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A mental structure for macro-economics
1
6 Circles5 Instruments of the ECB5 Financial markets
Roger Jean Claessens is an International lecturer and an independent consultant for the financial services industry.
Professor at UBI (United Business Institutes), BrusselsExpert lecturer for FEBELFIN (Federation of banks & insurance in Belgium) Expert lecturer for the EIB in LuxembourgExpert lecturer for BGL BNPPARIBAS others…
Author of several books:« Corporate culture », End 2011, Serbian Bank Association (SBA)«What is a bank?» 2009, Promoculture & Author House, UK« Branch Management», with P. Wiertz,2006 Promoculture & SBA « Ethics, corporate values and prevention of money laundering», 2003 SBA « Marketing in financial services », 2007 SBA
Member of the Luxembourg Club of Economists.
The purpose of the seminar
Provide you with a mental structure
The schedule of the day
Morning (a) The economic circuit (b) The economic cycles (c) The intervention of the Central Bank (d) The intervention of the Government (e) Money and the Financial Markets
Afternoon (1) The key economic indicators (2) Economic highlights of today
The schedule of the day
Morning - (a) The economic circuit- (b) The economic cycles- (c) The intervention of the Central Bank - (d) The intervention of the Government- (e) Money and the Financial Markets
Afternoon (1) The key economic indicators (2) Economic highlights of today
This is an economic circuit
(a) The economic circuit
Products & Services
GNP
CONSUMERS
Salaries, interest, rentalsLABOUR
ENTREPRENEURS
Offer
Offer
Demand
Demand
Samuelson underlines that every economy has to answer three basic questions:
What to produce? Is determined by the consumers. How to produce? Is determined by the competition between companies.
For whom? The answer to the third question is a matter of choice.
(a) The economic circuit
Products & Services
GNP
CONSUMERS
Salaries, interest, rentalsLABOUR
ENTREPRENEURS
Offer
Offer
Demand
Demand
WHAT?HOW?
FOR WHOM?
(a) The economic circuit
10
€ $
What happens when you purchase a product in the USA?
Salaries have been doubled,what are the consequenceson the economy?
Discussion
(a) The economic circuit
(a) The economic circuit
In Samuelson’s representation, the government is either acting as a consumer or as a company, dependant upon its specific action.
The guardian of the monetary system is the central bank
Products & Services
GNP
CONSUMERS
Salaries, interest, rentalsLABOUR
ENTREPRENEURS
Offer
WHAT?HOW?
FOR WHOM?
Demand
Demand
Offer
Government Central Bank
GNP = C+I+G+(X-M)
The Gross National Product is equivalent to the sum of private consumer spending (C), private investment spending (I), government spending (G) and net foreign spending (eXports - iMports) on final goods and services output.
(a) The economic circuit
The goal of modern economic management is to keep this circuit in balance.
There are two states of unbalance:
INFLATION = a state of unbalance, characterised by increasing prices. The consequence of inflation is a decreasing purchasing power of money, i.e. with the same amount of money you will acquire a decreasing number of goods and services.DEFLATION = is an unbalance characterised by
decreasing prices
(a) The economic circuit
You purchase one egg daily for one Euro!
What happens if the farmer knows that you had a big salary increase?
Discussion
(a) The economic circuit
17
INFLATION
18
INFLATION
(c) The intervention of the central bank
19
20
DEFLATION
ENTREPRENEURS
(a) The economic circuit : The Entrepreneur
The economic system depends upon people. Adam Smith pointed out that the individual motivation, invention, and innovation inspire an economy to greater prosperity.
The “Wealth of a Nation” depends upon imagination, entrepreneurship and discipline
(a) The economic circuit : The Entrepreneur
Market competition (the invisible hand in Adam Smith’s terms) leads a self-interested person to wake up in the morning, look outside at the earth and produce from its raw materials, not what he wants, but what others want!
The invisible hand (= the market) forces people to give up if they do not produce something more valuable than they started with.
(a) The economic circuit : The Entrepreneur
Strangely enough, we often make the statement in our part of the world, that we have discouraged the entrepreneurs because of administrative burdens, high social security contributions and high taxation.
(a) The economic circuit : The Entrepreneur
The entrepreneur is also someone who will continuously struggle to balance flexibility and cost cutting in order to discover the optimal structure of the enterprise, pushing for productivity, which is “the” competitive asset of a nation.
(a) The economic circuit : The Entrepreneur
Paul Krugman highlights how the government can induce firms to lift productivity.
