagated internationally. Expansion in economic activity in the U.S. spills into imports (exports of other nations), so U.S. expansion is transmitted to other nations. A rise in exports of other nations expands their economic activity and feeds back to the U.S. through increases in their imports from the U.S. In the 1930s, foreign repercussions were an important contributor to the spread of the Great Depression to the rest of the world. Only a very small nation can safely ignore foreign repercussions from changes occurring in their own economy.

Necessità coordinamento politiche economiche Necessità coordinamento politiche economiche. Mercantilismo monetario tedesco Irresponsabile che la Germania questo non lo comprenda: non hanno mai capito e sopratutto apprezzato Keynes sulla Germania 5 lezione mio libro, sezione 10. Teoria delle locomotiva (fare ricerca su Wiki) Bibliografia: Cesaratto, S. and Stirati, A. (2011), ‘Germany in the European and global crises’, International Journal of Political Economy, 39 (4), 56–87.

Aggiustamento della BdP attraverso Summa summarum Aggiustamento della BdP attraverso Cambi flessibili (svalutazione esterna) Cambi fissi (svalutazione interna) Attraverso la politica monetaria e fiscale (riduzione AD) Attraverso controlli sui movimenti commerciali (controllo delle importazioni) Salvatore: International Economics, 12th Edition © 2016 John Wiley & Sons, Inc.

17.5 Absorption Approach NO da qui sino alla fine The absorption approach integrates the effect of induced income changes in the process of correcting a balance of payments disequilibrium by a change in the exchange rate. Domestic equilibrium is given by: Y = C + I + (X – M) Define A (domestic absorption) = C + I Define B (foreign absorption) = X – M Y = A + B Salvatore: International Economics, 12th Edition © 2016 John Wiley & Sons, Inc.

17.5 Absorption Approach Y = A + B A depreciation of the currency is expected to increase B, foreign absorption (cioè X-M migliora). This can only occur if A falls or Y increases. If the economy is at full employment, Y cannot increase. Therefore, a depreciation must result in a fall in A, real domestic absorption, when then economy is at full employment. Riesprimerei così: se un paese in po (Y dato) ha un disavanzo (B < 0) può attraverso una svalutazione accrescere X e diminuire M, ma le maggiori X e le maggiori produzioni sostitutive delle M si scontrano con la po. Allora si deve ridurre A , cioè devono diminuire i consumi privati e/o pubblici, o gli investimenti privati e/o pubblici per far posto alle maggiori esportazioni e minori importazioni (slide successiva), Salvatore: International Economics, 12th Edition © 2016 John Wiley & Sons, Inc.

17.5 Absorption Approach Domestic absorption (A) falls if Income is redistributed from wages to profits (la propensione al consumo dei lavoratori > di quella dei capitalisti). The depreciation increases prices, lowering real cash balances and thus decreasing consumption. The depreciation pushes people into higher tax brackets, lowering disposable income and consumption. Fiscal or monetary authorities act to reduce domestic spending. Salvatore: International Economics, 12th Edition © 2016 John Wiley & Sons, Inc.

17.6 Monetary Adjustments and Synthesis of the Automatic Adjustments Monetary Adjustments Cambi fissi If the exchange rate does not float freely, BOP deficits tend to reduce a nation’s money supply (canale esterno di creazione di base monetaria) which, unless neutralized, will increase interest rates. (similarità a gold standard) Higher interest rates discourage domestic investment (?), and reduce national income, causing reduction in domestic imports, which reduces the deficit. Svalutazione interna Also attracts foreign capital, helping to finance the deficit. Ma questo non può durare aumento indebitamento estero. Salvatore: International Economics, 12th Edition © 2016 John Wiley & Sons, Inc.

17.6 Monetary Adjustments and Synthesis of the Automatic Adjustments Monetary Adjustments Cambi fissi The reduction in the money supply and income will also tend to lower prices in the deficit nation, stimulating exports and reducing imports. Svalutazione interna  implica periodi di elevata disoccupazione per far cadere salari monetari  questo comporta però distruzione capacità produttiva esperienza europea In theory, this automatic monetary-price adjustment could by itself eliminate both the trade deficit and domestic unemployment (due to the fall in income), but only in the long run  critiche: perdita capacità produttiva, deflazioni competitive gioco a somma zero…. Thus assume in the following that a change in the money supply affects the BOP through both prices and interest rates. Salvatore: International Economics, 12th Edition © 2016 John Wiley & Sons, Inc.

