Chapter 9: BOPFEX

Question 1

What is the national income account

Answer 1

The national income accounts records the value of national income that results from production and expenditure

National income is the income earned by a nation’s factors of production. An
approximate measure of national income is the gross national product (GNP).

Question 2

What is the gross national product (GNP)

Answer 2

Gross national product (GNP) is the value of all final goods and services produced by
a nation’s factors of production in a given time period.

Question 3

What is the national income adjusted for (list 3 things)

Answer 3

1. Depreciation of physical capital: Loss of income to capital owners
2. Income balance: difference between income received from rest of the world and paid to ROW

• net investment income: net income from capital
• net international payments to employees: net income from domestic labour working overseas and foreign labour working in country

3. Net unilateral transfer: payments of expatriate workers sent to their home countries
   (private remittances), pension payments sent to expatriate retirees, and foreign aid

Question 4

How to calculate gross national disposable income (list 4)

Answer 4

􏰀 1. Consumption (C): expenditure by domestic consumers

􏰀 2. Investment (I): expenditure by domestic firms on buildings, equipment, machinery

􏰀 3. Government purchases (G): expenditure by domestic government on goods and
services

􏰀 4. Current Account (CA): foreign net expenditure on domestic goods and services
(EX-IM), net investment payments, dividends etc.

Question 5

What is the current account

Answer 5

The current account (CA) is the net foreign expenditure by individuals and
institutions

Current Account = Trade Balance + Income Balance + Net Unilateral Transfers

Question 6

National Income Identity for a closed economy

Answer 6

Y=C+I+G

Question 7

What happen when CA Negative/Positive and country has debt

Answer 7

CA -ve –> lead to net external debt going up

CA+ve –> lead to net external debt going down

Question 8

What is the correlation for trade balance and current account? Are there any execeptions

Answer 8

For almost all countries, the trade balance and the current account move together: A country with a large trade deficit tend to have a large current account deficit and vice versa.

Exceptions: Philippines (TB<0 but CA>0), and Ireland (TB>0, CA<0)

􏰀 Why? Personal remittances in Philippines, profit payments due to 1990s FDI in Ireland.

Question 9

What happen when CA>0 and TB>0

Answer 9

When the value of production exceeds domestic expenditure, the value of exports is larger than the value of imports, then there is usually a current account surplus and the trade balance is positive.

􏰀 When a country earns more income from exports than it spends on imports, net foreign wealth is increasing.

The country is exporting present consumption and importing future consumption (intertemporal trade)**

Question 10

What happen when CA<0 and TB<0

Answer 10

When a country earns less income from exports than it spends on imports, net foreign
wealth is decreasing. The country is importing present consumption and exporting future consumption (intertemporal trade).

Question 11

What is national saving

Answer 11

National saving (S) = national income (Y) that is not spent on consumption (C) or government purchases (G).

In a closed economy, national saving is always equal to
investment (I).

S= Y-C-G

Question 12

What is private saving

Answer 12

Private saving is the part of disposable income (national income minus taxes,
Y − T ) that is saved rather than consumed

S(P) = Y -T-C

Question 13

What is government saving

Answer 13

Government saving is net tax revenue minus government expenditure:

S(G) =T−G

Question 14

National Saving calculation

Answer 14

S(P) + S(G) = S(N)

S(N)= Y - T -C + T-G = Y - C - G = I + CA

Thus an open economy can save by building capital stock I or acquiring foreign wealth

Question 15

Interpretation of S(P) = I + CA + (G-T)

What can individuals do with private saving

Answer 15

S(P) = I + CA + (G-T)

A country’s private saving can take three different forms:
􏰀 investment in domestic capital (I)
􏰀 purchases of wealth from foreigners, i.e. increasing net foreign wealth (CA)
􏰀 purchases of the domestic government’s newly issued debt (G − T )

Question 16

What is a net lender and net borrower

Answer 16

A country that has a current account surplus is called a (net) lender.

• In order to provide you that money –> I must have a deficit in my asset account –> Take it that I am buying assets from you

A country that has a current account deficit is called a (net) borrower.

• in order to finance deficit –> must have a surplus of assets (to sell you assets in order to borrow)

Question 17

What is a country’s Balance of Payment Account

Answer 17

statistical record of all economic transactions taking place between its residents and the rest of the world.