Higher productivity translates into higher standard of living.
But rising productivity requires rising investments in plant, equipment, research and education.
High taxes discourage the search for productivity.
(a) The economic circuit : The Entrepreneur
CONSUMERS
(a) The economic circuit : The Consumer
ON CONNAIT LE CONSOMMATEUR!
Keynes underlines in the mid thirties that households are the most important component of overall demand.
Keynes appoints income the chief determinant.
(a) The economic circuit : The Consumer
Veblen went even further than Marshall and encouraged economists to be more willing to meet with sociologists, anthropologists and psychologists if they wanted to develop a better understanding of the consumer.
(a) The economic circuit : The Consumer
Veblen made this rightful conclusion that consumers’ demand of goods is determined by the use of the good and the price that the consumer thinks other people will think he paid!
He analysed the underlying motivation of manypurchases.
(a) The economic circuit : The Consumer
How can one get a feel for the mood of both the consumers and the entrepreneurs?
By analysing the economic indicators. There are about 300 major indicators. Every week about 60 of them are being published on the key economies.
(a) The economic circuit : The Consumer
Products & Services
GNP
(b) The economic cycles
(b) The economic cycles
A fall of the GNP means that men and women will be in a more precarious situation and that pessimism will probably settle in.
It reflects the mood of the entrepreneurs and the consumers
(b) The economic cycles
There are 300 hundred key economic indicators divided into 3 categories :
1. the leading indicators = upstream indices of change
2. the coincidental indicators = indices of change3. the lagging indicators = downstream indices of
change
Example:4. The stock index5. Building permits6. Savings versus income
(b) The economic cycles
(b) The economic cycles
37
Each cycle is unique but contains enough similarities with others to enable us to draw general conclusions.
Let us also remember that many internal or external factors can have an impact on the economy, such as: politics, acts of war, etc.
(b) The economic cycles
What might be indicators around us of an economic boom or a slow down?
(b) The economic cycles
Discussion
• Production• employment• productivity• wages• sales• profits• output• credit• investment goods
• Stock exchange• GNP• public sentiment• risk taking• new activities• interest rates• central bank• resources• inventories
(b) The economic cycles
Orders exports / imports employment sacrificed prices raw materials intervention bankruptcies savings
Intensity of fluctuation Excess capacity liquidity credit-crunch competition central bank producers imagination
(b) The economic cycles
The better the understanding of a situation is, the greater the probability to take a right decision, hence the study of the economic indicators
They are the language of the economy
They are the basis for educated decisions
(b) The economic cycles
Markets do react to their release
Each week about 60 are released for the G 7
Monitoring is an on-going and time consuming process
Understanding their correlations is key to economic decisions
(b) The economic cycles
Salaries, interest, rentalsLABOUR
(b) The economic cycles
44
