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International Money and Finance
Session 1: Basic concepts............................................................................2
Video: Game of Theories: The Keynesians...............................................2
Video: How the Fed Worked: Before the Great Recession........................4
Video: How the Fed Works: After the Great Recession.............................5
Slides........................................................................................................8
Notes......................................................................................................15
Session 2: Determinants of exchange rates..............................................19
Video: Zimbabwe and Hyperinflation: Who Want to Be a Trillionaire?. . .19
Video: Purchasing Power Parity: When in India, Get a Haircut...............20
Video: Uncovered Interest Parity and the Carry Trade...........................21
Slides......................................................................................................22
Notes......................................................................................................28
Session 3: Exchange rate management and currency risk........................30
Slides......................................................................................................30
Notes......................................................................................................37
Session 4: The Euro, from inception to crisis and beyond.........................40
Paper on European sovereign debt crisis...............................................40
Video: Optimum Currency Areas............................................................47
Video: Optimum currency areas and the Euro........................................51
Video: Why are high bond yields a problem?.........................................52
Slides......................................................................................................53
Notes......................................................................................................64
Session 5: Banking crises, financial integration & cryptocurrencies.........67
Paper on bitcoin......................................................................................67
Video: The Great Recession....................................................................73
Slides......................................................................................................76
Notes......................................................................................................84
Session 6...................................................................................................85
Slides......................................................................................................85
Session 7: Wrap up....................................................................................89
Slides......................................................................................................89
Summary Fundamentals of Multinational Finance (6e edition).................91
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CH1: Multinational Financial Management: Opportunities and Challenges
...............................................................................................................91
CH2: The International Monetary System.............................................100
Key subjects............................................................................................106
Session 1: Basic concepts
Video: Game of Theories: The Keynesians
Business cycle theory: Keynesian.
The causes of business cycles, involves four major thoughts: the Keynesians, the
monetarists, the real business cycle theorists and the Austrians. They disagree on the
causes of business cycles and on the proper remedies.
Keynesian: How much flow of expenditure or aggregate demand there is to sustain
labour hires in a given period. This keeps people at work. Nominal wages are sticky. In
typical market; If demand falls, then the price falls, the marked clears. If that were true in
the labour market, a drop in aggregate demand would mean when each cuts, not people
losing jobs. But wages are not like many other prices, they do not always adjust so
quickly, hence we say they are sticky. Because there may be a long term contract, there
may be a law such as the minimum weight law, or sometimes it is just worker moral. If
the flow of aggregate demand expenditure into economy slows down, because wages
cannot be cut, well then workers have to be laid off. And that will lower the flow of
aggregate demand expenditure all the more because there is lower employment, lower
production, less being consumed, less being invested. The key example here, it really is
the great depression in 1930's.
Starting in 1929, a lot of American banks failed, depositors lost their money, this was the
four governmental guarantees, the money supply fell down by a third, and the stock
market crashed. So, there was less consumer spending and less investment. This led to a
great depression and high levels of unemployment. More recently, the great recession of
2008 also had a significant Keynesian element.
Key idea in Keynesian economics: Aggregate demand: Net exports, Government
spending, Investment, Consumption. This idea of aggregate demand is really different
from the real business cycle theorists, where the key problem is aggregate supply.
Keynesians tends to favour activist monetary and physical policy.
In typical Keynesians scenarios, if consumption and investment are falling, usually
government spending is gonna end up falling as well. Because there is less revenue
being produced in the economy, and less tax revenue and the less governments really
borrow a lot. That is gonna hurt governments ability to spend, that will be an additional
negative shock to aggregate demand.
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(aggregate demand curve is shifted to the left)
Output goes down in this model. Also, in this setting there may be some second order
effects; the aggregate supply curve may end up shifting back to the left as well. For
instance, some layed off workers, they end up demoralized, or they lose their work place
contacts. In the longer run, these people probably gonna be less productive.
What are the potential remedies here?