Crisi di un sistema di cambi fissi (v. Krugman 10° ed. pp Crisi di un sistema di cambi fissi (v. Krugman 10° ed. pp. 269-272) LASCIAMO STARE Fare scan di Krugman (il testo elettronico non si può copiare)

L’aggiustamento nell’euro (6 Lezioni: 5° e 6°) Torneremo sulle vicende dell’euro. Gli squilibri esteri alimentati dall’euro (ciclo di Frenkel) tenuti a bada da TARGET2 che impedisce che l’euro (che è un sistema di cambi fissi) esploda V. 6 Lezioni capp. 5 e 6 e appendici. Bibliografia: Cesaratto, S. (2017b), ‘Alternative Interpretation of a Stateless Currency Crisis’, Cambridge Journal of Economics., https://doi.org/10.1093/cje/bew065, working paper version available at: https://www.deps.unisi.it/it/ricerca/pubblicazioni-deps/quaderni-deps/anno-2016-da-n725-n/736-alternative-interpretations Cesaratto, S. (2015a), ‘Balance of Payments or Monetary Sovereignty? In Search of the EMU’s Original Sin – Comments on Marc Lavoie’s The Eurozone: Similarities to and Differences from Keynes’s Plan’, International Journal of Political Economy, 44 (2), 142-156. Cesaratto, S. (2015b), ‘Unlimited Targets? Some pointers’, available at: http://nakedkeynesianism.blogspot.it/2015/10/unlimited-targets-some-pointers.html, 1 October (accessed 8 February 2016). Cesaratto, S. (2013), ‘The implications of TARGET2 in the European balance of payments crisis and beyond’, European Journal of Economics and Economic Policy: Intervention, 10 (3), 359-382.

Synthesis of Automatic Adjustments Fixed Exchange Rate System 17.6 Synthesis of the Automatic Adjustments Assume that the nation is facing unemployment and a balance of payments deficit at equilibrium level of income. Synthesis of Automatic Adjustments Fixed Exchange Rate System Exchange rate can depreciate only within narrow limits allowed, and thus most adjustment must be monetary. Deficit reduces money supply, increases interest rates, reduces investment (?) and income, so imports fall, reducing deficit. La deflazione interna (svalutazione interna) richiede tempo per far riguadagnare competitività, per cui l’aggiustanto esterno è di quantità via politica fiscale. I tagli alla AD domestica accelerano la deflazione. Problema: la deflazione distrugge capacità produttiva, e questa non la si recupera facilmente (istéresi). Esperienza italiana e greca Managed Float If the currency depreciates somewhat, the trade balance improves and production and income rise as well. Pessimismo delle elasticità Salvatore: International Economics, 12th Edition © 2016 John Wiley & Sons, Inc.

17.6 Monetary Adjustments and Synthesis of the Automatic Adjustments Freely Flexible Exchange Rate System: Currency will depreciate until deficit is entirely eliminated. National economy is to large extent insulated from balance of payments disequilibria, and most of adjustments take place through exchange rate variation. Salvatore: International Economics, 12th Edition © 2016 John Wiley & Sons, Inc.

17.6 Synthesis of the Automatic Adjustments Disadvantages of Automatic Price Adjustments Freely Floating Exchange Rates Overshooting and erratic fluctuations in exchange rates interfere with international trade and impose costly adjustment burdens that may be unnecessary in the long run. Managed Float System Beggar-thy-neighbor monetary policies to stimulate domestic economy are disruptive and damaging to international trade. Perché la svalutazione interna non è vista come altrettanto “disruptive”? Salvatore: International Economics, 12th Edition © 2016 John Wiley & Sons, Inc.

17.6 Synthesis of the Automatic Adjustments Disadvantages of Automatic Price Adjustments Fixed Exchange Rate System Possibility of devaluation can lead to destabilizing international capital flows.(?) Con cambi fissi i flussi di capitali destabilizzanti avvengono prima, quando favoriti dai cambi fissi e paesi core prestano ai paesi periferici. Successivamente v’è il fenomeno dei sudden stop (v. sopra e 6 Lezioni cap. 5) Forces nation to rely primarily on monetary adjustments. Nei fatti l’aggiustamento è sopratutto fiscale (dunque non automatico) Aggiustamenti in cambi fissi dolorosissimi e probabilmente fallimentari (v. sopratutto Italia e Grecia)

Synthesis of the Automatic Adjustments Disadvantages of Automatic Income Adjustments Nation facing autonomous increase in imports at the expense of domestic production would have to allow national income to fall in order to reduce trade deficit. Nation facing autonomous increase in exports from full employment position would have to accept domestic inflation to eliminate trade surplus. Keynes riteneva che l’aggiustamento dovesse essere soprattutto sui paesi in surplus. I paesi in disavanzo dovevano essere sostenuti con prestiti dando loro tempo di aggiustare le partite correnti senza deflazioni selvagge. Una svalutazione li poteva aiutare. Salvatore: International Economics, 12th Edition © 2016 John Wiley & Sons, Inc.

