Macroeconomics - lecture 4
Economic crises
- = A sudden drop in economic activity, often accompanied by similar downturns in financial
and monetary variables (such as exchange rate)
- Crises defined in two pieces :
Different types of crisis
o Quantitative thresholds – just by measuring //thresholds
Inflation crisis
Currency crashed & currency debasements
Bursting of asset price bubbles
o Crisis defined by events
Banking crises
External debt crises
Domestic debt crises
Country can’t pay for pensions anymore for example
Why study crises?
- The last 15 years: global financial crisis, Eurozone crisis & pandemic crisis
Facing a crisis again – with economic consequences (pandemic)
- High social cost of crises (losing your job, a lot of businesses who can’t keep up anymore)
- The this time is different syndrome
Belief that this a novel feature of the modern society
- Lessons for policy and prevention that can be studied from past crises
Currency crises – defi niti on
- Qualitative (theoretical)
An episode in which the exchange rate depreciates substantially during a short
period of time. Usually currency crises hit currencies that are pegged or heavily
managed
- Quantitive (empirical)
Narrow: a depreciation at least 15% within a month
Exchange rate Pressure index: a weighted average of the monthly change in nominal
exchange rate and the change in foreign reserves
o Is the CB actually preventing depreciation?
Share of countries with annual depreciation rates >15% - can differ (10%, 25%, 35%), frequency quite
high from 1900
Why should we care?
- Source of distortion and instability
Exchange rate: exporters are affected – import is also more expensive (a lot of
import nowadays) effect prices in economy in general
- Currency crises often associated with
Recessions/Capital outflows, sudden stops/Sovereign debt crises/ Banking, financial
crises
o Sudden stops (capital outflow): big change in investment and local demand =
consequence: large unemployment
,Crises in Lati n America
- Motivation for creating this literature
- Events have a lot in common – we look at Mexico but the others have a similar story
Storyline
- 1960’s & early 1970s: Latin America countries
Growing fast
Massive inflow of foreign funds
o Massive inflows of foreign funds – let to large increases of debt levels =
increasing debt repayments (interests): easy way of paying back is to print
money = large devaluations ( defaults)
Pegged currency
o As an international investor, exchange rates matter a lot because
fluctuations have an impact on your profit pegged is ok
- Large devaluations
- Finally defaults sometimes
Within 5/6 years currency fell in a value of 8 times
Running large fiscal deficits – exploding to levels about 20 percent in ’80
First generati on model – consider Mexico
- Domestic money market equilibrium
If you’re holding money – you aren’t earning interest. The higher interest rate – the
more willing you are to invest in assets = the less you want to hold in your pocket
(see global economics)
o L(it) = the money demand
- Purchasing Power Parity: goods are priced at the same level internationally
There are frictions in international trade (buy a hoodie in Leuven, doesn’t have to be
the same price in New York) – so doesn’t hold in real life but it is still believed to
be a good approximation of how prices develop in the Long term
We say that P* = 1 threat them as constant, normalize them & exchange rate peg
so Pt = E(bar)
, - Uncovered interest parity
The returns on assets internationally have to be the same in expectation
Return on investing domestically – left hand side is internationally
With an exchange rate peg – the expected exchange rate next year will be the same
as today:
TAKE IT ALL TOGETHER
- If you want to keep an fixed exchange rate, you can’t do anything with money supply – so if
the country want to run a fixed exchange rate, the CB is losing its power
- Government budget constraint
Reorganise budget constraint
, o Part three: Correcting by interest payments – secondary budget deficit
o Part two: In a fixed exchange rate economy – the CB can’t print money to get
revenue because money supply needs to be constant over time
Money supply constant: no seignorage revenue (= print more
money to pay for debt)
o Part one: development of government foreign assets
If government is running large deficits – international debtors
Crisis: continuous deficits run the government into Btg <0 // Imagine there is a limit to how much
the government can borrow (B-)// government will have to choose between austerity and violating
the peg (to get seignorage revenue) // investors predict the moment and attack the currency
Main lessons: currency crises are triggered by unstainable fiscal policy – if you think an exchange peg
is good for economy (good for trade), you need to have more balanced government budget – this is
not enough.
ERM crisis – background
- 19779: 8 countries (BE,FR, DE..) establish the European exchange rate mechanism
Before there was a Eurozone
- 1990: UK joins
- Early 1990s: Germany sets high interest rates (inflation pressures from reunification) – till
then it had been doing quite well
Exchange rate peg with respect to a basket – if one country increases interest = bad
for other countries = capital outflows
- Spring 1992: Denmark rejects Maastricht treaty is referendum, France announces
referendum
Fear treaty will not go through
- 5-6 September 1992: Euro meeting in Bath
Economic crises
- = A sudden drop in economic activity, often accompanied by similar downturns in financial
and monetary variables (such as exchange rate)
- Crises defined in two pieces :
Different types of crisis
o Quantitative thresholds – just by measuring //thresholds
Inflation crisis
Currency crashed & currency debasements
Bursting of asset price bubbles
o Crisis defined by events
Banking crises
External debt crises
Domestic debt crises
Country can’t pay for pensions anymore for example
Why study crises?
