Organisation de Coopération et de Développement Économiques Organisation for Economic Co-operation and Development

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1 ECO/WKP(0)5 Unclassifid English - O. English Unclassifid ECO/WKP(0)5 Oganisation d Coopéation t d Dévloppmnt Économiqus Oganisation fo Economic Co-opation and Dvlopmnt 08-Ap-0 English - O. English ECONOMICS DEPARTMENT GLOBAL IMBALANCES, EXCHANGE RATE PEGS AND CAPITAL FLOWS: A CLOSER LOOK ECONOMICS DEPARTMENT WORKING PAPERS No. 856 By Paul van dn Nood All Economics Dpatmnt Woking Paps a availabl though th OECD intnt wbsit at JT Documnt complt disponibl su OLIS dans son fomat d'oigin Complt documnt availabl on OLIS in its oiginal fomat

2 ECO/WKP(0)5 ABSTRACT/RESUMÉ Global imbalancs, xchang at pgs and capital flows: a clos look This pap psnts a stylisd modl in which ith a savings glut o an xchang at pg in mging conomis divs down th lvl of intst ats in advancd conomis and, whn it hits th zo-at bound, poducs a wlfa loss. It shows that stuctual fom in th pusuit of btt social potction and financial makts in th mging conomis ducs this ngativ wlfa spillov. An xtnsion of th modl with th shot-un dynamics of xchang-at and capital movmnts shows that advs asymmtic shocks can lad to a ac to th bottom of intst ats. In that cas th global coodination of montay policis is wlfa nhancing fo both goups of conomis. Howv, th coodinatd quilibium is unstabl, which indicats that stong p-commitmnt aangmnts a quid to maintain coodination. This disadvantag diminishs if stuctual fom is adoptd to duc th volatility in capital flows. JEL classification cods: E5, F3, F59. Ky wods: xchang ats; global imbalancs; capital flows. ********** Ls déséquilibs mondiaux, l aimag ds taux d changs t ls mouvmnts d capitaux : xamn à la loup C documnt pésnt un modèl simplifié dans lqul un suabondanc d l épagn ou un mécanism d aimag ds taux d chang dans ds économis émgnts fait baiss l nivau ds taux d intéêt dans ls économis avancés t aboutit, losqu l on s hut à la limit ds taux nuls, à un pt d bin-êt. Il mont qu ls éfoms stuctulls visant à amélio la potction social t ls machés d capitaux dans ls économis émgnts éduisnt cs tombés négativs su l bin-êt. Un élagissmnt du modèl tnant compt d la dynamiqu d cout tm ds taux d chang t ds mouvmnts d capitaux mont qu ds chocs asymétiqus négatifs puvnt débouch su un sunchè à la baiss ds taux d intéêt. Dans c cas, un coodination mondial ds politiqus monétais amélio l bin-êt ds dux goups d économis. Toutfois, l équilib ésultant d ctt coodination st instabl, c qui indiqu la nécssité d solids ngagmnts péalabls visant à maintni la coodination. C désavantag diminu n cas d adoption d éfoms stuctulls pmttant d édui la volatilité ds mouvmnts d capitaux. Classification JEL : E5, F3, F59. Mots-clés : taux d chang ; déséquilibs mondiaux ; flux ds capitaux. Copyight OECD 0 Application fo pmission to poduc o tanslat all, o pat of, this matial should b mad to: Had of Publications Svic, OECD, u Andé-Pascal, Pais CEDEX 6.

