The Open Economy: Trade Balance and Terms of Trade notes Flashcards
What is the definition of trade openness?
Exports and imports as a % of GDP
What is the definition of financial openness?
Gross external assets and liabilities as a % of GDP
What does the Balance of Payments account record?
Transactions of goods and financial flows between the home and foreign countries
What is the BP split into?
The Current and Capital account
What does the current account represent?
The goods economy
What does the capital account represent?
The financial economy
What is the definition of the trade balance?
Net exports -> exports - imports (X - M)
What is contained within the current account?
The trade balance + net interest and profit receipts from assets
What is contained within the capital account?
Changes in stocks of foreign assets owned by home residents, home assets owned by foreign residents (private net capital flows) - changes in the forex reserves
What is the BP equation?
(Trade balance + net interest receipts) + (private net capital flows + changes in forex reserves)
What will the BP always equal and why?
It will always be equal to 0 because any increase in wealth from the current account is invested into the capital account
How do exchange rate regimes affect forex reserves?
Fully floating regime - no intervention to buy or sell currency, so has no control over the exchange rate
Fixed regime - a commitment to buy and sell currencies to maintain the chosen exchange rate -> this will require forex reserves to change
When will forex reserves increase in a fixed exchange rate regime?
When the government is trying to depreciate the UK currency by buying the currencies of foreign countries to increase the supply of UK currency
When will forex reserves decrease in a fixed exchange rate regime?
When the government is trying to appreciate the UK currency by using foreign currency to buy home currency and reduce the supply of UK currency
What is the definition of revaluation?
Authorities changing the fixed exchange rate so that e decreases
What is the definition of devaluation?
A new fixed exchange rate set by authorities that involved increasing e
What is the real exchange rate (Q) also seen to represent?
The competitiveness of a country. As Q decreases it means that P>P* for a given e meaning an increase in competitiveness -> as Q decreases, competitiveness increases
What is the definition of the Terms of Trade?
The ratio of the prices of exports to the prices of imports
What is the ToT formula?
Price of exports / Price of imports
What happens when the ToT formula is seen to increase?
This means the ToT have improved as a greater volume of imports can be bought for a given volume of exports
What kind of shock is a ToT shock? Example?
A ToT shock is an exogenous one e.g. a rise in oil prices will increase the price of UK imports -> -ve ToT shock
How does an increase in Q affect the ToT?
A rise in Q (real depreciation) will worsen the ToT as the real prices of imports increases
What is the volume effect when referring to a real depreciation?
An increase in Q -> increases competitiveness -> increases net exports -> BT improves
What is the relative price or ToT effect when referring to a real depreciation?
An increase in Q -> increases the price of given volume of imports -> BT worsens