Winter, 2002

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1. Here is an article from the Economist Magazine, commenting on the Japanese economy.  It notes that the economy for the past 10 years has been weak relative to its performance in previous decades. Recently, it has become even weaker, with output falling 13% in the year before November. There seems to be no end in sight.

The article points out that consumer prices are falling in Japan - there is a deflation. The article argues that the deflation may be part of the problem of weak output. It notes that all the conventional macroeconomic policies studied in econ 311 have been tried. The government has applied a large fiscal stimulus, to the point where the Japanese government debt is now quite large. By one measure monetary policy has been quite loose too: short-term interest rates in Japan are now close to zero. These policies seem not to have worked.

The article notes how real interest rates in Japan are quite high. Recall that the real interest rate is the nominal rate minus the inflation rate (which is negative, in Japan). Since the interest rate in Japan is essentially zero, the real interest rate is the negative of the inflation rate.

The article argues that the Japanese are now trying to jump-start the economy by engineering a decline in the value of the Yen. Other things the same, this makes Japanese goods less expensive to foreigners and foreign goods more expensive. This is supposed to increase demand for Japanese goods, leading to an expansion in economic activity in Japan. The mechanism is basically the one identified in 311. But, those models were closed economy models (i.e., they ignored the rest of the world). In this class, we will study how the mechanism works in open economy models. The article indicates that Japan's trading partners are nervous about the policy of depreciating the currency, because they fear that if it is successful, the increase in Japanese economic activity will come at the expense of decreased economic activity in Japan's trading partners.

From the point of view of the last two lectures, it is interesting to see just how much the Japanese exchange rate has moved in recent years. At the beginning of 2000, it stood at 100 yen per dollar. Now it is a little higher than 130 yen per dollar. That's a 30 percent change over the period of one year.

It's interesting to note the final conclusion of the Economist article: the problems of Japan are probably primarily located in the banking system. At best, devaluing the currency will only have short-term positive effects. In the long run, according to the Economist, the Japanese have to 'bite the bullet' and fix their banking system.

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2. Here is another article from the Economist, making essentially the same point about Japan as the previous article. This article displays data on the Japanese price level. It is interesting to see what a difference it makes whether you measure inflation using the consumer price index or the GDP deflator, which is an index of all prices in the economy, not just consumer prices. Consumer prices now are only a touch lower than where they were in 1994. The GDP deflator is down by nearly 10 percent. The article discusses how some people advocate that the Japanese government pursue policies to depreciate the Yen. It points out that Japanese trading partners (including the US) are a little nervous about this because, by reducing the cost of Japanese goods, it may allocate world demand for goods away from them and towards Japan.

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3. This article from the Economist magazine (Jan. 21) discusses in very general terms, the issue of flexible versus fixed exchange rates. It refers to Argentina's policy of fixing its exchange rate using a currency board. That policy has been abandoned recently with the devaluation of the Argentine currency. It asks whether the fixed exchange rate policy first implemented in the early 1990s was a good idea. It asks whether Argentina waited too long to abandon that policy. We will discuss the issues raised by this article in greater detail later in the course.

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4. An article on Turkey.

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5. An article on Japan.

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6. This is taken from the Economist magazine, 1/24/02. The Yen continues its recent pattern of depreciation, which is a problem for Uncovered Interest Parity (UIP). According to UIP, the fact that interest rates in Japan are much lower than interest rates elsewhere (say the US) implies that currency traders must be expecting the Japanese currency to appreciate. But, it seems like a stretch to imagine currency traders persist in a belief that the currency will appreciate when it keeps depreciating. Note how the US and South Korea appear to be critical of the depreciating Yen. One interpretation is that they're afraid the rise in demand for goods in Japan will come at the expense of reduced demand for goods in the US and South Korea.

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7. Another article, talking about the bad situation in Japan. The article talks about the tensions in Japan's trading partners over the depreciation of the yen. In addition, the article takes the position that the problems of Japan have to do with the banking system, and that depreciation of the yen won't help those problems.

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8. This is a nice summary of the economic situation in the US today. The Economist article begins by noting that the long string of interest rate cuts implemented by the Federal Reserve since the beginning of last year seems to have come to an end. This comes in the midst of some evidence that the recession that started in March 2001 may be coming to an end. The signals are mixed and very preliminary. For example, GDP growth was up slightly in the October-December 2001 period. But, this is just a preliminary estimate which will be revised several times and could easily be revised down. Also, the rise in GDP is due in part to an enormous surge in purchases of new cars in response to temporary sales incentives offered by the auto makers. To the extent that this surge reflected households' decisions to buy cars sooner rather than wait, the present surge in sales will correspond to a fall in sales in the future. Other factors which may bode well for aggregate output are the rise in government spending and cut in taxes that have occurred and will continue to occur. In addition, the interest rate cuts implemented by the Fed through 2001 are presumably still working their way through the economy. The article closes with the observation that the signs of strength may not be long-lasting, in which case the Fed will continue cutting rates. Interestingly, with rates below 2 percent, they don't have much further before reaching their lower bound.

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9. Here is an article talking about the euro. There is some gossipy stuff about ECB president, Duisenberg, how he plans to step down soon, the circumstances of his selection as president and what people think about him. There is then a discussion about the reasons for the euro's weakness relative to other currencies such as the dollar. The article talks about the prospects for further euro weakness. It argues that the euro is likely to weaken further because the US economy is likely to start growing again while Europe remains weak. (The framework we are developing in class is helpful for thinking about this.) The article argues that the persistent economic weakness in European economies reflects their slowness in implementing reforms to promote competition.