3 ECO/WKP(0)5 TABLE OF CONTENTS Global imbalancs, xchang at pgs and capital flows: a clos look... 5 Intoduction... 5 Th baslin modl... 5 Th suplus county pgs its xchang at... 8 Capital flows and xchang at swings... 9 Conclusion... Rfncs... 3 Figus. Saving glut with flxibl xchang ats Saving glut with fixd xchang ats

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5 ECO/WKP(0)5 Global imbalancs, xchang at pgs and capital flows: a clos look By Paul van dn Nood Intoduction In a cnt IMF policy staff discussion not Blanchad and Milsi-Ftti (0, haft BM) psnt a simpl stylizd modl to undpin som of thi mssags gading th nd to ign in global imbalancs. Spcifically, th modl illustats natly that if pat of th wold conomy is in a liquidity tap, small cunt account supluss in suplus countis might bnfit gowth and wlfa in th st of th wold. This shot pap svs two main puposs. Fist, it aims to plicat BM s findings using a fomal vsion of thi modl (thy us gaphics), so as to dpn th undstanding of its wokings. Scond, it aims to xplo possibl xtnsions so as to captu a numb of cunt policy issus. It will xplo two cass: (i) th cas of th suplus county (i.. China) maintaining an outight xchang at tagt and capital contols; and (ii) th cas of dficit and suplus countis bing xposd to financial stability isk associatd with xcssiv capital flows and majo swings in thi xchang at. Th baslin modl BM consid th following two-county modl. Dmand fo domstic output in th hom county is a function of its al xchang at (ngativly signd) and of th (al) intst at (id.). An analogous condition holds in th foign county, wh instad an appciation in th hom county is associatd with high output. Th modl is log-linaizd to facilitat th analytical solution: () () An astisk dnots th foign county and is an xognous dmand shock tm (which may includ fiscal policy). BM assum pfct capital mobility, so domstic and foign intst ats must b qual (asid fom a isk pmium which is st to zo fo convninc): (3) Both countis minimiz a loss function which is a function of th diffnc btwn output and an output tagt:. Economics Dpatmnt, mail: paul.vandnnood@ocd.og. Th autho is indbtd to Paola Subacchi fo stimulating xchangs on th topic and Pi Calo Padoan fo hlpful commnts on an ali daft. Th autho tains full sponsibility fo all os and omissions. 5

6 ECO/WKP(0)5 min min L L Th fist od conditions ad: (4) (5) ; (6) ; (7) Rspcting quality (3) yilds th following solution fo th xchang at: (8) As dpictd in th lft panl of Figu, BM s conclusion that an incas in saving in th foign county (i.. a ngativ dmand shock * <0) would yild an appciation of th xchang at of th hom county is coct. Th hom county can offst this by a cut in th intst at so that it can still achiv its output tagt (s quation (6)). Th is no wlfa loss. But th is a ngativ impact on th hom county s intst at. Impotantly, this suppots th savings glut xplanation of th intst at conundum (Bnank 005, Bnank t al. 0). Things chang whn th hom county no long disposs of its intst at instumnt bcaus it is at th zo at bound (=0, s th ight panl of Figu ). Th solution fo th xchang at now ads: (9) And output in th hom county quals: (0) This implis that th hom county suffs an output (and wlfa) loss if th foign county xpincs a ngativ dmand shock (i.. an incas in saving). This is in lin with BMs conclusion. As BM implicitly suggst, th only way th hom county can scap this loss is by gnating an offstting positiv dmand shock, i.. an xpansionay fiscal policy. But as BM not, this statgy will un into fiscal sustainability poblms. Altnativly, it can ty to psuad th foign county to duc its saving at by foming its conomy which may b ndd anyway to sustain long-un conomic gowth and to achiv social goals. Fo xampl, th foign county could impov its systms fo isk shaing (social scuity, insuanc makts) so as to mov incntivs fo xcssiv houshold saving. O it could dvlop its judicial systm to btt nfoc popty ights as this would facilitat th us of collatal fo bank cdit (and thus duc its cost). 6

7 ECO/WKP(0)5 Figu. Saving glut with flxibl xchang ats, * * = Ŷ *, * < Ŷ * = Ŷ * = Ŷ 0 = * 0 A = * B 0 = * 0 = 0 A C = Ŷ 0 0 Figu. Saving glut with fixd xchang ats, * * 0, * * = Ŷ = ê * = ê < Ŷ A * = Ŷ * 0 = = * A' * 0 A = Ŷ 0 = = * = 0 A' 0 0 7

