Chapter 3 Flashcards
It’s the statistical record of a country’s international transactions over a certain period oftime presented in the form of double-entry bookkeeping.
Balance of payments.
What can the Balance of payments be used about?
- Providing detailed information about the demand and supply of a country
- A country’s balance-of-payment data may signal its potential as a business partner for the rest of the world.
- Balance-of-payments data can be used to evaluate the performance of the coun- try in international economic competition.
Examples of international transactions.
- Import and export of goods and services
- Cross-border investments in businesses, bank accounts, bonds, stocks, and real estate.
Since the balance of payments is recorded over a certain period of time (i.e., a quarter or a year), it has the same time dimension as…
The National income accounting.
Any transaction that results in a receipt from foreigners will be recorded as a…
Credit, with a positive sign.
These entries arise from purchases of foreign goods and services, goodwill, financial claims, and real assets.
Debits.
A country’s international transactions can be grouped into the following three main types:
- The current account.
- The capital account.
- The official reserve account.
It includes the export and import of goods and services.
The current account.
It includes all purchases and sales of assets such as stocks, bonds, bank accounts, real estate, and businesses.
The capital account.
It covers all purchases and sales of international reserve assets such as·dollars, foreign exchanges, gold, and special drawing rights (SDRs).
The official reserve account.
It represents a reduction in the country’s net foreign wealth.
A current account deficit.
A country with a current account surplus acquires IOUs from foreigners, thereby increasing its…
Net foreign wealth.
The current account is divided into four finer categories:
- Merchandise trade
- Services
- Factor income, and
- Unilateral transfers.
It represents exports and imports of tangible goods, such as oil, wheat, clothes, automobiles, computers, and so on.
Merchandise trade.
It represents the net merchandise export.
The trade balance.
The second category of the current account, include payments and receipts for legal, consulting, and engineering services, royalties for patents and intellectual properties, insurance premiums, shipping fees, and tourist expenditures.
Services.
These trades in services are sometimes called…
Invisible trade.
The third category of the current account, consists largely of payments and receipts of interest, dividends, and other income on foreign investments that were previously made.
Factor income.
The fourth category of the current account, involve “unrequited” payments.
Unilateral transfers.
Examples of unilateral transfers.
Examples include foreign aid, reparations, official and private grants, and gifts. Unlike other accounts in the balance ofpayments, unilateral transfers have only one-directional flows, without offsetting flows.
Examples of factor income.
If U.S. investors receive interest on their holdings of foreign bonds, for instance, it will be recorded as a credit in the balance of payments. On the other hand, interest payments by U.S. borrowers to foreign creditors will be recorded as debits.
Examples of services/invisible trade.
For example, X-ray pictures taken at a local hospital in the United States may be transmitted overnight via the Internet to an IT outsourcing center in India. Then, doctors there would examine the digital images and data and e-mail their diagnosis back to the U.S. hospital for a fee. In this case, the U.S. effectively imported medical service from India.
What happens when a country’s currency depreciates against the currencies of major trading partners?
The country’s exports tend to rise and imports fall, improving the trade balance.
Explain the J-curve effect.
Following a depreciation, the trade balance may at first deteriorate for a while. Eventually, however, the trade balance will tend to improve over time.
In how many percent of the cases did Sebastian Edwards confirmed the existence of the J-curve effect, after examining cases of devaluations from the 1960s through the 1980s?
In 40% of the cases.
It measures the difference between U.S. sales of assets (exports) to foreigners and U.S. purchases foreign assets (imports).
The capital account balance.
U.S. sales (or exports) of assets are recorded as credits, as they result in…
Capital inflow.
U.S. purchases (imports) of foreign assets are recorded as debits, as they lead to…
Capital outflow.
In the absence of the government’s reserve transactions, the current account balance must be…
Equal to the capital account balance but with the opposite sign. When nothing is excluded, a country’s balance of payments must necessarily balance.
Mention the three categories of the capital account:
- Direct investment
- Portfolio investment, and
- Other investment.
It occurs when the investor acquires a measure of control of the foreign business. In the U.S. balance of payments, acquisition of 10 percent or more of the voting shares of a business is considered giving a measure of control to the investor.
Direct investment.
Provide an example of foreign direct investment (FDI).
When Honda, a Japanese automobile manufacturer, built an assembly factory in Ohio.
The second category of the capital account, mostly represents sales and purchases of foreign financial assets such as stocks and bonds that do not involve a transfer of control.
Portfolio investment.
Why have International portfolio investments have boomed in recent years?
Partly, due to the general relaxation of capital controls and regulations in many countries, and partly due to investors’ desire to diversify risk globally.
What do portfolio investment comprise?
Equity securities and debt securities.
Type of securities that include corporate shares.
Equity securities.
What do debt securities include?
(1) Bonds and notes.
(2) Money market instruments.
(3) Financial derivatives like options.
Why do Investors diversify their portfolio investments?
To reduce risk.
It includes transactions in currency, bank deposits, trade credits, and so forth. These investments are quite- sensitive to.both changes in relative interest rates between countries and the anticipated change in the exchange rate.
Other investments.
How can statistical discrepancy happen?
Recordings of payments and receipts arising from international transactions are done at different times and places, possibly using different methods.
What do we obtain when we compute the cumulative balance of payments including the current account, capital account, and the statistical discrepancies?
Overall balance or official settlement balance.
Why is the overall balance significant?
Because it indicates a country’s international payment gap that must be accommodated with the government’s official reserve transactions.
It is also indicative of the pressure that a country’s currency faces for depreciation or appreciation.
What should the central bank of the country do when a country must make a net payment to foreigners because of a balance-of- payments deficit?
It should either run down its official reserve assets or borrow anew from foreign central banks.
Name examples of official reserve assets.
Gold, foreign exchanges, and SDRs.
It includes transactions undertaken by the authorities
to finance the overall balance and intervene in foreign exchange markets.
The official reserve account.
After 1945, however, international reserve assets comprise…
- Gold.
- Foreign exchanges.
- Special drawing rights (SDRs).
- Reserve positions in the International Monetary Fund (IMF).
When the balance-of-payments accounts are recorded correctly, the combined balance of the current account, the capital account, and the reserves account must be…
zero.
State the equation of balance-of-payments identity (BOPI).
BCA+BKA+BRA= 0
Where:
BCA = balance on the current account. BKA = balance on the capital account. BRA = balance on the reserves account.
What would be the equation with the pure flexible exchange rate regime?
BCA = -BKA.
What is a dirty floating exchange rate system?
A dirty float is an exchange rate regime in which the country’s central bank occasionally intervenes to change the direction or the pace of change of the country’s currency value.
It was originated in Europe during the period of absolute monarchies, holds that precious metals like gold and silver are the key components of national wealth, and that a continuing trade surplus should be a major policy goal as it ensures a continuing inflow of precious metals and thus continuous increases in national wealth.
Mercantilism.
How can a country can run a balance-of-payments surplus or deficit?
By increasing or decreasing its official reserves.
