every transaction: credit ($in) - debit ($out) current account - -> G+S/Y/current transfer balance - -> sum > 0 = surplus capital account --> capital/ debt/ changes in non financial assets financial account direct I/ portfolio I abroad/ other I foreign exchange reserves

BALANCE OF PAYMENT Flashcards by JM L

CURRENT ACCOUNT DEFICIT

measures flow of funds between a nation and the rest of the world for the purchase of G+S

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FOREIGN EXCHANGE RESERVES

asset of other nations held by a country’s central banks

reserves consist primarily of foreign assets: gov bonds and foreign currency

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CAPITAL ACCOUNT

records transactions involving ownership of capital, forgiveness of debt, or the acquisition and disposal of non- produced, non- financial assets between a nation and all other nations

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FDI

buying and selling of a min 10% of a company’s shares by a foreign investor in dom economy or by dom investor in another nation’s economy

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FINANCIAL ACCOUNT

measures the exchanges between a nation and the rest of the world involving ownership of financial and real assets

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CURRENT ACCOUNT SURPLUSES

when the nation’s total export revenue exceeds total expenditure on imports X>M :)

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RELATIONSHIP BETWEEN THE ACCOUNTS

current + capital+ financial + changes in official reserves = 0
or
current= - (capital+ financial + changes in official reserves)

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BALANCE OF PAYMENTS

measures all the economic transactions of its economy with the rest of the world, including trade in G+S, financial transactions involving ownership of assets and transfers of capital between nations

–> current account: trade of G+S/ flow of Y

–> capital account: transfer of ownership of capital G

–> financial account: flow of funds for I in real assets or financial assets

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CURRENT ACCOUNT DEFICITS

“when a nation spends more on M (G+S) than it earns from sale of X… M>X”

effect on exchange rate…
when one nation d(X) > other D(M) from them
= upward pressure on the value of trading partner’s currency
= downward pressure on importing nations currency

thus, a current account deficit causes a country’s currency to weaken

LR: self correcting as there is an increase in the price of M and decrease in the price of X

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CURRENT ACCOUNT

HOW TO MEASURE BOP

balance of trade in goods
credit +: export input
debit: - import leakage

balance of trade in services
+: bought by foreigners (tourism) from dom P
-: purchased from foreigners and consumed by doms

Y balance
+ wage from abroad sent home
- wage to foreign workers sent abroad + IR

current transfer balance
+ official/ private transfer from foreigners to dom gov
- official/private transfer within nation to foreign gov

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CAPITAL ACCOUNT

HOW TO MEASURE BOP

Capital transfers
when a nation’s gov/ private sector donates money to another for the purchase of fixed assets of directly donate capital goods to residents
–> credit: recipient
–> debit: donors

Debt forgiveness
debt owed and forgiven
–> credit: debtor
–> debit: lender

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HOW BOP IS MEASURED

every transaction: credit ($in) - debit ($out)

current account

-> G+S/Y/current transfer balance
-> sum > 0 = surplus

capital account
–> capital/ debt/ changes in non financial assets

financial account
direct I/ portfolio I abroad/ other I

foreign exchange reserves

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FINANCIAL ACCOUNT
HOW TO MEASURE BOP
FDI/portfolio I/other I (loans)

direct investment (FDI)
abroad +: dom sells shares to foreign: inflow of $
abroad -: dom buy shares abroad: outflow
home +: foreign I in dom shares: increasein inflow
home -: foreigners sell their shares ownership to dom

portfolio I abraod (<10% I… dif to FDI)
abroad + dom investors sell asset, foreigners pay dom
abroad - dom investors buy foreign assets= payment
home +:foreign inv. buying dom securities: payment
home-: foreign inv sell dom securities to dom who must make payment

other investment
loans from dom banks to foreign borrower and savings by dom households in foreign bank= assets (+) for home country –> foreigners interests owe $ to dom

domestic borrowing from foreign bank and foreign savings in dom banks= liabilities (-) for home nation and asset for foreign nation