Question 18

What is credit and debit

Answer 18

once as a credit (+) and once as a debit (−).

Question 19

What are the BOP Accounts separated into (list 3)

Does it need to balance?

Answer 19

current account: accounts for flows of goods and services (imports and exports), and payments for factors ”at work” (capital and labor).

financial account: accounts for flows of financial assets (financial capital)

capital account: flows of special categories of assets (capital): typically nonmarket, non-produced, or intangible assets like debt forgiveness, copyrights and trademarks

current account + financial account + capital account = 0

Question 20

How does the BOP account balance

Answer 20

current account + financial account + capital account = 0 (if official reserves are included in the financial account)

current account + non-reserve portion of financial account + capital account = − official reserves (if official reserves are not included in the financial account)

Question 21

What does the current account entail

Answer 21

Current Account: refers to the current transactions

􏰀 Imports (−) and Exports (+)
⋆ Goods
⋆ Services: payments for legal services, shipping services, tourist meals

􏰀 Income balance
⋆ Net investment income: net income from capital (e.g. interest and dividend payments)
⋆ Net international payments to employees: net income from domestic labor temporarily
working abroad and foreign labor temporarily working in the country

􏰀 Unilateral transfers: Gifts of expatriate workers sent to their home countries (private
remittances), pension payments sent to expatriate retirees, and foreign aid.

Question 22

What does the capital account entail

Answer 22

records special transfers of assets such as copyright/trademark payments and debt forgiveness. In comparison to the financial account, this is a minor account for Singapore, the U.S. and many other countries

Question 23

What does the financial account entail

Answer 23

Financial account:
the difference between sales of domestic assets to foreigners and purchases of foreign assets by domestic citizens.

Question 24

How to denote financial inflow and outflow

Answer 24

Financial Inflow:
- Foreigners loan to domestic citizens by buying domestic assets.
- Domestic assets sold to foreigners are a credit (+) because the domestic economy acquires money during the transaction.

Financial Outflow:
- Domestic citizens loan to foreigners by buying foreign assets.
- Foreign assets purchased by domestic citizens are a debit (−) because the domestic economy gives up money during the transaction.

Question 25

What constitutes within the financial account

Answer 25

1. Official (international) reserve assets: foreign assets held by the central bank to cushion against financial instability.

Government bonds, currency, gold, and accounts at the International Monetary Fund.
􏰀 Official reserve assets owned by (sold to) foreign central banks are a credit (+) because
the domestic central bank can spend more money to cushion against instability.

Official reserve assets purchased by domestic CB counted as debit because domestic central bank can spend less money to cushion instability

2. All other assets: direct investment, long-term portfolio investment (maturity >1 year), short term capital flows (treasury bills, deposits, cash or cheque)
3. Statistical discrepancy:
   􏰀 Data from a transaction may come from different sources that differ in coverage, accuracy, and timing so the balance of payments account rarely sum to 0 in practice.

􏰀 The statistical discrepancy is the account added to or subtracted from the financial account to make it balance with the current account and capital account.

Question 26

US current account deficit and financial account surplus

Answer 26

About 70 percent of foreign assets held by the U.S. are denominated in foreign currencies and almost all of U.S. liabilities (debt) are denominated in dollars.

Changes in the exchange rate influence value of net foreign wealth (gross foreign assets minus gross foreign liabilities).

Appreciation of the value of foreign currencies makes foreign assets held by U.S. more valuable, but does not change the dollar value of its dollar-denominated debt.

Question 27

What IMF Standard of BOP does SG use?

Answer 27

Current Account + Financial and Capital Account + Net Errors and Omissions (Statistical Discrepancy) + Official Reserves = 0

SG official reserves balance recorded as separate item

Question 28

What is Depreciation and Appreciation

Answer 28

Depreciation is a decrease in the value of a currency relative to another currency.

• A depreciated domestic currency means that imports are more expensive but exports are cheaper for the foreigners.

Appreciation is an increase in the value of a currency relative to another currency

-

Question 28

What is Depreciation and Appreciation

Answer 28

Depreciation is a decrease in the value of a currency relative to another currency.

• A depreciated domestic currency means that imports are more expensive but exports are cheaper for the foreigners.

Appreciation is an increase in the value of a currency relative to another currency

-An appreciated currency is more valuable, and therefore it can buy more imports, but
exports are more expensive for the foreign buyers.

