BALANCE OF PAYMENT Flashcards
CURRENT ACCOUNT DEFICIT
measures flow of funds between a nation and the rest of the world for the purchase of G+S
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
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
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
FINANCIAL ACCOUNT
measures the exchanges between a nation and the rest of the world involving ownership of financial and real assets
CURRENT ACCOUNT SURPLUSES
when the nation’s total export revenue exceeds total expenditure on imports X>M :)
RELATIONSHIP BETWEEN THE ACCOUNTS
current + capital+ financial + changes in official reserves = 0
or
current= - (capital+ financial + changes in official reserves)
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
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
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
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
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
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
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)
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
IMPLICATIONS OF A PERSISTENT CURRENT ACCOUNT DEFICIT
FOREIGN OWNERSHIP OF DOM ASSETS
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
AD
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.