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MARSHALL LERNER CONDITIONS ASSUMPTIONS

the current account measures the REVENUES from the sale of X - the EXPENDITURE on M
total rev of net exports (TRXn) increases if X grows faster than M, and decreases vice versa
if a nation’s currency depreciates, it’s current account balance tends to improve, or move towards surplus
- -> as X is more appealing due to cheaper currency and M more expensive= increases (X-M)

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MARSHALL LERNER CONDITION AND THE J CURVE EFFECT (SR and LR effect of a depreciation)

when a nation’s currency depreciates…

SR
E.R decrease–> increase in (X-M)
–>depends on PEDXn
PEDXn<1= deficit (time, preferences)
domestic consumers need time to decrease M and foreign C need time to take notice of cheaper X
= deficit as they buy the same amount of more expensive M and sell the same amount of cheaper X

LR
PEDXn >1
more responsive consumer
substitute M with X
increase (X-M)= surplus

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IMPLICATIONS OF A PERSISTENT CURRENT ACCOUNT DEFICIT

FOREIGN OWNERSHIP OF DOM ASSETS

deficit: M>X= increase exporting ownership of financial/real assets: increase FDI and gov debt

IMPLICATIONS OF A PERSISTENT CURRENT ACCOUNT DEFICIT

INTEREST RATES

INTEREST RATES
attractiveness to foreign I
current account deficit= downward pressure on exchange rate= imported inflation: contractionary monetary policy= increase IR to attract FDI

IMPLICATIONS OF A PERSISTENT CURRENT ACCOUNT DEFICIT

INDEBTEDNESS

current account deficit= financial account surplus
source of credit in FA is foreign ownership of dom gov bonds= debt
when a central bank from another nation buys gov bonds form a nation with which it has a large CA surplus, the deficit nation is essentially going into debt to the surplus nation

:) foreign lending to a deficit nation benefits the deficit nation because it keeps the demand for gov bonds high and interest rates low, which allows the deficit country’s gov to finance its budget w/o raising taxes on domestic households and firms

:(
every dollar borrowed from a foreigner has to be repaid with interests.
Interest payments on the national debt costs US tax payers $400 billion in 2010, (10% of federal budget), and half of this went to foreign holders of US debt, thus $200 billion dollars of US taxpayers money was handed over to foreign interests, w/o adding a single dollar to AD

IMPLICATIONS OF A PERSISTENT CURRENT ACCOUNT DEFICIT

EFFECT OF INTERNATIONAL CREDIT RATINGS AND DEMAND MANAGEMENT

a large CA deficit requires a nation to run a FA surplus, which may consist of foreign ownership of the nation’s gov debt
over time the deficit financed through foreign borrowing reduce the attractiveness of the deficit country’s gov bonds to foreign investors, harming its international credit rating, forcing the gov to offer ever increase IR to foreign lenders
–> reduces ability to manage AD

EFFECT OF A CURRENT ACCOUNT SURPLUS ON DOMESTIC CONSUMPTION AND SAVING

imply that over time households are consuming at a lower level than households in deficit nations

money earned form sale of X but not spent on M
= money saved by nation with trade surplus

china X>M = nearly half of chinese output is not consumed by chinese households but by foreigners

a trade deficit nation may consume more than it produces through M

EFFECTS OF A CURRENT ACCOUNT SURPLUS ON THE EXCHANGE RATE

X>M
increase demand for nation's currency
=appreciation
decrease supply of nation's currency (as nation demands less foreign G/ M as they are more costly)
= appreciation

with time appreciation = less competitive
force dom producers to be more efficient or shut down
as foreign demand of their good will decrease

China: floating E.R and gov intervention
pegged to the US $ not allowed to appreciated

NEED FOR GOV INTERVENTION

EFFECT OF DEPRECIATION ON X AND M WHEN INELASTIC

DEPRECIATION MAY WORSEN A CURRENT ACCOUNT DEFICIT

market for country Z’s exports
cheaper X due to weaker currency but because it is inelastic overall revenue decreases

market for country Z’s M
more expensive M but because M is inelastic overall expenditure increases

OVER TIME IT COULD BECOME MORE ELASTIC?