- The last 15 years: global financial crisis, Eurozone crisis & pandemic crisis
Facing a crisis again – with economic consequences (pandemic)
- High social cost of crises (losing your job, a lot of businesses who can’t keep up anymore)
- The this time is different syndrome
Belief that this a novel feature of the modern society
- Lessons for policy and prevention that can be studied from past crises
Currency crises – defi niti on
- Qualitative (theoretical)
An episode in which the exchange rate depreciates substantially during a short
period of time. Usually currency crises hit currencies that are pegged or heavily
managed
- Quantitive (empirical)
Narrow: a depreciation at least 15% within a month
Exchange rate Pressure index: a weighted average of the monthly change in nominal
exchange rate and the change in foreign reserves
o Is the CB actually preventing depreciation?
Share of countries with annual depreciation rates >15% - can differ (10%, 25%, 35%), frequency quite
high from 1900
Why should we care?
- Source of distortion and instability
Exchange rate: exporters are affected – import is also more expensive (a lot of
import nowadays) effect prices in economy in general
- Currency crises often associated with
Recessions/Capital outflows, sudden stops/Sovereign debt crises/ Banking, financial
crises
o Sudden stops (capital outflow): big change in investment and local demand =
consequence: large unemployment
,Crises in Lati n America
- Motivation for creating this literature
- Events have a lot in common – we look at Mexico but the others have a similar story
Storyline
- 1960’s & early 1970s: Latin America countries
Growing fast
Massive inflow of foreign funds
o Massive inflows of foreign funds – let to large increases of debt levels =
increasing debt repayments (interests): easy way of paying back is to print
money = large devaluations ( defaults)
Pegged currency
o As an international investor, exchange rates matter a lot because
fluctuations have an impact on your profit pegged is ok
- Large devaluations
- Finally defaults sometimes
Within 5/6 years currency fell in a value of 8 times
Running large fiscal deficits – exploding to levels about 20 percent in ’80
First generati on model – consider Mexico
- Domestic money market equilibrium
If you’re holding money – you aren’t earning interest. The higher interest rate – the
more willing you are to invest in assets = the less you want to hold in your pocket
(see global economics)
o L(it) = the money demand
- Purchasing Power Parity: goods are priced at the same level internationally
There are frictions in international trade (buy a hoodie in Leuven, doesn’t have to be
the same price in New York) – so doesn’t hold in real life but it is still believed to
be a good approximation of how prices develop in the Long term
We say that P* = 1 threat them as constant, normalize them & exchange rate peg
so Pt = E(bar)
, - Uncovered interest parity
The returns on assets internationally have to be the same in expectation
Return on investing domestically – left hand side is internationally
With an exchange rate peg – the expected exchange rate next year will be the same
as today:
TAKE IT ALL TOGETHER
- If you want to keep an fixed exchange rate, you can’t do anything with money supply – so if
the country want to run a fixed exchange rate, the CB is losing its power
- Government budget constraint
Reorganise budget constraint
, o Part three: Correcting by interest payments – secondary budget deficit
o Part two: In a fixed exchange rate economy – the CB can’t print money to get
revenue because money supply needs to be constant over time
Money supply constant: no seignorage revenue (= print more
money to pay for debt)
o Part one: development of government foreign assets
If government is running large deficits – international debtors
Crisis: continuous deficits run the government into Btg <0 // Imagine there is a limit to how much
the government can borrow (B-)// government will have to choose between austerity and violating
the peg (to get seignorage revenue) // investors predict the moment and attack the currency
Main lessons: currency crises are triggered by unstainable fiscal policy – if you think an exchange peg
is good for economy (good for trade), you need to have more balanced government budget – this is
not enough.
ERM crisis – background
- 19779: 8 countries (BE,FR, DE..) establish the European exchange rate mechanism
Before there was a Eurozone
- 1990: UK joins
- Early 1990s: Germany sets high interest rates (inflation pressures from reunification) – till
then it had been doing quite well
Exchange rate peg with respect to a basket – if one country increases interest = bad
for other countries = capital outflows
- Spring 1992: Denmark rejects Maastricht treaty is referendum, France announces
referendum
Fear treaty will not go through
- 5-6 September 1992: Euro meeting in Bath