Question 29

What is a floating exchange rate. What happen when there is an increase in import demand domestically

Answer 29

Under pure floating exchange rate: the exchange rate moves to ensure D=S in the private market.

This shifts out the demand curve for foreign exchange (currency), driving up the equilibrium exchange rate.
􏰀 An increase in demand pushes up the price (the price of foreign currency, the exchange rate). The domestic currency is less valuable relative to the (now more expensive) foreign currency, i.e. the domestic currency depreciates.

Question 30

What happens under fixed exchange rate? What happen when there is an increase in import demand

Answer 30

With a completely pegged (fixed) exchange rate, the central bank buys or sells foreign currency to keep the price of foreign currency (the exchange rate) fixed at the same level. (Unless D=S at the fixed exchange rate.)

DD for foreign currency increase. To maintain fixed ER, the central bank needs to sell foreign currency. In this case, the country runs a “balance of payments deficit” (BP= minus offical
reserve assets)

Question 31

What are the assumptions to the elasticity approach

Answer 31

Assumption 1: There are no net capital flows (financial and capital account = 0)
􏰀 Private supply and demand for foreign exchange determined only by the current
account (CA).

Assumption 2: Domestic residents look only at prices expressed in domestic currency, and foreign residents look only at prices expressed in foreign currency.
􏰀 Hence, “elasticity approach”

Assumption 3: Supply is infinitely elastic
􏰀 Firms set a price for their product, then meet any forthcoming demand.
􏰀 Realistic? No. But Yes in short run.

The price at which domestic firms supply exportable goods with infinite elasticity must be set in domestic currency (P).

The price at which foreign firms supply the home country with importable goods must be set in foreign currency (P∗).

Question 32

How to express domestic demand for imports what happen to M when E increases?

Answer 32

MD , is a decreasing function of import price expressed in domestic currency, which is
the exchange rate* fixed price in foreign currency .
M = M D ( E P* )

A increase in E raise price of imports, shift curve to left, demand for imports decrease

Question 33

How to express demand for domestic exports what happen to M when E increases?

Answer 33

Demand for domestic exports, XD, is a decreasing function of export price expressed in foreign currency, which is
fixed price in domestic currency / the exchange rate.
X = X D ( P / E )

A increase in E causes domestic exports to be cheaper, leading to a movement on the XD curve

Question 34

By assumption 1, There are no net capital flows (financial and capital account = 0)
􏰀 Private supply and demand for foreign exchange determined only by the current
account (CA).

How does this link to demand for foreign exchange and supply of foreign exchange

Answer 34

Demand for foreign currency= import spending

Since borrowing is not allowed, foreign exchange must be obtained on the market to pay for imports.
􏰀 Import spending = import quantity * foreign currency price

Supply of foreign exchange = export revenue
Export revenue = export quantity * foreign currency price

Question 35

What is the net supply of foreign exchange equal to?

Answer 35

The net supply of foreign exchange is (P ̄/E)X − P ̄∗M, which is equal to the trade balance measured in foreign currency, TB∗.

Question 36

What is the effect of a depreciation on the trade balance

Answer 36

􏰀 Factor 1: A depreciation reduces the quantity of imports so the amount of foreign exchange spent on imports decreases. (Recall that the nominal price of imports is fixed in foreign currency.)
⋆ A depreciation improves trade balance via this factor

􏰀 Factor 2: A depreciation increases the quantity of exports.
⋆ A depreciation improves trade balance via this factor
􏰀 Factor 3: After a depreciation, any given quantity of exports earns less foreign
exchange than before because its nominal price is set in domestic currency. ⋆ A depreciation hurts the trade balance via this factor

Question 37

What is the marshall learner condition

Answer 37

When economy is in a position of balanced trade

εX +εM >1

εX : elasticity of demand for exports w.r.t. the real exchange rate
εM: elasticity of demand for imports w.r.t. the real exchange rate

Given that the economy is initially in balanced trade (TB=0), the Marshall-Lerner condition is necessary and sufficient for a depreciation to improve the trade balance (or for the foreign exchange market to be stable)

All else equal, starting with current account in zero, a real depreciation improves the current account if export and import volumes are sufficiently elastic w.r.t. the real exchange rate.