The challenge of the European Union is to decrease non-structural[1] unemployment. [1] Structural unemployment means unemployment linked to the changes or lack of changes within the economy, the social structure or demographics.
The unemployment in the EU remains significant for variousreasons, which we qualify as structural but are in fact non-structural.
The equilibrium in the employment market will be more and more difficult to establish. The structure of the age pyramid is changing dramatically.
(b) The economic cycles: The labour market
45
(1) The key economic indicatorsPopulation, employment & unemployment
46
(1) The key economic indicatorsPopulation, employment & unemployment
47
Products & Services
GNP
CONSUMERS
Salaries, interest, rentalsLABOUR
ENTREPRENEURS
Offer
Offer
Demand
Demand
48
(b) The economic cycles
49
The economic indicators and their correlation:1. GDP2. Unemployment3. Industrial production
(Source: The Economist)
(b) The economic cycles:
05/2000
11/2000
05/2001
11/2001
05/2002
11/2002
05/2003
11/2003
05/2004
11/2004
05/2005
11/2005
05/2006
11/2006
05/2007
11/2007
05/2008
11/2008
09/2009
05/2010
05/2011
08/2011
Se-ries1
7.3 2.7 1.5 0.8 2.8 1.7 2.2 3.6 4.2 4.3 3.5 3.3 3.5 2.9 2.1 2.2 1.2 -2 -2.6 3.1 3.2 2.9
-3
-1
1
3
5
7
GDP USA
50
05/2000
11/2000
05/2001
11/2001
05/2002
11/2002
05/2003
11/2003
05/2004
11/2004
05/2005
11/2005
05/2006
11/2006
05/2007
11/2007
05/2008
11/2008
09/2009
05/2010
05/2011
08/2011
Se-ries1
7.3 2.7 1.5 0.8 2.8 1.7 2.2 3.6 4.2 4.3 3.5 3.3 3.5 2.9 2.1 2.2 1.2 -2 -2.6 3.1 3.2 2.9
Se-ries2
4.1 3.9 4.5 5.4 6.1 5.9 5.8 5.7 5.7 5.4 5.2 5 4.7 4.4 4.5 4.7 5.1 6.5 9.7 9.7 9 9.1
-3
-1
1
3
5
7
9
11
USA
51
05/2000
11/2000
05/2001
11/2001
05/2002
11/2002
05/2003
11/2003
05/2004
11/2004
05/2005
11/2005
05/2006
11/2006
05/2007
11/2007
05/2008
11/2008
09/2009
05/2010
05/2011
08/2011
Series1
7.3 2.7 1.5 0.8 2.8 1.7 2.2 3.6 4.2 4.3 3.5 3.3 3.5 2.9 2.1 2.2 1.2 -2 -2.6 3.1 3.2 2.9
Series2
4.1 3.9 4.5 5.4 6.1 5.9 5.8 5.7 5.7 5.4 5.2 5 4.7 4.4 4.5 4.7 5.1 6.5 9.7 9.7 9 9.1
Series3
6.4 3.3 -1 -6.4 -2.9 0.2 0.1 2.3 3.4 4.6 3.9 1.9 3.6 4.9 1.9 1.9 1 -4.5 -10.7 1.7 5 3.7
-9
-4
1
6
USA
52
05/2000
11/2000
05/2001
11/2001
05/2002
11/2002
05/2003
11/2003
05/2004
11/2004
05/2005
11/2005
05/2006
11/2006
05/2007
11/2007
05/2008
11/2008
09/2009
05/2010
05/2011
08/2011
Se-ries1
3.7 3.6 2.3 1.7 1.3 1.2 1 0.5 0.6 1.9 1.4 1.6 1.7 2.6 3.1 2.6 1.6 -3.9 1.2 1.7 1.6 1.6
-3.5
-2.5
-1.5
-0.5
0.5
1.5
2.5
3.5
EU GDP
53
05/2000
11/2000
05/2001
11/2001
05/2002
11/2002
05/2003
11/2003
05/2004
11/2004
05/2005
11/2005
05/2006
11/2006
05/2007
11/2007
05/2008
11/2008
09/2009
05/2010
05/2011
08/2011
Se-ries1
3.7 3.6 2.3 1.7 1.3 1.2 1 0.5 0.6 1.9 1.4 1.6 1.7 2.6 3.1 2.6 1.6 -3.9 1.2 1.7 1.6 1.6
Se-ries2
9.5 9 8.4 8.3 8.4 8.3 8.7 8.8 8.8 9 8.9 8.4 8.1 7.8 7.2 7.3 7.1 9.5 9.9 9.9 9.9 9.9
-3.0
-1.0
1.0
3.0
5.0
7.0
9.0
EU
54
05/2000
11/2000
05/2001
11/2001
05/2002
11/2002
05/2003
11/2003
05/2004
11/2004
05/2005
11/2005
05/2006
11/2006
05/2007
11/2007
05/2008
11/2008
09/2009
05/2010
05/2011
08/2011
Series1
3.7 3.6 2.3 1.7 1.3 1.2 1 0.5 0.6 1.9 1.4 1.6 1.7 2.6 3.1 2.6 1.6 -3.9 1.2 1.7 1.6 1.6
Series2
9.5 9 8.4 8.3 8.4 8.3 8.7 8.8 8.8 9 8.9 8.4 8.1 7.8 7.2 7.3 7.1 9.5 9.9 9.9 9.9 9.9
Series3
3.8 1.9 3.8 -0.6 -0.33 -0.12 1.8 1.2 0.6 1.5 0.6 1 3.2 3.3 3.7 4.3 3.8 -15.9 1.4 5.3 5.3 2.9
-13.5
-8.5
-3.5
1.5
6.5
11.5
EU
55
05/2000
11/2000
05/2001
11/2001
05/2002
11/2002