EFFECT OF DEPRECIATION ON X AND M WHEN ELASTIC

DEPRECIATION MAY MOVE A COUNTRY TOWARDS CA SURPLUS
cheaper X due to weaker currency = greater demand
increase p(M)= decrease demand
increase (X-M)

EVALUATING THE GLOBAL TRADE IMBALANCE

continued decline in secondary/tertiary sectors in the west

continued dependence of M for deficit nations will completely wipe out remaining manufacturing sector jobs in Western Europe, the US and other countries with large trade deficits due to increase in free trader as people can get cheaper goods abroad

EVALUATING THE GLOBAL TRADE IMBALANCE | persisting poverty in developing countries

from the exporting nation's perspectives, persistent trade surpluses promise continued economic growth, but such export - orientated growth may come at the expense of improvements in the typical household's standard of living it this growth is continually fueled by more and more investment abroad FA deficits in these nations mean that households are forced to consume less that they would be able to if their currencies were allowed to appreciate and the current account were in better balance. Increased imports to countries like China may mean slower growth as their X sectors adjust to more competition from abroad, but it would also mean higher standard of living for the household as they begin to enjoy the increased purchasing power of their stronger currencies and the variety of M goods

EVALUATING THE GLOBAL TRADE IMBALANCE | the threat to economic sovereignty

continued increased ownership from foreigners of dom assets from FA surplus= US assets increasingly owned by foreigners

EVALUATING THE GLOBAL TRADE IMBALANCE | blame it on the RMB

china's policy of directly managing ER of RMB relative to the US $ = increase disruption in efficient allocation of R weak RMB = v. hard for american producers/ LEDCs to compete only when RMB is allowed to appreciate against $ and other currencies will it decrease the imbalance +ve others: more competitive +ve: increase buying power as they decrease P(M)

In the SR an increase in a budget surplus is most likely to reduce

CURRENT ACCOUNT

a measure of the flow of funds from trade in goods and services (value of exports minus imports), plus net income flows (profits, interest, wages, rents) and net transfers of money (foreign aid, grants, pensions, etc).

RECESSION

it occurs when an economy experiences two consecutive quarters of falling output (negative growth).

BUSINESS CONFIDENCE

expectations of businesses about the future of economic conditions, (which may be optimistic or pessimistic) and affects the level of investment.

DEFLATION

is a sustained decrease in the average level of prices in an economy.

explain a possible effect of the overvalued yen

For drawing a correctly labelled AD/AS diagram showing a fall in aggregate demand and for explaining that the overvalued yen results in a fall in the demand for exports (or an increase in the demand for imports) therefore a fall in AD, and a fall in real GDP and/or a fall in the average price level and/or an increase in unemployment.

diversification

An explanation that it is a strategy to increase the variety of goods and services produced in order to avoid (the risks associated with) over-specialisation.

why could GNI be greater than GDP

An explanation that there must be a positive figure (balance) for net property income (current transfers).

fdi benefits

supplement local savings/fill savings gap bring in more foreign exchange improve on technical skills and technology hiring and training of local workers improve on management skills /positive externalities of production with supporting diagram increase exports increase in AD with supporting diagram greater tax revenues may be used to finance development objectives

fdi costs

inappropriate infrastructure geared toward MNC needs bypassing of labour protection laws the “race to the bottom” as countries compete to host MNCs depending on the conditions, each of the potential benefits may not materialize

FD1 MS def

investment by a multinational corporation long term investment in another country investment in productive capacity in another country investment in another country representing at least 10% ownership.