essays on money, and the asymmetries of the international monetary system

Essays on Money, and the Asymmetries of the International Monetary System

Univesità degli Studi di Siena

By

Angel García Banchshttp://www.angelgarciabanchs.com/

Univesità degli Studi di Roma “La Sapienza”Dipartimento di Economia Pubblica

Italy, 11th of December 2009

PhD supervisors:Ernesto Screpanti (Univesità di Siena)Luís M. Mollejas (UCV, Caracas)Edward J. Nell (New School University, NY)

PhD committee: Sergio Cesaratto (Univesità di Siena)

Annamaria Simonazzi (Univesità “La Sapienza”)Claudio Sardoni (Univesità “La Sapienza”)

Structure of the Presentation

• Main argument of the thesis• Theoretical framework• Structure of the thesis (Chapters I, II and III)• Chapter I• Chapter II (main chapter)• Chapter III• Final remark

Essays on Money, and the Asymmetries of the International Monetary System - Angel García Banchs 2

Main argument of the thesis

• International monetary system (IMS) is fully asymmetric (few reserve issuing economies, RIEs, and a large group of reserve earning ones, REEs).

• International monetary asymmetries (IMAs) are relevant to monetary theory and policy:

whether or not the central bank issues an international reserve currency affects portfolios, balance sheet structures, the flexibility of monetary and fiscal policies, interest rate targeting rules and the exchange rate regime


Main argument of the thesis

• Whether or not the economy is a reserve issuing (RIE) or a reserve earning economy (REE) really, matters; and, in particular, in the case of REEs the availability of foreign currency assets (international means of payments) is fundamental to the determination of monetary and fiscal policies

• Why?

That, I shall soon explain. But before, I’ll explain my choice of the theoretical framework


Theoretical Framework

• Into what theoretical framework can my argument be incorporated? Neoclassical, New Keynesian, Post Walrasian or Keynesian (Post Keynesian)?

• The Keynesian (Post Keynesian) theory of money: money is not a veil; it affects motives and decisions (preference for liquidity in local currency)

• IMAs affect the motives and behavior of all sectors (preference for liquidity foreign currency)


Theoretical Framework

• Fundamental or generic uncertainty about the future, market outcomes, and credit crises, forces agents to hold local currency-denominated money and liquid assets/liabilities

• While uncertainty about foreign currency flows, the international monetary system, currency crises, and the access to international means of payments (necessary for production and imports to take place) forces institutional sectors to hold liquid assets/liabilities denominated in foreign currency


Structure of the thesis

• Chapter I deals with the theoretical framework and the Post Keynesian explanation for the existence of banks and money, as opposed to the mainstream transaction cost approach

• Published in English in Análisis de Coyuntura, UCV, Venezuela.



• Chapter II develops the core thesis (main argument) and presents compelling evidence of the presence of IMAs

• Published in Spanish in Investigación Económica, UNAM, Mexico, and also in English in the Journal of Post Keynesian Economics, USA



• Chapter III formalizes the argument by modeling the set of policy choices and behavior of REEs recurring to the PK-SFC approach to Macro and simulations, including a fiscal policy response to a global crisis like that of 2009

• Its publication its currently under the consideration of the Journal of Post Keynesian Economics, USA


Chapter I

• Transaction costs and specific risks are important, and banks are the best-suited institutions to deal with the informational asymmetries not taken care of by the market mechanism. But that task is not specific to banks, as can be undertaken as well by individual lenders/investors, brokers, rating agencies, auditors, and so on

• Thus, PKs argue the task specific to banks (i.e. the task that only banks are able to undertake) is: money creation.


Chapter I

• The PK view and the Circuit approach are capable of explaining the core of banking and the systemic (endogenous) need for money by reversing the causal link implied by the QTM, the saving-investment cycle and the base-multiplier

• But above all because they treat banks as the institutions capable of making the generic credit risk saleable, rather than as pure financial intermediaries


Chapter I

• Banks transform risky, illiquid, non-marketable assets based on personal credit into safe, liquid and marketable bank deposits which are socially perceived as money (BM and QM reserves, DEP INS, interbank network, LOLR, invest capital)

• Banks accommodate the liquidity demand required to deal with uncertainty and for production to take place

• In the PK framework banks and money affect motives and preferences (portfolio choices and economic behavior): it is always non-neutral.


