International Macro-Finance Flashcards
BOP
Currency Inflows
Credits earn foreign exchange
Source of funds (decrease in assets or goods or increase in liabilities is a credit)
Balance of Payments
(Go to bottom) Measures all financial and economic transactions between residence of a country and rest of the world, over period of time.
Transactions: purchase and sale of goods/services
Monetary transfer: donations, remittances, dividends, interest payments, purchase and sale of securities and of real assets.
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Currency outflows
A use of funds (increase in assets or goods or decrease in abilities is a debit).
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Accounts (three of them)
- Current account
- Capital account
- Official reserves account
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Current-account
Exports of goods and services are credits (an increase of funds); imports of goods and services are debits (decrease of funds)
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CURRENT ACCOUNT
Services examples
Also known as invisibles.
Examples: tourism, transportation services, banking services, education services as in tuition, consulting.
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CURRENT ACCOUNT
Investment income examples
(Interest and dividends are services paid for the use of capital). If a country has assets abroad it receives income; if it has liabilities to foreigners it pays income on these (outflow).
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CURRENT ACCOUNT
Unilateral transfers examples
Remittances (aliens sending money back to Mexico).
Gifts and donations
Trade balance and exchange rates
Devaluations of the currency in principle helps local production become more competitive, but is by no means a guarantee.
Rapid appreciations of the currency often lead to the disruption of local manufacturing. Local production is replaced by services (marketing, distribution, development).
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Capital account and CA transaction classification
Records private and public investment and lending.
Classifications
- Portfolio investment (T greater than one year)
- Foreign direct investment (control greater than 10%)
- Short-term investment (T less than one year). Also called hot money.
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Capital account - inflows
Inflows of capital are credits (nation sells assets to foreigners such as buildings, land, stocks, bonds). Nation receives cash
Example: sales of T bonds to China; acquisition of US firm by a foreign company; purchase of stocks in NASDAQ by foreign investors.
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Capital account - outflows
Outflows of capital are debits (nation purchases foreign assets).
Examples US residents buy shares of stocks and bonds abroad; US companies take over a company abroad; US real estate investment trust (REIT) buys commercial real estate abroad.
Why do investors stay away from countries?
Main reasons: low growth, high-risk, poor institutions.
Political unrest
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OFFICIAL RESERVES ACCOUNT
Measures changes in international reserves owned by central banks. Official reserves consist of gold and securities in foreign currency
Example: US firm sells €5 million in deposits to Frankfurt to the FED in return for dollars in Boston. Converting a private asset into an official reserve.
BOP CATEGORIES
NET EFFECT
Net effects: sum of all transactions must be zero: (because of double entry)
One traditional measure is:
Basic balance = current account + long-term capital flows.
Emphasizes long-term trends. Exclude short-term capital flows, heavily dependent on temporary factors.
What drives foreign companies and people’s demand for euros?
- Relative prices of goods and service
- tastes and preferences
- relative income
- risk-adjusted expected return on assets in euros versus those and other currencies
How is exchange rate (value) of the euro determined?
By demand (euros purchase with other currencies)… and supply (of euros to buy other currencies)
Gross national income (GNI) =
gross domestic product (GDP) + net foreign income (NFI)
GDP =
C+G+I+(x-m)
Private consumption (C) + government spending (G) + investments (I) + exports (X) - imports (M)
National spending =
Private consumption (C) + government spending (G) + investment (I)
Current account (CA) =
Gross national income (GNI) - national spending (C + G + I)
Current account (CA) =
Another way
Net exports (NX = X - M) + NFI = change in net foreign assets (= Delta NFA)
Current account (CA) > 0
Means output produced + income from foreign held assets > national spending
Domestic savings, investment & the capital account
GNI - C - G = savings (S) = GDP + NFI - C - G
And since GDP = C + G + I + (X minus M) = C + G + I + NX
Domestic savings, investment & the capital account
Savings =
Investment (I) + net exports (NX) + net foreign income (NFI)
Also…
Savings (S) - investment (I) = NX + MFI = CA
If S >I
The CA >0 (surplus)… Excess savings (or surplus capital) is spent overseas; assets not goods
Or
The capital Account has a deficit. (KA s capital outflow)
Net foreign investment =
Net private outflows + net public capital outflows + increasing official reserves = change in that foreign assets (= Delta NFA)
The link between current account and the capital accounts
implications
If CA is in surplus, the nation is a net exporter of capital.
NX + NFI >0 –> S >I = >Delta NFK >0
CA has a deficit, the nation is a net capital importer.
NX + NFI S <i>Delta NFK <0</i>
The link between current account and the capital accounts
When S<I
Nation borrows abroad or sells assets to foreigners to finance the deck.
Note: CA deficit happens when national spending > national income (GNI = GDP + NFI)
