The world world economy has been heavily influenced by the increase in the degree of connectivity and integration of countries, corporations, firms, and the people within them. This feature is termed globalisation and has affected economic, political, and social activities in both developed and developing economies. Although the benefits from this process have not been equitably distributed, and there is currently a noted rise in economic nationalism, protectionism and anti-globalisation forces, the gains from trade and the ongoing decreases in the costs of transportation and communication, suggest that there is sufficient incentive for society to become even more integrated over time.
From an economic perspective there are two main trends that define globalisation. First, countries continue to expand their trade in goods and services. And second, countries continue to reduce their barriers to capital flows. These two aspects are largely interrelated as the firms within a country may require capital to produce goods or provide services, while other firms may wish to pursue new opportunities within foreign markets. In addition, as the relatively wide international scope for business opportunities for firms increases, as a result of globalisation, it also poses many challenges. This was made abundantly clear during 2007/2008, when a housing and mortgage crisis in the United States developed into a global financial crisis. In addition, the continued development and growth of the crytocurrency market presents a number of unique opportunites and challenges for those involved in the foreign exchange market.
As a part of this course we will discuss the fundamental concepts, principles, and analytical theories that define various aspects of international finance, where a significant portion of the course will consider the behaviour of exchange rates fluctuations. In addition, we will also consider various ways in which the risks that are due to exchange rate fluctuations can be managed.
According to Wikipedia, “Globalisation refers to the free movement of goods, capital, services, people, technology and information. It is the action or procedure of international integration of countries arising from the convergence of world views, products, ideas, and other aspects of culture.” Such a definition is relatively broad and would possibly include the following elements:
From an economic perspective much of the current debate and research is primarily focused on aspects relating to the following concerns:
For many, these are interesting topics that affect both developed and developing countries. Some authors (see, for example, Dreher (2006), and Dreher, Gaston, and Martens (2008)) have also sought to create indexes to measure the degree of globalisation of the various countries, taking into account the three main dimensions of globalisation (economic, social, and political). These indexes are available at http://globalization.kof.ethz.ch/.
The theory relating to international economic transactions is well established, where following the suggestion of David Ricardo in the 19th century, countries gain from trade if they each specialise in the production of those goods in which they have a comparative advantage. Much of the initial research focused on cases where factors of production are generally less mobile between countries than within a single country. Traditionally, this observation has served as a starting point for the development of a theory of international trade based on the extreme assumption of perfect national mobility and perfect international immobility of the factors of production. In addition, it has also traditionally assumed that there is perfect mobility (both within and between countries) for the commodities produced.
Another facet of the early literature considers the role of different countries as distinct political entities, each with their own barriers or frontiers. In addition, one would want to account for the role of particular non-tradable goods. These features create a number of obstacles or frictions that do not generally arise in many of the early economic models. However, with the passage of time, these features have been assigned a prominent role in the specification of modern economic and financial models, and it also facilitates various investigations into the effects of duties and other impediments to trade. Note also that we can use these models to consider the effects of exchange rate variation and how it influences both the potential return and the risks that are associated with international investment. These foundations have been expanded over the last few decades and this discipline is of ever increasing importance, given the rise in the degree of openness and interdependence of economic systems.
As with most other disciplines, we can distinguish between theoretical and descriptive aspects of this area of study, where the former is further divided into the theory of international trade and international monetary economics. All these distinctions are of a logical and pedagogical nature, but of course both the descriptive and the theoretical part are necessary for an understanding of the international economic relations that exist in the real world.
The descriptive part, is largely concerned with the description of international economic transactions and the behaviour of exchange rates. Such behaviour is influenced by specific events that arise within an institutional context, where most international economic variables would be influenced by the flow of goods and financial assets, international agreements, as well as international organisations like the World Trade Organization, International Monetary Fund, and others.
The theoretical part seeks to establish general principles and logical frameworks that can serve as a guide to aid our understanding of actual events (that may be influenced by policy interventions). Like most economic disciplines, we make use of abstractions and models (often expressed in mathematical form) to bring clarity to critical aspects that need to be considered.
Although many aspects of international trade and international finance are strictly intertwined, this course will largely focus on aspects of international finance, which contains aspects of positive and normative economic postulates.
International finance is also often associated with aspects relating to international monetary economics, open-economy macroeconomics, and international macroeconomics, as it deals with the international monetary and macroeconomic relationships that exist between various countries. This field also deals with areas relating to potential balance of payments disequilibria, as well as the associated adjustment mechanisms or policies that may be employed to move towards sustainable balance of payments positions. In addition, it also considers the interaction between the balance of payments and other macroeconomic variables, the role of various exchange-rate regimes, and aspects relating to exchange-rate determination and forecasting.
As the name denotes, a significant part of international finance also incorporates a number of aspects that are regarded as prominent features of the finance literature. These would include the role of international financial markets, international monetary systems, international policy coordination and international monetary integration (or currency unions). Furthermore, there are also aspects that relate to studies of international liquidity concerns, currency crises, debt problems, etc. This subject area also considers the efficiency of international financial markets, where one could consider the exchange rate as the price of an asset that is associated with various risks and rewards. This may be of importance to those who are looking to develop various trading strategies that may be applied on the foreign exchange markets, while others may be looking to manage the risks that are associated with movements in foreign exchange rates.
It is also worth noting that one could make a distinction between much of the traditional international finance literature, which considers the balance of payments as a relatively static phenomenon, where the primary concerns relate to the specific determinants of trade and financial flows. This approach does not allow for dynamic interactions that may exist in the market. The modern view that has been adopted by the current international finance literature considers trade and financial flows as the outcome of intertemporal optimal saving and investment decisions that are made by forward-looking agents. This approach has reached a high degree of sophistication, where models are based on policy-invariant microfoundations and rational expectations, while stochastic components may also be included to describe the effects of various economic shocks.1
In a modern world, future leaders will need to understand the issues relating to the effects of globalisation if they are to make sound international financial decisions. In addition, they also need to be able to manage the myriad of risks that their institution will face in a competitive global environment. The objective of this course is to prepare students to deal with these and other real-world issues.
Dreher, A. 2006. “Does Globalization Affect Growth? Evidence from a New Index of Globalization.” Applied Economics 38 (10): 1091–1110.
Dreher, A., N. Gaston, and P. Martens. 2008. Measuring Globalization-Gauging Its Consequences. New York: Springer.
Krugman, P. 2000. “How Complicated Does the Model Have to Be?” Oxford Review of Economic Policy 16: 33–42.
Obstfeld, Maurice, and Kenneth Rogoff. 1996. Foundations of International Macroeconomics. Cambridge, Massachusetts: MIT Press.
Phelps, E. S. 2007. “Macroeconomics for a Modern Economy.” American Economic Review 97: 543–61.
Solow, R. M. 2000. “Towards a Macroeconomics of the Medium Run.” Journal of Economic Perspectives 14: 151–58.
Turnovsky, S. 1997. International Macroeconomic Dynamics. Cambridge (Mass): MIT Press.