05/2003
11/2003
05/2004
11/2004
05/2005
11/2005
05/2006
11/2006
05/2007
11/2007
05/2008
11/2008
09/2009
05/2010
05/2011
08/2011
GDP
-5.5 -4.7 0.6 -2.9 -1.9 -0.4 0.7 1 3.4 4.3 1.1 2 4 2.7 2 2 1.3 0 -5.5 1.7 2.4 -0.6
-6
-4
-2
0
2
4
Japan GDP
Axis Title
56
05/2000
11/2000
05/2001
11/2001
05/2002
11/2002
05/2003
11/2003
05/2004
11/2004
05/2005
11/2005
05/2006
11/2006
05/2007
11/2007
05/2008
11/2008
09/2009
05/2010
05/2011
08/2011
GDP
-5.5 -4.7 0.6 -2.9 -1.9 -0.4 0.7 1 3.4 4.3 1.1 2 4 2.7 2 2 1.3 0 -5.5 1.7 2.4 -0.6
Unemployment
4.9 4.7 4.7 5.3 5.2 5.2 5.2 5.3 5 4.8 4.5 4.2 4.1 4.2 4 4 3.9 4 5.7 4.9 4.5 4.6
-5
-3
-1
1
3
5
Japan
57
05/2000
11/2000
05/2001
11/2001
05/2002
11/2002
05/2003
11/2003
05/2004
11/2004
05/2005
11/2005
05/2006
11/2006
05/2007
11/2007
05/2008
11/2008
09/2009
05/2010
05/2011
08/2011
GDP
-5.5 -4.7 0.6 -2.9 -1.9 -0.4 0.7 1 3.4 4.3 1.1 2 4 2.7 2 2 1.3 0 -5.5 1.7 2.4 -0.6
Unemployment
4.9 4.7 4.7 5.3 5.2 5.2 5.2 5.3 5 4.8 4.5 4.2 4.1 4.2 4 4 3.9 4 5.7 4.9 4.5 4.6
Ind Produc-tion
1.14 0.7 -0.29 -1.19 -1 -1 0.48 0.28 0.69 0.38 0.11 0.12 0.31 0.52 0.16 0.08 0.42 0.2 -2.27 1.85 -1.3 -1.7
-5
-3
-1
1
3
5
Japan
58
GNP
CONSUMERS
LABOUR
ENTREPRENEURS
Offer
WHAT?HOW?
FOR WHOM?
Demand
Demand
Offer
Government Central Bank
59
5 Key tools of the central bank1. The printing of money2. The short term interest rates3. The fractional reserve
requirements 4. The open market policy5. The financial structure of the
banks
(c) The intervention of the central bank
1- Printing money
(c) The intervention of the central bank
The question central bankers must answer is:
“What is the correct money supply level?”
The easy answer is enough to buy all the goods and services produced, so that full employment is reached without a rise in prices.
P.Q = M.V
(c) The intervention of the central bank
P.Q = M.V
P = price level of goods and services
Q = quantity of goods and services produced in a national economy (= GDP)
M = the monetary supply (the assets of the consumers and the entrepreneurs, with corresponding liabilities for the banking system and the central bank)
V = is the velocity of the circulation of money
(c) The intervention of the central bank
Reserve requirement of 10 out of 100
100 is deposited with Bank A Bank A is going to deposit 10 with CB and lend 90
90 is deposited with Bank BBank B is going to deposit 9 with CB and lend 81
81 is deposited with bank CBank C is going to deposit 8,1 with the CB and lend 72,9
…
M0 = cash = 100 = monetary baseM1 = cash + sight deposits = 342,9 = money supply = (100+90+81+72,9)
(c) The intervention of the central bank
(c) The intervention of the central bank
(c) The intervention of the central bank
The preference curve of the borrowers
2- Interest rates
The preference curve of the lenders
(c) The intervention of the central bank
2- Interest rates
(c) The intervention of the central bank
The cost of borrowing and the return of a deposit
(c) The intervention of the central bank
When the perspective changes, the curve moves
Interest rateShort term interest rate + inflation
= +/- long term interest rate
Real interest rate = +/- nominal interest rate – inflation
(c) The intervention of the central bank
2 – Interest rates
0
20
40
60
80
100
120
140
160
180
Q1 Q2 Q3 Q4 Q5 Q6 Q7 Q8 Q9 Q10 Q11 Q12
Interest shares GDP Bonds
(c) The intervention of the central bank
Money makes the economic system work.
