Professional Documents
Culture Documents
SUPPLEMENT
6-1
139
ADDITIONAL
CASE
STUDY
6-2
Figure 1 The Saving Investment Correlation 0.37 0.36 0.35 0.34 0.33 0.32 0.31 0.3 0.29 0.28 0.27 0.26 0.25 0.24 0.23 0.22 0.21 0.2 0.19 0.18 0.18 0.2 0.22 0.24 0.26 0.28 Saving/GDP 0.3 0.32 0.34 0.36 0.38
1 2
M. Feldstein and C. Horioka, Domestic Saving and International Capital Flows, Economic Journal 90 (June 1980): 31429. The countries are those of the OECD except Iceland, Portugal, Turkey, and Yugoslavia. The data cover the period 19601974. Figure 1 is constructed from the data in Feldstein and Horioka, ibid., Table 1.
140
Investment/GDP
Source: M M. Feldstein C. H Horioka, Domestic Capital Flows, Economic Journal (June 1980): 319. S F ld i and dC i k D i Saving S i and d International I i lC i l Fl E E ii J J ll 90 319 (1980)
Chapter Supplements
141
Feldstein and Horiokas work has been updated and modified by many authors over the years. Although the correlation between saving and investment rates varies with particulars such as which countries are included and which time periods are considered, the basic finding remains the same: Countries that have high saving rates are also countries with high investment rates and countries with low saving rates are also countries with low investment rates. Should we conclude that capital is actually immobile? Not necessarily. Other evidence shows that interest rates on comparable assets are quite similar even though the assets are located in different industrial countries.3 And casual observation finds that financial markets seem to have become more global over time. Furthermore, since saving and investment are both endogenous variables, common influences on saving and investment could yield a positive correlation even if capital is completely mobile across national boundaries. Concern about common influences is the main reason why Feldstein and Horioka averaged saving and investment rates across long periods of time and studied the crosscountry relationship. This technique allowed them to separate the effect from short-run business cycle fluctuations that may induce a correlation between saving and investment within a country from year to year. But even over long periods of time, saving and investment continue to be endogenously determined, and common influences may still be important. One way that a correlation might occur is in response to sustained shifts in a countrys productivity or demographics that lead to an increase in its long-run investment rate and its long-run saving rate.4 For instance, a technological advance in one country may increase investment at the world interest rate and, because it also increases income, may lead to an increase in saving. Another possible reason for the correlation is that government policies may be oriented to running zero average trade deficits because certain constituencies favor balanced trade. Thus, saving and investment may be forced into equality over time through this policy of an average trade deficit equal to zero. Finally, as Supplement 5-3 emphasizes, long-run budget constraints apply equally to countries, just as they do to governments or households. Accordingly, a country cannot borrow (or lend) forevereventually the foreign debt will have to be repaid. This means that over long periods of time, a country will tend to have balanced trade and saving will tend to equal investment.
For details, see the survey by M. Obstfeld, International Capital Mobility in the 1990s, in P. B. Kenen, ed., Understanding Interdependence: The Macroeconomics of the Open Economy, Princeton: Princeton University Press, 1995. For details, see M. Obstfeld and K. Rogoff, Foundations of International Macroeconomics, Cambridge: MIT Press, 1996, 16164. See also L. Tesar, Savings, Investment and International Capital Flows, Journal of International Economics, 31 (1991), 5578.
LECTURE
SUPPLEMENT
6-3
It may be possible for a country to have persistent small trade deficits, provided the foreign debtGDP ratio is not increasing over time.
142
ADDITIONAL
CASE
STUDY
6-4
144
CHAPTER 6
in government saving reflects an enormous swing in the federal budget from a deficit of $290 billion in fiscal year 1992 to a surplus of $69 billion last year. By contrast, during the early 1980s a decline in private saving was accompanied by an exploding federal budget deficit and a substantial drop in national saving. A common refrain of those days highlighted the evils of twin deficits, whereby foreign borrowing was seen as financing fiscal profligacy. But because todays widening deficit has supported a surge in investment financed by foreign borrowing, this solo deficit will pay off over time in productivity gains and a rising standard of living. Besides financing investments for the future, the trade deficit also provides economic benefits today. First, the deficit helps keep the economy from overheating as strong growth in business and consumer spending is met with imports. This safety valve has allowed the economic expansion to continue into its ninth year without hitting the capacity limits and bottlenecks so often seen at mature stages of an expansion. Second, the rising trade deficit had been accompanied by a decline in prices of imported goodsuntil recently, especially oil and related productskeeping a lid on inflation despite tight labor markets. The rate of unemployment has been at or below 4.5 percent for the past year, and below 5 percent for well over two years, with absolutely no sign of price pressure.
Finally, increased foreign competition associated with the widening trade gap has spurred recent gains in productivity as U.S. firms are forced to improve their efficiency. Indeed, the strongest gains in productivity during the past few years have been in the manufacturing sector, precisely where foreign competition has been keenest. Perhaps the best example is the significant gain in productivity over the past decade in U.S. auto manufacturing, which is universally viewed as a response to intense competition from abroad. And while such gains may sometimes result in lost jobs, the appropriate policy response is not to pull up the drawbridge and refuse to compete but to provide adjustment and training assistance to workers. Over the next year, international trade critics likely will point to record-breaking U.S. deficits as a symptom of failed trade policies and unfair competition from abroad. But the trade deficit tells us nothing about whether competition is fair or unfair in any particular marketonly economic analysis on a case-by-case basis can uncover violations of trade rules. The deficit, however, does reflect a shortfall of national saving relative to domestic investment. And on this score, the deficits recent rise has been associated with a surge in investment that should enhance future economic performance.