8 ECO/WKP(0)5 Th suplus county pgs its xchang at Whil BM s modl is a asonabl way of dscibing th cunt lationship btwn th Unitd Stats and many mging conomis, it dos not hold fo its lationship with China, fo two impotant asons. Fist, th foign county is assumd to pick its xchang at as a function of th stngth of its domstic dmand (saving), but this is out of lin with th Chins policy famwok, which is ath opating an xchang at tagt tout cout. Scond, th assumption of pfct capital mobility may not hold givn that China maintains capital contols. W thfo fomulat th modl as follows. Fist, adding an xchang at tagt fo th foign county modifis th loss function to: min, L (5a) Scond, w dop condition (3) of intst at abitaging. Th fist od conditions now ad: ; (6a) ; ; (7a) This mans that th two countis no long maintain th sam intst at. A yild spad of th foign county against th hom county opns up (s th lft panl of Figu ). It cosponds to th cost of stilizd intvntion in th foign county ( is th intst at and on foign svs and * is th intst at paid on dposits of th banking systm with th cntal bank). If th foign county xpincs an incas in saving ( * <0, s again th lft panl of Figu ), it will cut its intst at, phaps liminat th yild spad (as assumd in Figu ), but th will b no spillov ffcts onto th intst at of th hom county. Impotantly, this finding invalidats th savings glut hypothsis sinc saving in th foign county xts no influnc on th intst at in th hom county! Evn so, th hom county will un a low intst at than in th BM modl, vn in th absnc of a savings glut fom th foign county. This is bcaus th hom county nds to offst its high xchang at by unning a low intst at so as to achiv its output tagt. So it is th pggd xchang at ath than th savings glut that divs th intst at down in th hom county. It is intsting to xamin what happns if w -intoduc th zo-at bound in th hom county (s th ight panl of Figu ). Output in th hom county is now dtmind as: ; (0a) This outcom is indpndnt of th savings popnsity in th foign county. Th xchang at policy of th foign county, but not its savings popnsity, has an advs impact on th hom county s output and wlfa. Conclusion: it is not th Chins savings glut that gnats a wlfa loss in th US, but it is th Chins xchang at policy that dos so! Th implications a cla-cut. Th hom county is likly to xt pssu on th foign county to abandon its xchang at policy and capital contols. But this 8

9 ECO/WKP(0)5 bings us back to squa on: th BM modl again applis and th wlfa loss mains. Thfo, dopping th xchang at pg and opning th capital account in th foign county will only hav th hopd-fo wlfa-nhancing ffct on th hom county if it is combind with stuctual fom of th kind discussd in th pvious sction. Capital flows and xchang at swings Nxt, it may b usful to go back to th baslin vsion of th modl sinc it dos dscib coctly th situation fo th lationship btwn th Unitd Stats and most suplus countis oth than China -- and as w hav sn it would also apply to China onc it has abandond its xchang at pg and capital contols. Howv, th analysis can b nichd by looking not only at th long-un solution, but also at th shot-un dynamics. In th long un th intst at spad is abitagd away, but it dos tak tim fo this to happn. If th foign county s yild gap is positiv, i.. th hom county is unning an asi montay policy than th foign county, this will pompt capital flows fom th hom to th foign county, which divs th foign county s xchang at up. This may giv is to a cuncy wa. This can b vy simply modld by adding an xchang at quation to th baslin modl: (3b) Not that in long-un quilibium Δ = 0 and hnc = *, which givs us back th baslin modl. Th loss functions now ad: min L min L* (4b) (5b) So both countis tad thi output tagt against th objctiv of stability of thi xchang at. Exchang at volatility may pos political costs. Incasd unctainty fo xpots and foign invstos may put pssu on policymaks to adjust policy. In addition, th capital flows that div th xchang at up (o down) thmslvs may incas financial stability isks (bubbl fomation, suddn stops, banking cisis, tc.) in th futu. Hnc, in som sns, th paamt β may b intptd to dpnd on th at of tim pfnc of policymaks. In this modl countis intact with ach oth and play a Nash gam. Th Nash solution can b found by solving th fist od conditions fo a minimum loss, which yilds action functions fo ach county s montay policy: () So, if on county cuts its intst at, th oth will follow suit, tc. in a ac to th bottom. This may poduc a wlfa loss fo both, as dmonstatd blow. Coodination may thus pay off. () 9