Chapter II

• IMS is fully asymmetric (few RIEs, and many REEs).

• IMAs are relevant to monetary theory and policy:

Foreign currency liquidity preference and whether or not the central bank issues an international reserve currency affects portfolios, balance sheet structures, the flexibility of monetary and fiscal policies, interest rate targeting and the exchange rate regime


Chapter II

• Both RIEs and REEs must be concerned with the FX rate, foreign capital flows and net payments to ROW. But only REEs must accumulate foreign currency assets because their local currencies do not circulate abroad.

• Two effects: the quantity effect and the price effect


Chapter II

• The quantity effect implies a strong policy-induced link between r and GIR: the fact that REE central banks must target a min stock of GIR affect interest rate targeting

• The price effect derives from the fact that in REEs two forms of monetary reserves coexist: lc reserves and fc reserves; the price of the former is r and that of the latter x; it implies that in REEs the link between r and x weakens as fc reserves increase. The greater such a stock is the greater the capacity of the central bank to limit the impact of Δr upon x.


Chapter II

• As long as foreign currency reserves are allowed to vary sufficiently, the impact upon the exchange rate can be limited:

Δr >0 (<0) → fc inflows(outflows)= ΔGIR <0 (>0) → Δx ≈ 0.

• This, along with the bias against currency appreciations, explains why central banks are often willing to accumulate large stocks of GIR, provide they are able to limit sterilization costs (Bres, GD vs. DS).


Chapter II


Reserve Earning Economies (REE) and 1°, 2°, and 3° Reserve Issuing Economies (RIE)

Is trade with RIE-1°

large?

REE

(all other)

RIE-1°

(US)

Where is it accepted?

RIE-2°

(EU)

RIE-3°

(UK, Jap)

No

Yes

Is the local

currency accepted abroad?

Everywhere

Yes

Regionally

No

Chapter II

• Notice that although RIEs need take into account the impact of interest rate changes upon capital flows, they need not accumulate fc reserves

• This implies peso/dollar (and peso/euro) rates are largely determined by the accumulation of fc reserves on the part of REEs

• But, on the contrary, the exchange rate between reserve currencies (e.g. the dollar/euro rate) is mostly determined by private holdings (market or endogenously determined)


Chapter II


International monetary asymmetries and the link between the foreign exchange rate and the short-term interest rate

Reserve IssuingEconomies

Local CurrencyReserves

Reserve EarningEconomies

Foreign CurrencyReserves

Local CurrencyReserves

Interest Rate

FX Rate

Interest Rate

Chapter II


Central Banks’ balance sheet

A S S E T S

Gross Intl Reserves (GIR)Gold and Gold CertificatesForeign Currency AssetsOther International Reserve AssetsDomestic Credit (DC=CG+CFS)Credit to Gov (CG)Credit to Financial Sys (CFS)IMFSubtotal Other AssetsOther Assets in Foreign Currency not GIR

Other AssetsTOTAL ASSETS (ASS)

L I A B I L I T I E S

International Reserve Liabilities (IRL)IMFBase Money (BM =CASH+BRES)Notes and Coins in Circulation (CASH)Deposits from Banking Institutions (BRES)Debt Securities (DS)Deposits Public Adm (GD)Other LiabilitiesTOTAL LIABILITIES (LIA)

C A P I T A L Capital (K)

Chapter II


Reserve Issuing Central Banks: Main components

A S S E T S






Chapter II


Reserve Earning Central Banks: Main components

A S S E T S






Chapter II

• To distinguish whether or not a central bank is attempting to stabilize the currency one should look at BS rather than at the FX rate itself

• In general, the larger GIR/Total Assets ratio and the (BRES+GD+DS)/Total Liabilities ratio, the greater the effort to stabilize the FX rate and endogenously sterilize (peg interest rates). That is, the smaller DC and Cash, the greater the effort

• Cash substitutes and high reserve requirement rates are required in REEs for sterilization purposes


Chapter II

• Monetary policy is, thus, more elastic in RIEs than in REEs, as the latter, apart from targeting short-term rates so as to influence indirectly foreign currency flows, must intervene directly so as to accumulate fc reserves (asset side) and, hence, must endogenously compensate those interventions replacing Cash with BREs, GD and DS


Chapter II


Chapter II


*In SAU 44% of total liabilities correspond to other liabilities; thus, one would expect cash substitutes to be underestimated.