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10. Here is a 2/8/02 article about Argentina. The article notes that the 'convertibility law' in Argentina, which required the central bank to maintain a one-to-one exchange rate between dollars and pesos, stopped the high money growth that fueled the high inflation of the 1980s (our long-run model is useful for understanding this). The article argues that the convertibility law had one bad consequence. By pegging the peso to a currency (the US dollar) which then appreciated, Argentina hurt its exports (this is something you need our short-run model to understand). So, now Argentina has dropped the policy of pegging the peso to the US dollar. Now people are afraid that Argentina will return to its old policy of generating a lot of money growth. There are two pressures operating on the government to generate a lot of money growth. One is captured by our classroom analysis. Argentina is in a recession, and they are looking for the beneficial effects of an increase in the money supply. There is a second motive too. Increasing the money supply is a way for the government to pay for its expenditures. The way it works is like this. The fiscal authorities go to the local financial markets and issue debt to bring in enough cash to pay the government's bills. Then the central bank does an open market operation in which it buys up that debt. The net effect is the same as if the government had directly printed money to pay for its bills. The Argentine government has a strong incentive to pay its bills by 'printing money' because they have high expenditure needs (made higher by the existence of a recession) and they have low taxes. The low taxes partly reflect that output and therefore income is low in Argentina. In part, they reflect the tax system itself which lets a lot of people off the hook from paying taxes. International agencies have for years tried to encourage Argentina to get its tax system in order so that it is not tempted to resort to inflationary money growth to finance its expenditures. But, this is a difficult thing to do, and Argentina has not been successful at it yet. It's difficult to do because when you raise taxes, everyone tries to get everyone else to bear the burden. If this happens on a big scale, then nothing gets done.

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Winter, 2003

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11. Here is a 1/10/2003 article from the Economist Magazine. The article discusses gyrations of the US dollar in the past decade. The dollar appreciated from 1994 until late 2001. After that, it depreciated. Note first that the exchange rate discussed in the article is different from what we discussed in class, in two ways. (1) The exchange rate in the article is really an average of the exchange rate between the US dollar and the currencies of the countries with which the US trades. It is a weighted average: in the average, the countries with which the US trades a lot a weighted heavily; the countries with which the US trades relatively little are weighted less. Just to be sure we know what we are talking about, let s(i) be the exchange rate between the US and country i. Let w(i) be a set of weights, one corresponding to each country, i. Then the weighted average exchange rate is the sum, over all i, of w(i)s(i). Each w(i) is positive and the sum of the w(i)'s is unity. Also, each w(i) is proportional to how much trade the US does with country i. (2) The definition of the exchange rate in the article seems to deviate from the one that I gave in class. Our 'standard' definition of the exchange rates is that it is domestic currency/foreign currency. Put differently, the exchange rate is the price of one unit of the foreign currency. As a result, a 'depreciation' corresponds to a rise in the exchange rate, under the standard definition. However, the definition used in the Economist article is different, it is represented as foreign currency/US dollar. So, under this definition, a currency depreciation corresponds to a fall in the exchange rate. To some extent, this lack of consistency is inevitable. What is the 'domestic currency' and what is the 'foreign currency' obviously depends on where you sit. Perhaps it is natural that the Economist magazine adopts the definition of the exchange rate that they do, given that it is situated in London. For them, US dollar is 'foreign currency' and the currency of US trading partners is like 'domestic currency'. This is why, above, I said that the Economist's definition of the exchange rate 'seems to' deviate from the one presented in class.

   The magnitude of the move in the exchange rate is very large: it rose by over 30 percent from 1994 to 2001. The article reviews the various reasons why this might have happened. It does this in a very down-to-earth way, by impressing on the reader that an exchange rate reflects the relative demand by people for two objects: the currencies of two countries. It talks about the factors that make people want to hold one currency versus another, i.e., which the determine the exchange rate between the two currencies. It argues that the strong dollar in the 90s reflected the many profitable investment opportunities in the US - to get at them, foreigners had to first convert their currencies into dollars, and this put the dollar in demand. The dollar continued to be strong from a while after September 11, 2001. The article attributes this to the fact that when there is global economic uncertainty, investors are usually relatively less worried about the US (even though in this case it was the US that was attacked!), and this gave another boost to the demand for dollars. 

   The article says that in a way it was very surprising that the dollar continued to be so strong in 2001. The US slipped into a recession then, and with the decline in economic activity US residents had less need for dollars. This should have put downward pressure on the dollar. In addition, the US current account went into deficit. This meant that foreigners would be sitting on a growing pile of dollars, which they would be trying to get rid of, according to the Economist magazine article.

   The article attributes the recent dollar weakness to a view that the profitability of investment returns in the US has started to slip. This makes foreigners less interested in acquiring dollars for the purchase of US return-bearing assets like equity and bonds.

   After discussing the factors that influence the movements in the value of the US dollar, the article turns to what the implications of a weaker dollar might be. They note that US exporters will be happy about this: the currency they earn by selling abroad will now fetch more US dollars. Foreign exporters will of  course be correspondingly unhappy. The article reports that for some Americans a 'strong dollar' might be a source of pride. The article says this is naive. A strong dollar affects different Americans in different ways. Some will be happy that it is weakening.

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The Economist article by well-known international economist McKinnon discusses the economic history of Japan in the 1990s. He refers to the generally low level of investment and economic growth in this period, and how the Japanese government has done its best to stimulate Japan by raising spending. His observations about the relationship of the US-Japanese interest rate differential to the exchange rate between the two currencies (see his Figure 1) show you how the UIP is used in practice.