Synthesis of the Automatic Adjustments Disadvantages of Automatic Monetary Adjustments Nation must passively allow money supply to change as a result of balance of payments disequilibria, giving up use of monetary policy to achieve domestic full employment without inflation. Questo non è mai accaduto (questi automatisdmi pare non esitessero neppure nel gold standard). Peraltro la quantità di moneta è endogena e dipende dalla AD. La politica monetaria può scoraggiare la AD con un rialzo dei tassi (la politica monetaria agisce sui tassi, non sulla quantità di moneta). Ma sono soprattutto i tagli fiscali a determinare l’aggiustamento. Salvatore: International Economics, 12th Edition © 2016 John Wiley & Sons, Inc.

Case Study 17-1 Income Elasticity of Imports Salvatore: International Economics, 12th Edition © 2016 John Wiley & Sons, Inc.

Case Study 17-2 Private Sector and Current Account Balances Salvatore: International Economics, 12th Edition © 2016 John Wiley & Sons, Inc.

Case Study 17-3 Growth in the United States and the World, and U. S Case Study 17-3 Growth in the United States and the World, and U.S. Current Account Deficits Salvatore: International Economics, 12th Edition © 2016 John Wiley & Sons, Inc.

Case Study 17-4 Growth and Current Account Balance in Developing Economies Salvatore: International Economics, 12th Edition © 2016 John Wiley & Sons, Inc.

Case Study 17-5 Effect of the Asian Financial Crisis of the Late 1990s on OECD Countries Salvatore: International Economics, 12th Edition © 2016 John Wiley & Sons, Inc.

Case Study 17-5 Interdependence in the World Economy Salvatore: International Economics, 12th Edition © 2016 John Wiley & Sons, Inc.

Appendix: Derivation of Foreign Trade Multipliers with Foreign Repercussions Leggere una volta   Salvatore: International Economics, 12th Edition © 2016 John Wiley & Sons, Inc.

Appendix: Derivation of Foreign Trade Multipliers with Foreign Repercussions   Salvatore: International Economics, 12th Edition © 2016 John Wiley & Sons, Inc.

Appendix: The Transfer Problem Again NO Assume that both the paying and receiving countries are operating under a fixed exchange rate system and full employment. The transfer of real resources occurs only if expenditures in the paying and/or receiving country are affected. In the paying nation, expenditures must fall (perhaps through an increase in taxes), and in the receiving nation, expenditures must increase. Salvatore: International Economics, 12th Edition © 2016 John Wiley & Sons, Inc.

Appendix: The Transfer Problem Again This leads to a trade surplus in paying nation and a trade deficit in the paying nation, representing the transfer or real resources. If the sum of the MPM in the paying nation and the receiving nation equal one, the entire transfer takes place through the equal transfer of real resources, and it is complete. If the sum of the MPMs is less than one, the transfer of real resources is less than the transfer of financial resources, and is incomplete. Salvatore: International Economics, 12th Edition © 2016 John Wiley & Sons, Inc.

Appendix: The Transfer Problem Again If the sum of the MPMs is greater than one, the transfer of real resources is greater than the transfer of financial resources, and is over-complete. If the trade balance of the paying nation worsens rather than improves, the adjustment is said to be perverse. In other words, real resources are transferred to the paying country. If adjustment via income changes is incomplete, the terms of trade of the paying country must deteriorate, further reducing real income and imports. (The reverse is true for over-complete transfers.) Salvatore: International Economics, 12th Edition © 2016 John Wiley & Sons, Inc.

Appendix: The Transfer Problem Again If the sum of the MPMs is greater than one, the transfer of real resources is greater than the transfer of financial resources, and is over-complete. If the trade balance of the paying nation worsens rather than improves, the adjustment is said to be perverse. In other words, real resources are transferred to the paying country. If adjustment via income changes is incomplete, the terms of trade of the paying country must deteriorate, further reducing real income and imports. (The reverse is true for over-complete transfers.) Salvatore: International Economics, 12th Edition © 2016 John Wiley & Sons, Inc.

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