Chapter 9: BOPFEX Flashcards
What is the national income account
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).
What is the gross national product (GNP)
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.
What is the national income adjusted for (list 3 things)
- Depreciation of physical capital: Loss of income to capital owners
- 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
- Net unilateral transfer: payments of expatriate workers sent to their home countries
(private remittances), pension payments sent to expatriate retirees, and foreign aid
How to calculate gross national disposable income (list 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.
What is the current account
The current account (CA) is the net foreign expenditure by individuals and
institutions
Current Account = Trade Balance + Income Balance + Net Unilateral Transfers
National Income Identity for a closed economy
Y=C+I+G
What happen when CA Negative/Positive and country has debt
CA -ve –> lead to net external debt going up
CA+ve –> lead to net external debt going down
What is the correlation for trade balance and current account? Are there any execeptions
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.
What happen when CA>0 and TB>0
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)**
What happen when CA<0 and TB<0
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).
What is national saving
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
What is private saving
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
What is government saving
Government saving is net tax revenue minus government expenditure:
S(G) =T−G
National Saving calculation
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
Interpretation of S(P) = I + CA + (G-T)
What can individuals do with private saving
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 )
What is a net lender and net borrower
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)
What is a country’s Balance of Payment Account
statistical record of all economic transactions taking place between its residents and the rest of the world.
What is credit and debit
once as a credit (+) and once as a debit (−).
What are the BOP Accounts separated into (list 3)
Does it need to balance?
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
How does the BOP account balance
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)
What does the current account entail
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.
What does the capital account entail
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
What does the financial account entail
Financial account:
the difference between sales of domestic assets to foreigners and purchases of foreign assets by domestic citizens.
How to denote financial inflow and outflow
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.
What constitutes within the financial account
- 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
- All other assets: direct investment, long-term portfolio investment (maturity >1 year), short term capital flows (treasury bills, deposits, cash or cheque)
- 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.
US current account deficit and financial account surplus
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.
What IMF Standard of BOP does SG use?
Current Account + Financial and Capital Account + Net Errors and Omissions (Statistical Discrepancy) + Official Reserves = 0
SG official reserves balance recorded as separate item
What is Depreciation and Appreciation
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
-
What is Depreciation and Appreciation
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.
What is a floating exchange rate. What happen when there is an increase in import demand domestically
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.
What happens under fixed exchange rate? What happen when there is an increase in import demand
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)
What are the assumptions to the elasticity approach
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∗).
How to express domestic demand for imports what happen to M when E increases?
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
How to express demand for domestic exports what happen to M when E increases?
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
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
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
What is the net supply of foreign exchange equal to?
The net supply of foreign exchange is (P ̄/E)X − P ̄∗M, which is equal to the trade balance measured in foreign currency, TB∗.
What is the effect of a depreciation on the trade balance
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
What is the marshall learner condition
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.
