International Financial Environment Ing. Jana Šimáková, Ph.D. simakova@opf.slu.cz – • Boeing 787 Dreamliner International Financial Environment •???What is the financial system??? – • Questions and Applications International Financial Environment •Financial system is system that allows transfer money between savers and borrowers • •Functions •to channel funds from lenders to borrowers •to create a payment and clearing mechanism – • Definition of Financial System International Financial Environment •M-System –based on capital markets –USA, Great Britain • •B-System –based on financial intermediaries (banks) –Czech Republic, Germany, Austria – • Types of Financial System International Financial Environment •???What about financial system in your country??? • •Compare the financial system in your home country with one typical B-based system and one typical M-based system. – • Questions and Applications International Financial Environment •domestic credit provided by financial sector (% of GDP) • http://data.worldbank.org/indicator/FS.AST.DOMS.GD.ZS • • •market capitalization of listed companies (% of GDP) • http://data.worldbank.org/indicator/CM.MKT.LCAP.GD.ZS • • • • Statistics International Financial Environment •Complex system of international arrangements, rules, institutions, policies in regard to exchange rates, international payments and international capital flows • •Institutional framework within which –International payments are made –Movements of capital are accommodated –Exchange rates are determined • •International monetary system has evolved over time as international trade/business/finance have changed, technology has improved and political systems have changed – • Definition of the International Monetary System International Financial Environment •??? •When government of Greece experienced problems in meeting its debt obligation in 2010, some investors became concerned that the crisis would spread to other European countries. Explain why integrated European financial markets might allow a debt crisis in one European country to spread to other countries in Europe. •??? – • Questions and Applications International Financial Environment •???What is the money, why money came into existence??? • – • Questions and Applications International Financial Environment Definition of the Money •Money is any good that is widely accepted for the purposes of the exchange and in the repayments of debts • •Functions •medium of exchange •money is used to intermediate the exchange of goods and services •it solves the problem of the double coincidence of wants •unit of account •money measures the market value of goods, services, and other transactions •it decreases number of prices (in barter: 4 types of goods = 6 prices, 100 types of goods = 495 prices) •store of value •money is a way to keep some of our wealth in a readily spendable form for future needs International Financial Environment •???Can we consider Bitcoin or other cryptocurrencies as money??? • – • Questions and Applications International Financial Environment •Bimetallism (before 1850s – 1870) • •Classic Gold Standard (1870s – 1914) • •Interwar period (1918 – 1939) • •Bretton Woods system (1945 – 1972) • •System of floating exchange rates (1972 – present) – • Evolution of the International Monetary System International Financial Environment •Variety of exchange rate regimes –Selection depends on a country’s preferences and specifics •Three most important currencies (USD, EUR, JPY) –Discussions on the role of GBP and CNY •Evidences on monetary integration with the Eurozone as the most advanced example •Financial crises as a phenomena of current system –Crises in Latin America –Crises in South-East Asia –Global financial crisis •Discussions on controls and regulation of international capital flows Present International Monetary System International Financial Environment Balance of Current Account in Selected Countries International Financial Environment Current Account Imbalances (% of World GDP) International Financial Environment Top 20 Countries According to Foreign Exchange Reserves International Financial Environment •International financial institutions are integral part of the international monetary system as they built up the institutional framework •Several institutions with global or remarkably international influence –International Monetary Fund –World Bank and World Bank Group –Central banks of major economic centers (Federal Reserve System, European Central Bank, Bank of Japan, Bank of England) –Regional development banks –Bank for International Settlements –European Investment Bank •Listed institutions differ in size as well as objective – • Key International Financial Institutions International Financial Environment •Final stage of long-lasting process of economic integration in Europe •EMU has been a long standing objective since late 1960s •Euro area with single currency and monetary policy emerged in 1999 •Economic and monetary union involves –Policy harmonization to remove obstacles to factor mobility –A more marked and wider range of common policies, especially