10 ECO/WKP(0)5 0 Th coodinatd solution can b found by minimizing th combind loss function:, ~ min L (3) This yilds th following intst at lationships: (4) (5) It is ath cumbsom to comput th analytical solution, so w will vt to a numical solution. Th lasticitis of output with spct to th xchang and intst at a calibatd on th ady-ckon tabls mging fom th OECD s Global Modl (Hvé t al. 00). Accodingly, fo th hom county th paamt is st at 0. and th paamt at 0.5 (this oughly cosponds to th scond ya ffct in th Unitd Stats modl). Fo th shot-un impact of intst ats on th xchang at psntd by th paamt χ a valu of.5 is adoptd in lin with findings by Kans and Mann (006). Th wight of (futu) financial instability isk associatd with capital inflows in th wlfa loss function β is had to dtmin mpiically, but it is plausibl that this must b in th ang 0 <β <, i.. its wight is non-zo, but small than th wight of cunt output. Fo convninc a baslin valu of 0.5 is adoptd. To maintain baslin symmty btwn th two conomis th sam paamt valus a adoptd fo th foign county. Th oth assumd baslin paamt valus a 0;. It is now possibl to comput th payoff matix gauging th wlfa ffcts of fou scnaios: both countis coopat; both countis dfct; th hom county dfcts; and th foign county dfcts. Without asymmtic shocks th payoff matix ads (* is th invs of ): Foign Foign Dfcts Coops Dfcts Coops Hom * * Hom L L* L L* Dfcts Dfcts Coops Coops Foign Foign Dfcts Coops Dfcts Coops Hom * * Hom * * Dfcts Dfcts Coops Coops So th intst at is th sam in both countis (4% in this cas), and th is no wlfa loss in ith scnaio.

11 ECO/WKP(0)5 An intsting cas to xamin is whn th hom county is hit by an advs dmand shock (=-) and thfo ass its montay policy. This will st in motion a capital flow to th foign county and div up its xchang at. Th latt will spond by cutting its intst at to undo som of th xchang at hik. Th hom county will thn again cut its intst at, tc. This ac to th bottom will stop whn a nw quilibium is achd. Th intsting qustion is if th a wlfa gains to b apd fom th coodination of montay policis of th two countis. Th payoff matix blow suggsts that this is indd th cas. Foign Foign Dfcts Coops Dfcts Coops Hom * * Hom L L* L L* Dfcts Dfcts Coops Coops Foign Foign Dfcts Coops Dfcts Coops Hom * * Hom * * Dfcts Dfcts Coops Coops Th sult is that in th Nash solution (both dfct) th hom conomy maintains an undvalud xchang at, as is to b xpctd. Th hom county fails to achiv its output tagt whil th foign county movs byond this tagt. Hnc th foign conomy is likly to ovhat, although w cannot b absolutly su sinc w hav not modlld th supply sid of th conomy (a possibl xtnsion of th modl). Th coodinatd quilibium is an intnational montay systm in which xchang ats float but wh montay policy is coodinatd. It sults in a balancing of th xchang at lativ to th Nash quilibium and a small intst at spad, which is Pato supio to th Nash solution. Howv, in th coodinatd quilibium ach play can ais wlfa by dfcting, so both will dfct lik in th gam of chickn. Hnc, whil th Nash quilibium is stabl, th coodinatd quilibium is not. This indicats that stong p-commitmnt aangmnts a quid to maintain th coodinatd quilibium. Is th any ol fo stuctual policy h? In fact th is. If both countis fom thi conomis so as to mak thm mo silint to xchang at isk and capital flows (in o out), th isk of xchang at ovshoots falls and th associatd wlfa loss will fall as wll (s th payoff matix blow fo th cas χ = 0.75). Howv, th constllation of an unstabl coodinatd and stabl Nash quilibium mains. Only at th limit (χ = 0) th isk ffct vanishs. Foign Foign Dfcts Coops Dfcts Coops Hom * * Hom L L* L L* Dfcts Dfcts Coops Coops Foign Foign Dfcts Coops Dfcts Coops Hom * * Hom * * Dfcts Dfcts Coops Coops

