CFA L3 learning notes-CME-International Interactions
LOS-identify and interpret macroeconomic, interest rate, and exchange rate linkages between economies
International interactions play a crucial role in the global economy, and understanding the macroeconomic, interest rate, and exchange rate linkages between economies is essential.
1.Macroeconomic Linkages:
-Current account reflects net exports, investment income flows, and unilateral transfers.
-Capital account includes Foreign Direct Investment (FDI) and Portfolio Investment (PI) flows.
-Changes in the current account are linked to aggregate demand and affect net private saving and the government surplus.
-The capital account balances the excess of investment and government spending over domestic saving and taxes.
-Changes in income, relative prices, interest rates and asset prices, and exchange rates maintain balance between the current and capital accounts.
-The pace of adjustment differs between investment markets (quick) and the real economy (slow).
2.Impact of Tax Cut on a Large, Diversified Economy:
-The tax cut aimed at reducing business taxes and increasing corporate investment is likely to:
-Improve the country’s current account balance due to increased domestic investment and reduced production facilities moving abroad.
-Impact the country’s capital account balance by potentially attracting more foreign direct investment (FDI).
-Encourage growth in other countries through increased demand for goods and services. -Affect the current and capital accounts of other countries through changes in trade flows and investment patterns.
-The tax cut is likely to induce adjustments in the financial markets, such as changes in interest rates, exchange rates, and asset prices.
3.Interest Rate/Exchange Rate Linkages:
-Interest rates and exchange rates are closely linked.
-Under a fixed exchange rate regime with unrestricted capital flows, interest rates must be the same in countries whose currencies are pegged to each other.
-If the exchange rate is not credibly fixed, yield differentials may emerge, leading to differential risk and return expectations.
-In floating exchange rate systems, interest rates generally tend to be higher in currencies expected to depreciate and lower in currencies expected to appreciate.
-Real interest rate differentials are not always exploitable due to deviations from purchasing power parity (PPP).
-Real interest rates are linked globally through the requirement that global savings equal global investment.
-Low global real interest rates after the global financial crisis were attributed to high global saving levels and low capital investment in developed markets.
01 Jul 2023 - by toptradeready.com