(c) The intervention of the central bank
(c) The intervention of the central bank
3 – Fractional reserve requirement
The representation of a bank’s balance sheet
Sum of assets
Sum of liabilities
Net worth
Assets-Liabilities to third parties
(c) The intervention of the central bank
3 – Fractional reserve requirementCommercial Bank Central Bank
%DEPOSIT
SLOAN
S DEPOSITS
(c) The intervention of the central bank
Commercial Bank Central Bank
Purchase of bonds
Euro
4 – Open market policy or “quantitative easing”
(c) The intervention of the central bank
Commercial Bank
5 – Balance sheet structure
(c) The intervention of the central bank
05/2000
11/2000
05/2001
11/2001
05/2002
11/2002
05/2003
11/2003
05/2004
11/2004
05/2005
11/2005
05/2006
11/2006
05/2007
11/2007
05/2008
11/2008
05/2009
09/2009
04/2010
05/2011
08/2011
GDP
7.3 2.7 1.5 0.8 2.8 2.2 2.2 3.6 4.3 4.3 3.5 3.3 3.5 2.9 2.1 2.2 1.2 -1.2 -2.9 -2.6 0.01 2.8 2.3
s t interest rate
6.57 6.49 3.95 2.05 1.82 1.82 1.22 1.05 1.08 2.06 3.015 4.006 5.002 5.225 5.118 4.51 2.008 0.2 0 0.02 0.022 0.013 0.27
-3
-1
1
3
5
7
USA: GDP vs Short term interest rate
78
05/2000
11/2000
05/2001
11/2001
05/2002
11/2002
05/2003
11/2003
05/2004
11/2004
05/2005
11/2005
05/2006
11/2006
05/2007
11/2007
05/2008
11/2008
05/2009
09/2009
04/2010
05/2011
08/2011
Short term
6.57 6.49 3.95 2.05 1.82 1.82 1.22 1.05 1.08 2.06 3.15 4.006 5.002 5.22 5.18 4.51 2.008 1.28 0 0.02 0.02 0.013 0.27
Long term
6.39 5.6 5.45 4.95 5.21 5.21 3.99 4.11 4.77 3.99 4.22 4.51 5.014 4.57 4.86 4.47 3.46 2.96 3.2 3.4 3.82 3.13 2.12
0.00
1.00
2.00
3.00
4.00
5.00
6.00
7.00
USA rates
79
05/2000
11/2000
05/2001
11/2001
05/2002
11/2002
05/2003
11/2003
05/2004
11/2004
05/2005
11/2005
05/2006
11/2006
05/2007
11/2007
05/2008
11/2008
05/2009
09/2009
04/2010
05/2011
08/2011
short term
4.18 5.1 4.55 3.38 3.42 3.42 2.55 2.08 2.07 2.15 2.13 2.44 2.87 3.61 4 4.6 4.74 3.9 1.3 0.075 0.064 1.4 1.54
long term
5.34 5.06 5.06 4.59 5.09 5.09 4.11 4.11 4.11 3.78 3.33 3.43 3.96 3.67 4.36 4.24 4.002 3.27 3.4 3.4 3.07 3.1 2.24
0.5
1.5
2.5
3.5
4.5
5.5
EU rates
80
05/2000
11/2000
05/2001
11/2001
05/2002
11/2002
05/2003
11/2003
05/2004
11/2004
05/2005
11/2005
05/2006
11/2006
05/2007
11/2007
05/2008
11/2008
05/2009
09/2009
04/2010
05/2011
08/2011
short term
0.04 0.05 0.02 0.02 0.03 0.03 0.02 0 0.02 0 0.02 0.02 0.04 0.04 0.057 0.073 0.075 0.077 0.048 0.039 0.029 0.016 0.15
long term
0.171 0.17 0.128 0.134 0.134 0.136 0.06 0.134 0.156 0.142 0.13 0.148 0.192 0.167 0.168 0.16 0.134 0.139 0.142 0.132 0.131 0.115 1.02
0.10
0.30
0.50
0.70
0.90
1.10
Japan rates
81
The ECB’s president argues that its most valuable asset is information,
not money.82
GNP
CONSUMERS
LABOUR
ENTREPRENEURS
Offer
WHAT?HOW?
FOR WHOM?
Demand
Demand
Offer
Government Central Bank
About 200 years ago Adam Smith defined what, in his view, should be the role for a government.
“First”, he said, “providing for national defence, second, administering justice through a court system; third, maintaining public institutions and resources such as roads, canals, bridges, educational systems, and the dignity of the sovereign.”
(d) The intervention of the government
(d) The intervention of the government
From the end of the 19th century the economic functions of the state developed without interruption in almost all of the industrialised countries.
Today, simultaneously public and private institutions exert control.
(d) The intervention of the government
The state intervenes, as a spending prone economic agent, to improve the real or nominal income of certain citizens. (For example the minimum income level are nowadaysamong the usual objectives of the public authorities).
The State, all things considered, behaves exactly like any other large consumer or investor or entrepreneur.
(d) The intervention of the government
Keynes recommended, in addition to state intervention resorting to budget deficits to stimulate the economy, to spend thus more than the receipts and to borrow to finance this extra expenditure.
Many states did pursue this economic policy only too well with a resulting high inflation and/or a high
indebtedness as a result.
(d) The intervention of the government
One of the functions of the state consists in attenuating the acute or chronic crises of unemployment or inflation as well as promoting the economic growth.
(d) The intervention of the government
The balance of payments is a good source in this respect.
It reveals the overall situation of the economy and provides an excellent idea of the economic activity by both the state and the consumers and producers.
(d) The intervention of the government
Trade in goods balance -20
Plus Trade in services balance 4
Plus Transfer payments 2
Plus Investment income 6
Equals CURRENT ACCOUNT -8
Equals CAPITAL ACCOUNT 5
Plus Balancing item 3
BALANCE OF PAYMENTS 0
91
(d) The intervention of the government
A surplus in the overall balance will indicate a probability of a strong and stable currency, of a healthy economy with stable interest rates, where the investment climate should be favourable.
Deficits can occur. During recessions, balanced budgets are probably not the best thing.
Over the course of the business cycles budgets should be balanced.
(d) The intervention of the government
With huge non-funded pension liabilities, European governments will struggle to keep their budget deficits within the limits they agreed to when joining the Euro.
The solution has to do with welfare reform rather than tax harmonisation
The real problem in the EU is that taxes on labour are very high, probably too high. The answer to that is not tax harmonisation but the reform of the welfare state.
(d) The intervention of the government
The national debt is a relatively new and impressive event.
On the positive side, a national debt undeniably allows for internal transfers between individuals of the same age or different age.
On the negative side, an external national debt constitutes a real charge for the economy and a limitation to the national consumption.
(d) The intervention of the government
95
Intérêts& Capital
Time
The law of compounded interest
96
At 10 % p.a. = capital & int. Double in 7,2 years.
(e) Money and the financial markets
The art of asking questions…..
(e) Money and the financial markets
98
What might be the difference between
those markets?
1. The money market2. The capital market3. The foreign exchange
market4. The stock market5. The future market
Discussion
(e) Money and the financial markets
The art of asking oneself questions
(e) Money and the financial markets
The market is available for financial transactions up to one year for the professionals of the financial sector.
Periods are standard and the computation of interest is done on an exact day count basis.
Beyond one year one talks about the capital market.
(e) Money and the financial markets
1. Money Market
Quotations are with bid and offer rates- for instance 2.25 – 2.35 for a given period;
This means that if you would call a bank you:
Could place money at 2.25 less the margin of the bank & Could borrow at 2.35 plus the margin of the bank (providing a contractual framework).
(e) Money and the financial markets
1. Money Market
The capital market comprehends transactions beyond one year.
Rates reflect the inflation expectations of the market participants, mainly the governments and institutional borrowers and lenders.
The main instrument used to raise long term capital is a bond.
(e) Money and the financial markets
2. Capital Market
Bond pricing is determined by:• the rating of the issuer, • the rating of the bond, • the market’s appetite for a certain rate or
borrower, • the placement power of the underwriters, • the commissions, • the tenor of the bond, …
(e) Money and the financial markets
2. Capital Market
Present Value (PV) & Future value (FV) of money
What will be the purchasing power of 100 € in year from now?
(e) Money and the financial markets
2. Capital Market
105
Future value (FV) = Present value x interest ratePresent Value (PV) = Future value (FV) x discount factor
Discount factor for one year =
Discount factor for two years =
21
1
r
r1
1
(e) Money and the financial markets
2. Capital Market
106
Bond pricingPlease note what would happen with a 3 % and with a 10 % discount rate!
(1.07)³
100.000
(1.07)³
10.000
(1.07)²
10.000
1.07
10.000
107.83681.6008.1608.7309.346
(e) Money and the financial markets
2. Capital Market
Price
Interest rate
(e) Money and the financial marketsBond Price
SS&&PP RRaattiinngg MMooooddyy’’ss EEqquuiivvaalleenntt
DDeeffaauulltt PPrroobbaabbiilliittyy ((SSuubbsseeqquueenntt yyeeaarr))
AAAAAA AAaaaa 00..0022
AAAA AAaa33//AA11 00..0055
AA AA22//AA33 00..0088
BBBBBB BBaaaa22 00..2288
BBBB BBaa11//BBaa22 11..5533
BB BBaa33//BB11 77..2288
CCCCCC BB22//BB33 1144..0000
CCCC BB33//CCaaaa 1177..0000
CC CCaaaa//CCaa 1188..2255
(e) Money and the financial marketsCredit risk – credit ratings
Samuelson’s circle shows a closed economy.
When a consumer purchases a piece of equipment in another economic/currency system, he will need to exchange his national currency into the foreign one.
(e) Money and the financial markets
3. Foreign Exchange Market
€ $Consume
r
Market
(e) Money and the financial markets
3. Foreign Exchange Market
• The seller could accept the currency of the buyer and change the currency in his home country.
• When would he choose that option?
• What determines the value of a currency?
(e) Money and the financial markets
112
3. The foreign exchange markets
Discussion
The foreign exchange market is the largest market in the world. It is an over the counter market, regulated by a strict code of conduct.
The daily turnover is now close to an estimated $4.000.000.000.000.
(e) Money and the financial markets
3. Foreign Exchange Market
It is by large the largest market in the world and the most unpredictable, although theoretically there is a fundamental link between the interest rates, the balance of payments of countries and the exchange rates of their currencies.
(e) Money and the financial markets
3. Foreign Exchange Market
EUR / USD 1.39458 - 1.39475
Prices are quoted as shown:The EUR is the unit - buyer & selling side
(e) Money and the financial markets
3. Foreign Exchange Market
The dealer which is being called quotes:
EURO / USD 1.39458 – 1.39475
1.39458 is the buying side = the rate at which he is willing to purchase EURO against USD
1.39475 is the selling side = the rate at which the dealer is willing to sell EURO against USD
(e) Money and the financial markets
3. Foreign Exchange Market
The dealer which is being called quotes: EURO / USD 1.39458 – 1.39475
Settlement needs to be done in two working days - physical exchange
$
€
Settlement risk !
(e) Money and the financial markets
3. Foreign Exchange Market
Inflation - Interest rates & Foreign Exchange
1970 : £ = 120 FLUX = € 32003 : £ = 66 FLUX = € 1.602011 : £ = 50 FLUX = € 1.10
There is a relationship between the inflation and theinterest rate and the exchange rate
(e) Money and the financial markets
The key economics indicator : the exchange rate
Difference in interest rate
Expected difference in
inflation rate
Difference between
forward & spot rate
Expected change in spot rate
equals equals
equals
equals
(e) Money and the financial markets
The key economics indicator : the exchange rate
(e) Money and the financial markets4_ Stock Market
(e) Money and the financial markets
4_ Stock Market
Forward Future
Specific amounts Standard amounts
Over the counter Organised market
Settlement risk Off-setting is easy
Up to 12 months Up to what the market will bear
(e) Money and the financial markets
5_Futures Market
122
The name derivative comes from the fact that the profit or loss is derived from the fluctuation of another product called the “underlying” product
(e) Money and the financial markets
5. Futures and derivatives Market
The underlying product might be a raw material such as wheat, petrol, but could also be shares or bonds, a portfolio, and so on.
A derivative could be an option to purchase or to sell something at a later date at a certain price.
(e) Money and the financial markets
5. Futures and derivatives Market
The prices of the derivatives will fluctuate in line with:
1. The interest rate2. The volatility of the underlying instrument3. The time 4. The actual price of the underlying instrument5. The price at maturity of the contract
(e) Money and the financial markets
5. Futures and derivatives Market
“People often talk about financial markets as if they were casinos, but they are more dangerous than any gambling den. The numbers on a roulette wheel never change, but markets offer no guarantee that yesterday’s odds will be the same tomorrow. 126
(e) Les marchés financiers
0
20
40
60
80
100
120
140
160
180
Q1 Q2 Q3 Q4 Q5 Q6 Q7 Q8 Q9 Q10 Q11 Q12
Interest shares GDP Bonds
(e) Money and the financial markets
Market Fundamentals
0
20
40
60
80
100
120
140
160
180
Q1 Q2 Q3 Q4 Q5 Q6 Q7 Q8 Q9 Q10 Q11 Q12
Interest shares GDP Bonds
(e) Money and the financial markets
Market Fundamentals
0
20
40
60
80
100
120
140
160
180
Q1 Q2 Q3 Q4 Q5 Q6 Q7 Q8 Q9 Q10 Q11 Q12
Interest shares GDP Bonds
(e) Money and the financial markets
Market Fundamentals
What would happen in extreme economic deterioration, characterised by hyper-inflation?
(e) Money and the financial markets
Discussion
0
50
100
150
200
250
300
350
Q1 Q2 Q3 Q4 Q5 Q6 Q7 Q8 Q9 Q10 Q11 Q12
Interest shares GDP Bonds
(e) Money and the financial markets
Market Fundamentals
132
The schedule of the day
Morning - (a) The economic circuit- (b) The economic cycles- (c) The intervention of the central bank - (d) The intervention of the government- (e) Money and the financial markets
Afternoon (1) The key economic indicators (2) Economic highlights of today
Products & Services
GNP
CONSUMERS
Salaries, interest, rentalsLABOUR
ENTREPRENEURS
Offer
WHAT?HOW?
FOR WHOM?
Demand
Demand
Offer
Government Central Bank
(1) The key economic indicators1. Measuring economic
activity2. Growth3. Population, employment
and unemployment4. Fiscal indicators5. Consumers6. Investment and savings7. The balance of payments8. The exchange rates9. Money and the financial
markets10. Prices and wages
(1) The key economic indicators Consumption
(1) The key economic indicators Investments and Savings
(1) The key economic indicators Economic activity
The gross domestic product is measured per quarter and is often expressed as a percentage increase or reduction compared with the previous quarter.
The change is often annualised.
One speaks about a recession when the GDP falls two quarters in a row.
(1) The key economic indicators Growth
140
(1) The key economic indicators Growth
(1) The key economic indicators Growth
GNP
CONSUMERS
LABOUR
ENTREPRENEURS
Offer
WHAT?HOW?
FOR WHOM?
Demand
Demand
Offer
Government Central Bank
(1) The key economic indicatorsPopulation, employment & unemployment
(a) The economic circuit
(1) The key economic indicatorsExchange rate
(1) The key economic indicators Fiscal indicators
(1) The key economic indicators The balance of payments
(1) The key economic indicators Fiscal indicators
Government spending as percentage of national income in G7 countries
2000 2010
France 51.6 55.9
UK 36.6 52.5
Italy 46.1 51.6
Germany 45.1 47.9
Canada 42.0 43.2
United States 33.9 41.6
Japan 39.0 40.8
(a) The economic circuit
What are the recent
economichighlights?
Discussion
151
152
(2) The economic highlights of today
“WE ARE A MOONWALKER NATION”
President Obama visits Facebook on the 20th of April 2011
154
156
157
158
159
160160
(2) The economic highlights of today
Most crisis do not detonate like bombs – they emerge:
What could be their indicators?
(2) The economic highlights of today
Most crisis do not detonate like bombs – they emerge:
What could be there indicators?
° fraud, waste, abuse
° disinformation
° financial indicators
° economic indicators
° lack of common sense
1. Aging2. Far-East3. Connectivity4. “GRIN”
technologies5. Environnemen
t
(genetics, robotics, internet, nano technology)
The trend
163
Conclusion
Economics is the study of choice. It does not tell us what to choose. It only helps us understand the consequences of our choices.
“New Ideas from dead economists”, Todd Bucholz
Sources
Sources
Bibliography
“Pocket Economist”, M Bishop, The Economist Books,2000“Economics” Paul Samuelson, Armand Colin ( old French edition), 1964“Economics for Professional Investors” Tim Lee, Prentice Hall Professional Finance series, 1998“New Ideas of Dead Economists”, Todd Bucholz, Plume, 1990“The world is flat”, T. Friedman, Penguin, 2006 “The dead of inflation” R.Bootle, Nicholas Brealey, 1996“International Economics, P. Krugman & M. Obstfeld, Addison Wesley Longman,1995
169
AddendumInterventions & Ideas for the financial sector
Interventions in 2008 - 2009
1. Bank deposit guarantee2. Bank recapitalisation3. Purchase of poor quality assets4. Liquidity guarantee5. Lending guarantee6. Mergers7. Investment banks accepting commercial bank
regulations8. Stress test
9. Short selling crack down 10. Derivatives regulations11. Interest rates decrease12. Help for municipalities and households13. Corporate tax cuts14. Tax rebates for individuals15. Infrastructure improvement programs16. IMF 17. EU Supervision
Interventions in 2008 - 2009
18. Accounting rules19. Credit rating agencies20. Executive pay21. Private equity22. Credit card regulations23. Product transparency 24. Off-shore centres
Interventions in 2008 - 2009