12 ECO/WKP(0)5 Conclusion Th modl by Blanchad and Milsi-Ftti (0) dos a good job in xplaining how a savings glut in China may ith div down th intst at in th Unitd Stats (th intst at conundum) o lad to a wlfa loss in th Unitd Stats whn th latt is in a liquidity tap. Th ason fo th latt situation is that US cannot cut its intst at to offst an incas in its xchang at in spons to wak (impot) dmand in China. A vsion of th modl in which China pgs its xchang at, shows that it is not th savings glut p s, but ath th xchang at pg that divs down US intst ats and, whn it hits th zo-at bound, poducs a wlfa loss. Th policy implications a simila though. In both cass, stuctual fom in China in th pusuit of btt social potction and financial makts has positiv wlfa spillovs on th Unitd Stats. Impotantly, this sult can pobably b gnalisd to all mging suplus and advancd dficit conomis. An xtnsion of th modl with th shot-un dynamics of xchang-at and capital movmnts shows that advs asymmtic shocks can lad to a ac to th bottom of intst ats. In that cas coodination of montay policis is wlfa nhancing. Howv, th coodinatd quilibium is unstabl, which indicats that stong p-commitmnt aangmnts a quid to maintain coodination. This disadvantag diminishs if both countis fom thi conomis so as to mak thm mo silint to xchang at isk and capital flows.

13 ECO/WKP(0)5 Rfncs Bnank, B. (005), Th Global Saving Glut and th U.S. Cunt Account Dficit, Sandidg Lctu, Viginia Association of Economists, Richmond, Viginia, Mach 0, 005. Bnank, B., C. Btaut, L.P. DMaco and S. Kamin (0), Intnational Capital Flows and th Rtuns to Saf Assts in th Unitd Stats, , Boad of Govnos of th Fdal Rsv Systm, Intnational Financ Discussion Paps No. 04. Blanchad, O. and G.-M. Milsi-Ftti (0), (Why) Should Cunt Account Balancs B Rducd? IMF Policy Staff Discussion Not, Mach, 0. Hvé, K., N. Pain, P. Richadson, F. Sédillot and P.-O. Bffy (00), Th OECD s Nw Global Modl, OECD Economics Dpatmnt Woking Paps, No Kans, J. and P. Manns (006), Th Impact of Montay Policy on th Exchang Rat: A Study Using Intaday Data, Intnational Jounal of Cntal Banking, Vol., No. 4. 3