in relation to macroeconomic policy –Irrevocably fixed exchange rates or, as in the case of the EU, a single currency –A common monetary policy – that is, one interest rate and exchange rate policy determined by a single Central Bank –Some pooling of foreign exchange reserves –Possible inter-state transfers to offset economic distortions arising from EMU Economic and monetary union (EMU) International Financial Environment European Union and Euro Area (Eurozone) International Financial Environment Map of the Eurozone (euro area), showing which countries use the euro as their currency. Includes members, pre-members (ERM II or ERM-2 waiting area), EU non-members using the euro, and other EU countries (color blind accessible). Updated for July 2020 with the entry of Croatia and Bulgaria into the ERM-II. •United Kingdom (GBP) –Before Brexit: „opt-out“ clause and five economic tests by Gordon Brown –Brexit left United Kingdom outside the EU •Denmark (DKK) –„Opt-out“ clause –Adoption of Euro refused by referendum •Sweden (SEK) –Referendum + political decision to not fulfill one criterion •BG, CZ, HR, HU, PL, RO –Convergence criteria must be fulfilled first –Political will to accept the euro must exist – Why Some EU Members do not Have the Euro? International Financial Environment •Stage One (July 1, 1990 – December 31, 1993) –Exchange controls were abolished, capital movements liberalized –Set up of formal convergence •Stage Two (January 1, 1994 – December 31, 1998) –Name of the new currency decided –Practical framework for the euro adoption defined –European Central Bank established •Stage Three (January 1, 1999 – continuing) –11 countries joined Euro Area (Greece two years later) –Single monetary policy came into effect –Euro coins and notes introduced in early 2002 Three Stages for the EMU Implementation International Financial Environment •Nominal convergence –Five convergence criteria (Maastricht criteria) for countries joining the Euro Area •Real convergence –Economic cycle, structure of economy –Real exchange rates, productivity, labor costs –International trade, international investments •Institutional convergence –Legal institutions and legal acts –Shareholders‘ and creditors‘ rights, investor protection –Market regulations –State capacity on enforcing contracts and tax collection Convergence is Key in the EMU International Financial Environment Maastricht Convergence Criteria International Financial Environment What is measured Price stability Sound public finances Sustainable public finances Durability of convergence Exchange rate stability How it is measured Consumer price inflation rate Government deficit as % of GDP Government debt as % of GDP Long-term interest rate Deviation from a central rate Convergence criteria Not more than 1.5 percentage points above the rate of the three best performing Member States Reference value: not more than 3% Reference value: not more than 60% Not more than 2 percentage points above the rate of the three best performing Member States in terms of price stability Participation in ERM II for at least 2 years without severe tensions •Benefits –elimination of intra-EU transaction costs lower interest rates –uniform interest rates –removal of exchange rate uncertainty in intra-EMU trade –removes the option of competitive devaluations between EU states –financial integration –economic cushioning from domestic political instability –creates a new international currency to represent the EU’s combined economic weight Costs and Benefits of EMU International Financial Environment •Costs –short term deflation –loss of the exchange rate as a tool of national economic policy –loss of power to set interest rates and control the supply of money –potential problems related to a lack of ‘real’ convergence and potential policy conflicts –the inappropriateness of one monetary policy for so many states •ECB is the central bank with responsibility for conducting monetary policy for the euro area •European System of Central Banks (ESCB) comprises the ECB and the national central banks of all EU Member States whether they have adopted the euro or not •Eurosystem comprises the ECB and the the national central banks of those countries that have adopted the euro –The Eurosystem and the ESCB will co-exist as long as there are EU Member States outside the euro area •Euro area consists of the EU countries that have adopted the euro European Central Bank (ECB) International Financial Environment •The primary objective is to maintain price stability in the euro area •Price stability defined as a year-on-year increase in the Harmonized Index of Consumer Prices (HICP) for the euro area of below 2% •Operational framework consists of the following instruments –Open market operations •Main refinancing operations •Longer-term refinancing operations •Fine-tuning operations •Structural operations –Standing facilities •Marginal lending facility •Deposit facility –Minimum reserve requirements to credit institutions – • Objective and instruments of the ECB monetary policy International Financial Environment Have a Nice Day J