International Macro-Finance

Question 0

BOP

Currency Inflows

Answer 0

Credits earn foreign exchange

Source of funds (decrease in assets or goods or increase in liabilities is a credit)

Question 1

Balance of Payments

Answer 1

(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.

Question 2

BOP

Currency outflows

Answer 2

A use of funds (increase in assets or goods or decrease in abilities is a debit).

Question 3

BOP

Accounts (three of them)

Answer 3

1. Current account
2. Capital account
3. Official reserves account

Question 4

BOP

Current-account

Answer 4

Exports of goods and services are credits (an increase of funds); imports of goods and services are debits (decrease of funds)

Question 5

BOP
CURRENT ACCOUNT
Services examples

Answer 5

Also known as invisibles.

Examples: tourism, transportation services, banking services, education services as in tuition, consulting.

Question 6

BOP
CURRENT ACCOUNT
Investment income examples

Answer 6

(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).

Question 7

BOP
CURRENT ACCOUNT
Unilateral transfers examples

Answer 7

Remittances (aliens sending money back to Mexico).

Gifts and donations

Question 8

Trade balance and exchange rates

Answer 8

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).

Question 9

BOP

Capital account and CA transaction classification

Answer 9

Records private and public investment and lending.

Classifications

1. Portfolio investment (T greater than one year)
2. Foreign direct investment (control greater than 10%)
3. Short-term investment (T less than one year). Also called hot money.

Question 10

BOP

Capital account - inflows

Answer 10

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.

Question 11

BOP

Capital account - outflows

Answer 11

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.

Question 12

Why do investors stay away from countries?

Answer 12

Main reasons: low growth, high-risk, poor institutions.

Political unrest

Question 13

BOP

OFFICIAL RESERVES ACCOUNT

Answer 13

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.

Question 14

BOP CATEGORIES

NET EFFECT

Answer 14

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.

Question 15

What drives foreign companies and people’s demand for euros?

Answer 15

1. Relative prices of goods and service
2. tastes and preferences
3. relative income
4. risk-adjusted expected return on assets in euros versus those and other currencies

Question 16

How is exchange rate (value) of the euro determined?

Answer 16

By demand (euros purchase with other currencies)… and supply (of euros to buy other currencies)

Question 17

Gross national income (GNI) =

Answer 17

gross domestic product (GDP) + net foreign income (NFI)

Question 18

GDP =

Answer 18

C+G+I+(x-m)

Private consumption (C) + government spending (G) + investments (I) + exports (X) - imports (M)

Question 19

National spending =

Answer 19

Private consumption (C) + government spending (G) + investment (I)

Question 20

Current account (CA) =

Answer 20

Gross national income (GNI) - national spending (C + G + I)

Question 21

Current account (CA) =

Another way

Answer 21

Net exports (NX = X - M) + NFI = change in net foreign assets (= Delta NFA)

Question 22

Current account (CA) > 0

Answer 22

Means output produced + income from foreign held assets > national spending

Question 23

Domestic savings, investment & the capital account

Answer 23

GNI - C - G = savings (S) = GDP + NFI - C - G

And since GDP = C + G + I + (X minus M) = C + G + I + NX

Question 24

Domestic savings, investment & the capital account

Savings =

Answer 24

Investment (I) + net exports (NX) + net foreign income (NFI)

Also…
Savings (S) - investment (I) = NX + MFI = CA

Question 25

If S >I

Answer 25

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)

Question 26

Net foreign investment =

Answer 26

Net private outflows + net public capital outflows + increasing official reserves = change in that foreign assets (= Delta NFA)

Question 27

The link between current account and the capital accounts

implications

Answer 27

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>

Question 28

The link between current account and the capital accounts

When S<I

Answer 28

Nation borrows abroad or sells assets to foreigners to finance the deck.

Note: CA deficit happens when national spending > national income (GNI = GDP + NFI)