14 ECO/WKP(0)5 WORKING PAPERS Th full sis of Economics Dpatmnt Woking Paps can b consultd at Intst at pass-though duing th global financial cisis: th cas of Swdn (Apil 0) by Nils-Jakob Habo Hansn and Pt Wlz 854 What divs inflation in th majo OECD Economis (Apil 0) by Digo Mocco, Shingo Watanab and Bois Counèd 853 Mitigation potntial of moving fossil ful subsidis: A gnal quilibium assssmnt (Apil 0) by J.M. Buniaux and J. Chatau 85 Enhancing labou utilisation in a socially inclusiv socity in Austalia (Apil 0) by Vassiliki Koutsogogopoulou 85 Mting infastuctu nds in Austalia (Mach 0) by Claud Giono 850 Rstoing fiscal sustainability in Spain (Mach 0) by Pi Bynt, Andés Funts, Robt Gillingham and Robt Hagmann 849. Divs of homownship ats in slctd OECD countis (Mach 0) by Dan Andws and Aida Calda Sánchz 848. How fficint a banks in Hungay? (Fbuay 0) by Magit Molná and Dánil Holló 847. Stngthning th macoconomic policy famwok in South Afica (Fbuay 0) by Tatiana Lysnko and Goff Banad 846. To mov o not to mov: what divs sidntial mobility ats in th OECD? (Fbuay 0) by Aida Calda Sánchz and Dan Andws 845. Rfoming th labou makt in Spain (Fbuay 0) by Anita Wölfl and Juan S. Moa-Sanguintti 844. Macoconomic Impact of Basl III (Fbuay 0) by Patick Slovik and Bois Counèd 843. Th policy and institutional divs of conomic gowth acoss OECD and non-oecd conomis: nw vidnc fom gowth gssions by Romain Bouis, Romain Duval, and Fabic Mutin 84. Limiting Long-Tm Unmploymnt and Non-Paticipation in Swdn (Fbuay 0) by Nils-Jakob Habo Hansn 84. Enhancing th cost-ffctivnss of climat chang mitigation policis in Swdn (Fbuay 0) by Stéphani Jamt 840. Policis towads a sustainabl us of wat in Spain 4

15 ECO/WKP(0)5 (Fbuay 0) by Andés Funts 839. Incasing public scto fficincy in Slovakia (Januay 0) by Flix Hüfn 838. Raising ducation outcoms in Switzland (Januay 0) by Andés Funts 837. Th Pic Rsponsivnss of Housing Supply in OECD Countis (Januay 0) by Aida Calda Sánchz and Åsa Johansson 836. Housing makts and stuctual policis in OECD countis (Januay 0) by Dan Andws, Aida Calda Sánchz and Åsa Johansson 835. Raising potntial gowth aft th cisis: A quantitativ assssmnt of th potntial gains fom vaious stuctual foms in th OECD aa and byond (Januay 0) by Romain Bouis and Romain Duval 834. Th GDP impact of fom: a simpl simulation famwok (Januay 0) by Sbastian Bans, Romain Bouis, Philipp Biad, San Doughty and Mhmt Eis 833. Impoving th flxibility of th Dutch housing makt to nhanc labou mobility (Januay 0) by Jns Høj 83. Making th Dutch pnsion systm lss vulnabl to financial ciss (Januay 0) by Jns Høj 83. Ral hous pics in OECD countis: th ol of dmand shocks and stuctual policy factos (Dcmb 00) by Dan Andws 830. Intnational financial intgation and th xtnal positions of uo aa countis (Dcmb 00) by Philip R. Lan 89. Impoving fiscal pfomanc though fiscal councils (Dcmb 00) by Robt Hagmann 88. Minimising isks fom imbalancs in Euopan banking (Dcmb 00) by Sbastian Bans, Philip Lan and Atu Radziwill 87. Rsolving and avoiding unsustainabl imbalancs (Dcmb 00) by Sbastian Bans 86. Cunt account imbalancs in th uo aa: a compaativ pspctiv (Dcmb 00) by Sbastian Bans, Jmy Lawson and Atu Radziwill 5

Content Skills Assessments Lessons. Pull Ups with progressions. Stick Curl Ups with progressions. Push Ups with progressions

Content Skills Assessments Lessons. Pull Ups with progressions. Stick Curl Ups with progressions. Push Ups with progressions Tach: CORE Physical Education Gad 4 Ya: 2012-13 Cous: Physical Education Gad 4 Month: All Months S p t m b O c t o b P Class Wam Up Activity Essntial Qustions What a th bnfits of bing physically fit? How