Capital Flows Flashcards
What is Financial Globalization
It measures the freedom of capital flows expressed as (EX-IM)/GDP
de Jure vs de Facto Financial Openness
de Jure: What are restrictions to international capital movements?
de Facto: How much international trade in financial assets?
Types of assets
-Portfolio investment
-Foreign Direct Investment (FDI)
-Other investments
-Derivatives
-Reservs
What is Portfolio Investment
Buying shares of a company in another country (debt), or government bonds
What is Foreign Direct Investment
Greater than 10% ownership in a foreign company
What are Other Investments
Cross border bank lending through bank loans and trade credit
What are Reserves
Savings or liquid funds
What does the Chinn-ito index show about de Jure financial openness?
Chinn-ito index shows movement towards greater openness with -2.5= completely closed and 2.5= completely open. However, more so for developed than developing economies.
What are Flows
The value of assets traded for a year:
-represented as Inflows/GDP and Outflows/GDP
What do Inflows/GDP represent
The net purchase of domestic assets by foreign investors
What do Outflows/GDP represent
The net purchase of foreign assets by domestic investors
What are Stocks
The value of all assets held in a year (cumulative of flows)
How to calculate Stocks over multiple years
-At = At-1 + at
-At = At-2 + at-1 + at
-etc
How to calculate International Integration Measure
(Inflows + Outflows)/GDP
Between Flows and Stocks; what is more volatile
Flows are more volatile, especially in crisis (ex. 2008 collapse was accelerated by banks pulling out capital in foreign markets)
What does the Solow model explain about the first financial globalization
Capital-scarce countries should have a high return on capital (capital flows from capital abundant countries to capital scarce countries)
what is the Solow model equation
yt=At(kt)
-At= efficiency parameter (technology) or TFP (Total Factor Productivity)
-kt= capital
-yt= output (produced using inputs more or less efficiently)
What is the Marginal Productivity of Capital (MPK)
-The additional unit of output per unit of capital (return on capital)
-In aggregate: decreasing returns (MPK = derivative of yt/ derivative of kt)
What is the Washington Consensus
Collection of ideas in 1990’s aimed at modernizing, reforming, deregulating and opening economies.
What is the Lucas Puzzle
Capital flows towards developed countries from developing countries rather than the other way around.
What is the explanation of the Lucas Puzzle
That Solow’s TFP=A is not constant, but rather much higher in developed countries causing capital to flow there.
What is International Risk Sharing (risk diversification)
If investors are risk-averse they will diversify investments into multiple countries
Are financial markets globally integrated?
Investors still tend to hold large share of investments either domestically or geographically close.
What does the equation Y= C+I+G+EX-IM represent?
National Income identities
Difference between GDP and GNI?
-GDP is the value of all final goods and services produced within the national border (products)
-GNI is the value of all final goods and services produced by national factors of production (income)
How to calculate GNI
GNI = GDP + NFI (Net receipts of Factor Income in Rest of the World)
How to calculate NFI
NFI = Income residents receive from abroad - income that foreigners receive from domestic country
What is the Current Account (CA)
A nations transactions with the rest of the world
How to calculate Current Account
-CA= EX - IM +NFI –> = S-I
- CA = S-I or EX - IM + NFI
CA surplus vs deficit
-CA surplus: the country is saving more than investing (lending money to the world)
-CA deficit: the country is spending more than investing (borrowing money from the world)
What is the Balance of Payment (BOP)
the register of all economic transactions with foreign economic agents
How to calculate BOP
-CA + FA (Financial Account) + KA (Capital Account)
-must =0
How to calculate Foreign Accounts (FA)
-Records flow of financial assets (FDI, NPF, and Net Other)
-FA= Inflows - Outflows
How to calculate Capital Accounts (KA)
-Records flow of non-financial assets (ex. debt forgiveness)
-KA= non-financial Inflows - non-financial Outflows
What two factors drive Current Accounts
-Consumption Smoothing: If anticipated future income is high, countries will run a current account deficit
-Demographics: Ageing countries should save and run current account surpluses
What causes domestic distortions of CA
-Too high private savings: lack of social insurance, lack of financial development
-Too low private savings: asset bubbles, excessive leverage
What causes systemic distortions of CA
eg. After the Asian Crisis, emerging markets ran a CA surpluses were so large that they drove down interest rates and incentivized over-borrowing
What is an explanation for the Chinese Saving Puzzle
Domestic financial distortions, artificial ageing, and lack of social insurance
How to Calculate Net External Position (NFA)
-NFAt= NFAt-1 + CAt
-if a country runs CA deficit, NFA deteriorates
What are capital gains or losses
-Changes in the value of assets and liabilities, influenced by the market value or exchange rate
-NFAt - NFAt-1 = CA + capital gains or losses
What is the US exorbitant privilege
-Gourinchas and Rey: return on US assets held by foreigners (US debt) is less than the return on foreign assets held by the US
What is exorbitant duty
The consequence of exorbitant privilege when there is a financial crisis
What is an external adjustment
-Mechanisms used to close CA deficit
- 2 types: Trade Channel and Financial Channel
What is the Trade Channel
-consume less than what is produced
-run trade surplus
What is the Financial Channel
-Make capital gains on NFA
-higher return on foreign assets
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