Keynesians tend to favour activist monetary and fiscal policy. Central banks should
expend their money supply to help maintain that flow of nominal expenditure, they
should lower interest rates and have easy conditions for credits. Keynesians also tend to
favour a lot of government defecits spending; governments should spend more, start
new public works programs, try to put people to work and fund those programs by
borrowing money even if the revenue isn't there from the economy right now. The
government is doing anything to restore that flow of aggregate demand.
Problems in Keynesians theory:
1. Keynesians economics does not always why aggregate demand fell in the first
place. In this sense, Keynesians economics may rely on some other mechanisms.
Sometimes what Keynesians call aggregate demand problems, they will be
aggregate demand problems on the surface, but beneath that there is some
deeper maybe some hidden sectoral problems in the economy or slow growth or
productivity is the actual problem, so there is some deeper melody, a week
aggregate demand is some kind of symphton. So just checking that aggregate
demand, even if it is just a good short run protection, it may not always be the
best way of solving your problems.
2. Many economists believe that actually monetary policy usually is a meth to
stabalise the flow of a nominal expenditure. If that is the case, Keynesianism
effect will evolve into monetarism. Keynesians also tend to have a lot of faith in
governments ability to time and target fiscal policy. But will government spend
that money quickly enough? Will government actually succeed in hiring the
unemployed workers.
3. Keynesians economics predicts that you either have high unemployment or high
inflation, but not both at the same time. Stagflation (high inflation & high
unemployment). There is also the public choice critic of Keynesian economics. The
Keynesian recipe is to run high deficits in recessions, but in good times have a
balanced budget or even a surplus. But a lot of governments don't do that. They
like having the deficits all the time. So it could be, there is a symmetry build into
the Keynesian system where over time you get to many deficits and perhaps
eventually a fiscal crisis.
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Video: How the Fed Worked: Before the Great Recession
The Federal Reserve is one of the most powerful players in the economy, because it
control the supply of money. And through that control, it influences aggregate demand
int he economy.
Sometimes the Fed wants to increase aggregate demand, and at other times, decrease
aggregate demand. But how does it do this? The Fed uses the money supply and interest
rates to affect the amount of loans and credit. Let's briefly recap how the Fed did this in
the old days, before 2008. The Fed typically conducted monetary policy by targeting the
federal funds rate with open market operations. What's the federal funds rate? This is the
overnight lending rate from one major bank to another. Banks do loan money to each
other. Recall that banks make money by taking in deposits and using those deposits to
make loans. Banks cannot lend out all of their deposits, because they need some funds
on hand to settle transactions with other banks, to give to customers, and also to satisfy
the Federal Reserve which requires, by law, that banks hold a certain percentage of their
deposits as reserves. Prior to 2008, the banks didn't have much incentive to keep excess
reserves – that is, reserves above and beyond what was required by law – so the banks
tried to keep reserve holdings relatively low. Sometimes banks found themselves with
too few reserves to meet the requirements of their customers or of the Fed, so they
borrowed reserves from other banks. Borrowing and lending of reserves in the federal
funds market that established an interest rate, the federal funds rate.
The second concept, open market operations (expansionary OMO, Contractionary OMO).
The Fed affects the federal funds rate by performing open market operations, and those
we define as the Fed using its reserves to buy and sell government securities, typically
Treasury bills. And the Fed is making those trades with banks. So if the Fed wanted to
lower interest rates, it would buy T-bills from banks, thus increasing the supply of bank
reserves. We call that an expansionary open market operation.
The new reserves would allow banks to make more loans, thus stimulating the economy,
making it easier to start or expand new businesses or easier to get a mortgage. This
increase in reserves, it also would lower the opportunity cost of banks loaning those
reserves out to other banks, and that, in turn, would lower the federal funds rate.
Thus, prior to 2008, the Federal Reserve used open market operations to change the
supply of reserves until the federal funds rate was more or less at the level the Fed
wanted.
This figure shows excess reserves prior to October, 2008. U.S. Excess reserves at
depository institutions:
