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May, 2014

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Understanding the Evolution of International Capital Mobility

The broad trends and cycles in the world capital market over the last century reflect changing responses to the fundamental policy trilemma. Before 1914, each of the world’s major economies pegged its currency’s price in terms of gold, and thus, implicitly, maintained a fixed rate of exchange against the currency of every other major country. Financial orthodoxy saw no alternative mode of sound finance. Latin American interludes of floating exchange rates were viewed from the main financial centers with “fascinated disgust,” to use the words of Bacha and Diaz-Alejandro (1982).

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Alternatively, Austria could maintain freedom of private capital movement but allow the schilling/mark rate to float. In that case, Austria would be free to lower its interest rates, but the schilling would depreciate against the mark as a result. Both developments would tend to spur aggregate demand for Austrian output.

The limitations that open capital markets place on exchange rates and monetary policy often are summed up by the idea of the “inconsistent trinity” or, as Alan Taylor and I have labeled it, the “open-economy trilemma” (Obstfeld and Taylor, 1998): that is, a country cannot simultaneously maintain fixed exchange rates and an open capital market while pursuing a monetary policy oriented toward domestic goals. Governments may choose only two of the above. If monetary policy is geared toward domestic considerations, either capital mobility or the exchange rate target must go. If fixed exchange rates and integration into the global capital market are the primary desiderata, monetary policy must be subjugated to those ends.

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It is a trite but true assertion of international monetary economics that the exchange rate is an open economy’s most important price. The United States has become ever more open to trade since the end of World War II, as Robert Feenstra documents in his article in this symposium. Exchange rate movements therefore have increasingly become a cause for public and official concern.

Fundamental Tradeoff

In most of the world’s economies, the exchange rate is a key instrument, target, or indicator for monetary policy. An open capital market, however, deprives a country’s government of the ability simultaneously to target its exchange rate and to use monetary policy in pursuit of other economic objectives. As an example, consider Austria, which for more than two decades has pegged the exchange rate between its currency, the schilling, and the German mark. Since market participants understand that the exchange rate will not change by more than a few basis points, nominal interest rates in Austria must closely match those in Germany. The rates are kept in line by arbitrageurs who would massively borrow in the currency with the lower interest rate and lend in the currency with the higher interest rate, confident that their gains will not be erased by a movement of the exchange rate. But equality of interest rates also means that Austria cannot conduct a monetary policy independent of Germany’s; both Austria’s exchange rate and interest rate will be determined exogenously. Since it is Austria (and not Germany) that is pegging the exchange rate, the Austrian central bank has only one monetary role, to offset any incipient change in the schilling’s exchange value against the mark.

Austria can regain an independent monetary policy in two ways. If it could prohibit any cross-border financial transactions, Austria would cut off the arbitrageurs and decouple its interest rate from Germany’s, but could still maintain the fixed exchange rate. In that case, Austria might unilaterally lower its interest rates, for example, but investors no longer would have the right to move funds from Vienna to Frankfurt in response to the resulting return differential. Pressures in the foreign exchange market would be limited to mark demands from Austrian importers and from exporters to Austria wishing to convert their schilling earnings into marks. Any exchange-rate effect of these trade-driven demands for marks, which are orders of magnitude below the potential demands associated with international financial flows, could normally be offset by sales of Austrian official mark reserves as necessary.

THE GLOBAL CAPITAL MARKET: The Integration of Global Capital Markets 3

Figure 1 offers another indicator of capital mobility, the standard deviations of the difference between one-year interest rates on sterling-denominated assets sold in New York and those sold in London. (See Obstfeld and Taylor, 1998, for data on levels of mean annual interest differentials.) The interest differential, as well as is variability, should equal zero if capital mobility between the two centers is perfect, but these measures can deviate from zero in the presence of transaction costs, political risks, and other barriers to the free flow of money. In practice, differences in the American and British financial instruments chosen for comparison also can lead to interest differences. By focusing on return standard deviations, I downplay such discrepancies, which are not necessarily evidence of financial-market segmentation.

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THE GLOBAL CAPITAL MARKET: The Integration of Global Capital Markets 2

Given the benefits of a global capital market, why was the market still so fragmented and limited in scope a full generation after the end of War II? It had not always been so. Until World War I, a vibrant, free-wheeling capital market linked financial centers in Europe, the western hemisphere, Oceania, Africa, and the Far East. A nineteenth-century reader of the Economist magazine could track investments in American railroads, South African gold mines, Egyptian government debt, Peruvian guano, and much more. The laying of the trans-Atlantic cable in 1866 reduced the settlement time for intercontinental transactions from roughly ten days (the duration of a steamship voyage between Liverpool and New York) to only hours (Officer 1996, p. 166). This enormous communications advance of the era was perhaps more significant than anything that has been achieved since.

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THE GLOBAL CAPITAL MARKET: The Integration of Global Capital Markets

Economic theory leaves no doubt about the potential advantages of global financial trading. International financial markets allow residents of different countries to pool various risks, achieving more effective insurance than purely domestic arrangements would allow. Furthermore, a country suffering a temporary recession or natural disaster can borrow abroad. Developing countries with little capital can borrow to finance investment, thereby promoting economic growth without sharp increases in saving rates. At the global level, the international capital market channels world savings to their most productive uses, irrespective of location. The resulting economic gains are difficult to quantify, as I discuss in a moment, and may work through subtle mechanisms. For example, producers who can diversify risks in financial markets may undertake more high-yield but risky investments, increasing average rates of economic growth. In that case the welfare gains can be enormous (Obstfeld, 1994).

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The Asian financial turmoil of 1997 started as a seemingly localized tremor in far-off Thailand, but then swelled into a crisis with repercussions in stock markets on every continent. Both international lending institutions led by the International Monetary Fund, and national governments including those of the United States, Japan, and the European Union, joined in the policy response. The U.S. Federal Reserve, headed for monetary tightening in the fall of 1997, postponed its move for fear of destabilizing world markets further.

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Intercultural practices mean eradication of weed that adversely affects the crop yield. Different studies have highlighted much importance to interculture. For the present analysis, interculture has shown high significance. This variable has shown the highest t value (5.76) among all other included variables. The coefficient is the highest among all others variables included in the model. It explains that one rupee invested for interculture, will result in increase of rupees 21.60 in the total revenue.
Plant Protection
Application of pesticide covers plant protection. To save crop from pest attack, plant protection is very necessary. It further expresses that investing one rupee on plant protection; the total return will be increased by 1.20 rupees. Khuda bux, et al while analyzing the factor affecting cotton yield found the cost of plant protection measures had a positive effect on yield and this variable was highly significant with coefficient of 0.224.
Correlation Matrix
The correlation matrix indicates if there exists a linear relationship between two variables. The correlation coefficient value lies between 0 and 1. The value 0 depicts no relationship whereas value of 1 indicates perfect correlation. Table-3 explains the correlation between the variables.The correlation matrix explained in table-2 depicts that there is positive and high correlation between the variables. The diagonal matrix shows a value of 1 as the variable with itself has a perfect correlation.

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ECONOMIC ANALYSIS OF INPUT TREND IN COTTON PRODUCTION PROCESS IN PAKISTAN: METHODOLOGYThe data required for doing cost-benefit analysis have been collected from different organizations of Pakistan. These institutions include Punjab Economic Research Institute (PERI) Lahore, Cotton Research Institute Multan and Apcom, Islamabad. These organizations overtime have prepared cost of production of cotton. After collecting data, analysis is based on Cobb Douglas production function. The Multiple Linear regression has been used to study the impact of individual input on total return. The model functional form is:
Y = a + P1X1 + P2X2 + P3X3 + P4X4 +P5X5 + P6X6 + P7X7 +€
P’s are coefficient of the relevant input;
Where Y = Total income/revenue rupees per acreage.
X1= Cost of land preparation rupees per acreage X2= Cost of seed rupees per acreage X3= Cost of irrigation rupees per acreage X4= Cost of interculture rupees per acreage X5= Cost of the fertilizer used rupees per acreage X6= Cost of the plant protection rupees per acreage Bs=Coefficient of the variables € =error term a = constant
Cost-Benefit Analysis
The cost benefit has been calculated using following formula. Total benefit is termed as Net Return.
TC = Total Cost of production TR = Total revenue earned Net Return = TR-TC

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The higher return is an incentive for the grower to put more area under cotton. However the increasing cost of inputs and lower crop return have forced the cotton growers to switch over to other crops like rice etc.There had been upward and downward trend in yield and production also.
Production depends on area under cotton and per acre yield. Although, the per acre cotton yield have experienced increasing trend from 1947 to 2008. However the after 1983-84 the yield trend increased at higher rate. The intensity of pest attack and adverse weather conditions are two major sources of yield reduction. Pakistan cotton production and yield since 1947 are shown in graph-3 and graph-4 respectively. read only
Significance of Cotton Production Inputs
The cotton production process involves use of various inputs including land preparation, inputs like seed, irrigation water, fertilizer, pesticide and labor etc. Overtime, the prices of these inputs have increased resulting higher cost of production. In addition the cotton crop is susceptible to various pests attack and natural hazards like rain, hail storm and humidity etc. Different studies have been carried out by experts regarding input impact on cotton yield and production. The individual input effects studies have also been conducted. Sabo E, Daniel j.D 2 while carrying out economic analysis of cotton found that among the cost of inputs variables, the highest cost was of labor ($453.68). Khuda bux, et al. while analyzing the factor affecting cotton yield found the cost of plant protection measures had a positive effect on yield and this variable was highly significant with coefficient of 0.224. Pakistan cotton yield remained sluggish up 1960. Afterward when green revolution was introduced and chemical fertilizers and new cotton varieties were introduced, the yield started increasing. During 1983-84 heavy rains badly damaged the crop and the country had to import cotton. During 1986 and up to 1992 the rate of textile mills installation increased at an increasing rate. The increasing trend of input use coupled with partial crop mechanization increased per hectare cost of production. It has been confirmed by various field studies that although the appropriate use of inputs has resulted in increased yield, but the farmer profit share have gradually been reduced.

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