Chapter II


A L L C O U N T R I E S Graph II-11: The Average Ratio of "Liquidity Requirements" (BRES/DC) during

the whole period from January 2003 to December 2006

0%

100%

200%

300%

400%

500%

600%

700%

800%

900%

1000%

USA JAP BRA EU ARG UK NOR CHI MEX VEN PERU KUW IND SAU UAE

Countries

Liquidity RequirementsIn these cases all ratios are above 1000%

Ratio of liquidity requirements

Chapter III

• Chapter III formalizes the argument within the context of a REE

• PK tradition: relevance of buffer stocks and stock-flow norms affecting the real and financial spheres

• The relative availability of foreign currency reserves ˗ e.g. GIR/(M+Rrow) ˗ determines fiscal and monetary policies, the growth rate of government expenditures, the issue of lc and fc debt, interest rate targeting, exchange rate intervention and sterilization, switching mechanisms


Chapter III

• The initial process of foreign currency accumulation requires a sacrifice in terms of higher than desired r, a reduction in grg and, perhaps, the issue of FCD

• But once a min stock for the whole economy is built, r can be set a the desired level rBG =rBG

T and grg=grg* ,

while ΔFCD≤0

• REEs that keep accumulating reserves after the minimum has been reached become net lenders to the ROW under conditions of sustained fiscal and current account surplus (sterilization costs need not increase if BRES increase)


Chapter III


Growth rate of Government Expenditures as a function of the stock of foreign currency reserves

Foreign currency debt as a function of the stock of foreign currency reserves

Interest rate setting as a function of the stock of foreign currency reserves

Chapter III


Chapter III


• Experiments:1) An increase in the target real wage rate (An autonomous i

ncrease in wage inflation)2) A 1-period increase in the growth rate of government exp

enditures3) A permanent increase in the growth rate of government e

xpenditures4) A permanent decrease in the income tax rate5) A permanent decrease in the corporate tax rate6) A permanent decrease in the bank tax rate7) A 1-period increase in the rate of interest on T-Bills

http://www.angelgarciabanchs.com/phd-exp1.htm










Chapter III


8) A 5-period permanent increase interest rate of on T-Bills9) A 1-period switch to a market-determined exchange rate10)

A permanent increase in the propensity to consume out of income

11) A permanent increase in the propensity to consume out of wealth

12) A decrease in the ROW's rate of price inflation13)

A permanent decrease in the ROW's propensity to import out of income

14) A permanent increase in the ROW's imports demand-real exchange rate elasticity












Chapter III


15) A permanent increase in the real exchange rate elasticity of the demand for imports

16) A permanent decrease in the propensity to import out of income

17) A permanent increase in foreign currency liquidity preference due to an equivalent decrease in the preference for local currency bonds

18) A permanent increase in liquidity preference due to an equivalent decrease in the preference for equities

19) A decrease in the rate of bank reserve requirements



Chapter III


20) A global economic crisis without domestic fiscal stimulus

gry-row=[2009-2013]=[-2.0%, 1.5%, 1.5%, 2.0%, 2.5%] grg=[2009-2013]=[3.0%, 3.0%, 3.0%, 3.0%, 3.0% ] 21) A global economic crisis with domestic fiscal stimulus gry-row=[2009-2013]=[-2.0%, 1.5%, 1.5%, 2.0%, 2.5%] grg=[2009-2013]=[17.5%, 4.0%, 3.0%, 3.0%, 3.0% ]

MODEL REEs (Baseline).lnk

Chapter III


-4

-3

-2

-1

0

1

2

3

4

1960 1970 1980 1990 2000 2010 2020 2030 2040 2050

Real consumptionReal investmentReal government expenditure

Real exportsReal importsReal GDP

Graph III.4.35: Contribution to real GDP growth of aglobal economic crisis w/o domestic fiscal stimulus (orthodox)

%

-4

-3

-2

-1

0

1

2

3

4

1960 1970 1980 1990 2000 2010 2020 2030 2040 2050

Real consumptionReal investmentReal government expenditure

Real exportsReal importsReal GDP

Graph III.4.36: Contribution to real GDP growth of a global economic crisis with domestic fiscal stimulus (Keynesian)

