feenstrataylorintlmacro3

Chapter Introduction

The Global Macroeconomy

This chapter defines the key elements and issues of international macroeconomics, and describes how the rest of the book will address them. It introduces exchange rates, discusses the basics of international finance, and briefly describes fundamental macroeconomic policy issues in the global economy.

Foreign Exchange: Currencies and Crises
Globalization of Finance: Debts and Deficits
Government and Institutions: Policies and Performance
Conclusions

So much of barbarism, however, still remains in the transactions of most civilized nations, that almost all independent countries choose to assert their nationality by having, to their inconvenience and that of their neighbors, a peculiar currency of their own.

John Stuart Mill

Neither a borrower nor a lender be; / For loan oft loseth both itself and friend./And borrowing dulls the edge of husbandry.

Polonius, in William Shakespeare’s Hamlet

History, in general, only informs us of what bad government is.

Thomas Jefferson

1. Introduction to international macroeconomics, the study of large-scale interactions among interdependent economies.

2. Key elements and issues of international macro:
a. Multiple monies: Why do they exist? How do they affect the global economy? What are the effects of changes in their relative values? Is having a national currency desirable?
b. Financial integration: Why do financial transactions occur? Who lends to whom, and why? Why are some debts not repaid? Is financial integration desirable?
c. Policy choices: What are the economic consequences of capital flows and exchange rates? Can policy makers use monetary and fiscal policies to improve macroeconomic performance, and if so, how?

3. This chapter explains how the ensuing chapters will address these issues.

International macroeconomics is devoted to the study of large-scale economic interactions among interdependent economies. It is international because a deeper exploration of the interconnections among nations is essential to understanding how the global economy works. It is macroeconomic because it focuses on key economy-wide variables, such as exchange rates, prices, interest rates, income, wealth, and the current account. In the chapters that follow, we use familiar macroeconomic ideas to examine the main features of the global macroeconomy.

The preceding quotations indicate that the broad range of topics and issues in international macroeconomics can be reduced to three key elements: the world has many monies (not one), countries are financially integrated (not isolated), and in this context economic policy choices are made (but not always very well).

Money John Stuart Mill echoes the complaints of many exasperated travelers and traders when he bemoans the profusion of different monies around the world. Mill’s vision of a world with a single currency is even more distant today: in his day, the number of currencies was far smaller than the more than 150 currencies in use today. Why do all these monies exist, and what purposes do they serve? How do they affect the working of our global economy? What are the causes and consequences of the changing value of one currency against another? Do the benefits of having a national currency outweigh the costs?
Finance William Shakespeare’s Polonius would surely be distressed by the sight of the mounting debts owed by the United States and other borrower countries to the rest of world. For him, happiness meant financial isolation, with income exactly equal to expenditure. Over the centuries, however, this has been a minority view among individuals and among nations. Today, the scale of international financial transactions has risen to record levels as capital has become ever more mobile internationally. Why do all these transactions occur, and what purposes do they serve? Who lends to whom, and why? Why are some debts paid but not others? Does the free flow of finance have costs as well as benefits?
Policy Thomas Jefferson’s assessment of government may be extreme, but looking at economic outcomes around the world today, it surely contains some truth. If government policies were always optimal, recessions never happened, currencies never crashed, and debts were never in default…well, that would be a nice world to inhabit. The reality—all too apparent after the global financial crisis of 2008—is that policy making is frequently not optimal, even at the best of times in the best-run countries. And in the worst run countries, poverty, underinvestment, hyperinflation, crises, and debt problems are common events. How do exchange rates and international capital flows affect an economy? How can policy makers avoid bad economic outcomes and formulate better monetary and fiscal policies? What are the trade-offs for each policy decision? Is there even a single “right” approach to the many intricate economic problems facing interdependent nations?

Many fundamental questions like these must be answered if we are to understand the economic world around us. To that end, the chapters that follow combine economic theory with compelling empirical evidence to explain the workings of today’s global macroeconomy. This introductory chapter briefly explains the road ahead.