Source: Robert G. Murphy, Our Friend, the Trade Deficit, The Washington Post, Friday, May 21, 1999; A31.
ADDITIONAL
CASE
STUDY
6-5
$1 collected in February. That leaves room to cut the yen price, which could increase sales in Japan. The Japanese, conversely, must raise dollar prices in the United States to collect the same number of yen once the dollars are exchanged for the Japanese currency. A few companies, including Honda and Nissan, announced price increases this month . . . . The Clinton Administration is counting on the yens strength to shrink the trade deficit . . . . Administration officials even cite a trade theory that says that for every 1 percent increase in the value of the yen, the trade deficit with Japan will eventually shrink by $5 billion. The Boeing Companys transactions with Japan tend to support this theory. Boeing prices the planes it sells to Japan in dollars, not yen. So the fall in the value of the dollar means that the Japanese can spend less in yen to buy the dollars to buy the planes. We sell planes under long-term negotiated contracts, and we dont expect any impact on prices from the latest currency changes, said Paul Binder, a Boeing spokesman. Boeing, the nations single biggest importer, sold the Japanese $2.5 billion in commercial airliners last year, or 5 percent of the total American exports to Japan in 1992. The shipment to Japan will be similarly large this yearand less costly to the Japanese in yen, which could encourage them to buy more planes.
145
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CASE
STUDY
6-6
Source: U.S. Department of Commerce, Bureau of Economic Analysis and Federal Reserve Board. Note: Real tourism exports and imports are constructed by summing travel and passenger fare categories measured in 2005 chained dollars available from the National Income and Product Accounts (http://www.bea.gov). The real exchange rate is a weighted average of the foreign exchange values of the U.S. dollar against the currencies of a large group of major U.S. trading partners. The index weights, which change over time, are derived from U.S. export shares and from U.S. and foreign import shares. For details on the construction of the weights, see the Winter 2005 Federal Reserve Bulletin.
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CASE
STUDY
EXTENSION
6-7
180 140 100 60 Percent 20 20 60 100 140 180 1979 1980 1981 1982 1983 1984 1985 1986 1987 1988 1989 1990 Change in log CPI Change in log exchange rate
Figure 2 100 75 50
Change in log exchange rate 25 Percent 0 25 50 75 100 1984 1985 1986 1987 1988 1989 1990 1991 1992 1993 1994
Source (Figures 1 and 2): International Monetary Fund, International Financial Statistics.
1
Figures 1 and 2 present changes in the logarithms of the two variables. The change in the logarithm is a measure of the growth rate of a variable. The close negative relationship between the inflation rate and the change in the exchange rate thus illustrates that price level increases were indeed matched by currency depreciation. See Supplement 7-5, Growth Rates, Logarithms, and Elasticities, for more information on growth rates and logarithms.
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ADVANCED
TOPIC
6-8
1 2 3
This is a particular concern since exchange rates can be quite volatile in the short run. See Chapter 13 of the textbook and Supplement 13-11, Exchange Rate Volatility. Note that we are, of course, defining the forward rate (f) in an analogous manner to the spot rate (e)it is the number of units of foreign currency per dollar. To see this, let the premium be p. Then, f/e = 1 + p, so the arbitrage condition is (1 + p)(1 + i) = (1 + i*). Since p and i are small numbers, their product is very small and can be ignored; multiplying out thus gives the result in the text. Note that this is exactly the same as the reasoning used to derive the Fisher equation (Supplement 5-6, Deriving the Fisher Equation). This underlies uncovered interest parity, which is discussed in more detail in Supplement 13-7, Uncovered Interest Parity.
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STUDY
6-9
Figure 1
160 140 120 100 80 60 40
Real Exchange Rates, 19732009 (Foreign Currency per U.S. Dollar, Index, 1973 = 100)
Canadian Dollar
UK Pound
Yen
1973 1976
1979
1982
1985
1988
1991
1994
1997
2000
2003
2006
2009
Source: Federal Reserve Board and U.S. Department of Labor, Bureau of Labor Statistics. Note: Real exchange rate is computed as nominal exchange rate multiplied by ratio of U.S. consumer price index to foreign consumer price index.
149
CASE
STUDY
EXTENSION
1.6
1.4 e 1.2
C$/US$
1 PPP .8
1988
1989
1990
1991
1992 e
1993
1994 PPP
1995
1996
1997
1998
A number of studies use the Big Mac data to analyze PPP. See, for example, R. Cumby, Forecasting Exchange Rates and Relative Prices with the Hamburger Standard: Is What You Want What You Get With McParity? National Bureau of Economic Research Working Paper no. 5675 (July 1996); M. Pakko and P. Pollard, For Here or To Go? Purchasing Power Parity and the Big Mac, Federal Reserve Bank of St. Louis Review (January/February 1996): 321; L. Long, Burgernomics: The Economics of the Big Mac Standard, Journal of International Money and Finance (December 1997): 86578; R. Click, Contrarian MacParity, Economics Letters (November 1996): 20912.
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Chapter Supplements
151
3.0
Germany
1.0
1988
1989
1990
1991
1992 e
1993
1994 PPP
1995
1996
1997
1998
9 8 7 HK$/US$ 6 5 4 3 2 PPP e
Hong Kong
1988
1989
1990
1991
1992 e
1993
1994 PPP
1995
1996
1997
1998
1500
South Korea
1200 won/US$
PPP
900
e 600
1989
1990
1991
1992
1993 e
1994 PPP
1995
1996
1997
1998