%

Chapter III


96

97

98

99

100

101

102

1960 1970 1980 1990 2000 2010 2020 2030 2040 2050

Inflationary pressure thresholdEmployment rateDeflationary pressure threshold

Graph III.4.38: Evolution of employment rate, following aglobal economic crisis with domestic fiscal stimulus (Keynesian)

%

96

97

98

99

100

101

102

1960 1970 1980 1990 2000 2010 2020 2030 2040 2050

Inflationary pressure thresholdEmployment rateDeflationary pressure threshold

Graph III.4.37: Evolution of employment rate, following aglobal economic crisis w/o domestic fiscal stimulus (orthodox)

%

Chapter III


-8

-7

-6

-5

-4

-3

-2

-1

0

1

1960 1970 1980 1990 2000 2010 2020 2030 2040 2050

Effect upon nominal wagesEffect upon real wagesEffect upon prices

Graph III.4.40: Effect upon real wage rate, following aglobal economic crisis with domestic fiscal stimulus (Keynesian)

%

-8

-7

-6

-5

-4

-3

-2

-1

0

1

1960 1970 1980 1990 2000 2010 2020 2030 2040 2050

Effect upon nominal wagesEffect upon real wagesEffect upon prices

Graph III.4.39: Effect upon real wage rate, following aglobal economic crisis w/o domestic fiscal stimulus (orthodox)

%

Chapter III


-35

-30

-25

-20

-15

-10

-5

0

1960 1970 1980 1990 2000 2010 2020 2030 2040 2050

Effect upon net international reserve ratio

Graph III.4.42: Change in net international reserves ratio, following aglobal economic crisis with domestic fiscal stimulus (Keynesian)

Months

-35

-30

-25

-20

-15

-10

-5

0

1960 1970 1980 1990 2000 2010 2020 2030 2040 2050

Effect upon net international reserve ratio

Graph III.4.41: Change in net international reserves ratio, following aglobal economic crisis w/o domestic fiscal stimulus (orthodox)

Months

Chapter III


-6

-4

-2

0

2

4

6

1960 1970 1980 1990 2000 2010 2020 2030 2040 2050

PSBR (Government surplus) Current Account

Graph III.4.43: Evolution govt. and current account to GDP ratios,after a global economic crisis w/o domestic fiscal stimulus (orthodox )

%

-6

-4

-2

0

2

4

6

1960 1970 1980 1990 2000 2010 2020 2030 2040 2050

PSBR (Government surplus) Current Account

Graph III.4.44: Evolution of govt. and current account to GDP ratios,after a global economic crisis with domestic fiscal stimulus (Keynesian)

%

Chapter III


-80

-70

-60

-50

-40

-30

-20

-10

0

10

1960 1970 1980 1990 2000 2010 2020 2030 2040 2050

Total Government debtCentral Bank billsGovernment deposits at Central Bank

Graph III.4.45: Evolution of govt. debt, cb bills, and govt. dep. at CB,following a global economic crisis w/o domestic fiscal stimulus (orthodox)

%

-80

-70

-60

-50

-40

-30

-20

-10

0

10

1960 1970 1980 1990 2000 2010 2020 2030 2040 2050

Total Government debtCentral Bank billsGovernment deposits at Central Bank

Graph III.4.46: Evolution of govt. debt, cb bills, and govt. dep at CB,following a global economic crisis with domestic fiscal stimulus (Keynesian)

%

Final remark

• IMS is fully asymmetric:

whether or not the central bank issues an international reserve currency and the availability of foreign currency reserves in REEs affect portfolios, balance sheet structures, the flexibility of monetary and fiscal policies, interest rate targeting rules, the issue of lc and fc, the FX regime and sterilization policies

• Not only liquidity preference in local currency, but also foreign currency liquidity preference and the IMS are responsible for global unemployment


Appendix

Ensayos sobre el dinero, y las Asimetrías del Sistema Monetario Internacional - Angel García Banchs 45

Thesis in PDF

Equations of the model

essays on money, and the asymmetries of the international monetary system

Documents

monetary theory

international reserve

flexibility of monetary

determination of monetary

sienaby angel garca

currency crises

foreign currency flows

new keynesian