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BF464: International Finance. The Balance of Payments and International Linkages. CHAPTER OVERVIEW. I. BALANCE-OF-PAYMENT CATEGORIES II. THE INTERNATIONAL FLOW OF GOODS, SERVICES,AND CAPITAL III. COPING WITH CURRENT ACCOUNT DEFICITS. PART I. BALANCE-OF-PAYMENT CATEGORIES.

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Bf464 international finance

BF464: International Finance

The Balance of Payments and International Linkages


Chapter overview
CHAPTER OVERVIEW

  • I. BALANCE-OF-PAYMENT CATEGORIES

  • II. THE INTERNATIONAL FLOW OF GOODS, SERVICES,AND CAPITAL

  • III. COPING WITH CURRENT ACCOUNT DEFICITS


Part i balance of payment categories
PART I.BALANCE-OF-PAYMENTCATEGORIES

  • A. THE BALANCE OF PAYMENTS (B-O-P)

  • 1. PURPOSE:

  • Measures all financial and economic transactions over a specified period of time.


Balance of payment categories
BALANCE-OF-PAYMENTCATEGORIES

  • 2. Double-entry bookkeeping

  • a. Currency inflows = credits

  • earn foreign exchange

  • b. Currency outflows = debits

  • expend foreign exchange


Balance of payment categories1
BALANCE-OF-PAYMENTCATEGORIES

  • 3. Three Major Accounts:

  • a. Current

  • b. Capital

  • c. Official Reserves

  • 4. Current Account

  • records net flow of goods, services, and unilateral transfers.


Balance of payment categories2
BALANCE-OF-PAYMENTCATEGORIES

  • 5. Capital Account

  • a. Function: records public and private investment and lending.

  • b. Inflows = credits

  • c. Outflows = debits


Balance of payment categories3
BALANCE-OF-PAYMENTCATEGORIES

  • 5. Capital Account (con’t)

  • d. Transactions classified as

  • 1.) Portfolio

  • 2.) Direct

  • 3.) Short term


Balance of payment categories4
BALANCE-OF-PAYMENTCATEGORIES

  • 6. Official Reserves Account

  • a. Function:

  • 1.) Measures changes in international reserves owned by central banks.

  • 2.) Reflects surplus/deficit of

  • a.) Current account

  • b.) Capital account

  • b. Reserves consist of

  • 1.) Gold

  • 2.) Convertible securities


Balance of payment categories5
BALANCE-OF-PAYMENTCATEGORIES

  • 7. Net Effects:

  • a. Sum of all transactions must be zero:

  • 1.) Current account

  • 2.) Capital account

  • 3.) Official reserves


Part ii the international flow of goods services and capital
PART II. THE INTERNATIONAL FLOW OF GOODS, SERVICES, AND CAPITAL

  • II. LINKS FROM INTERNATIONAL TO DOMESTIC FLOWS

  • A. Global Linkages

  • set of basic macroeconomic identities which link:

  • -Domestic spending and production to current and capital accounts.

  • B.Domestic Savings and Investmentand the Capital Account

  • 1. National Income Accounting

  • a. National Income (NI) is either spent (C) or saved (S)

  • NI = C + S (5.1)


The international flow of goods services and capital
THE INTERNATIONAL FLOW OF GOODS, SERVICES, AND CAPITAL CAPITAL

  • b. National spending (NS) is

  • divided into personal spending (C)and investment (I)

  • NS = C + I (5.2)

  • c. Subtracting (5.2) - (5.1)

  • NI - NS = S - I (5.3)

  • If NI >NS, S > I which implies that surplus capital spent overseas.


The international flow of goods services and capital1
THE INTERNATIONAL FLOW OF GOODS, SERVICES, AND CAPITAL CAPITAL

  • d. In a freely-floating system,

  • excess saving = the capital account balance

  • e. Implications:

  • 1.A nation which produces more than it spends will save more than it invests domestically with a net capital outflow producing a capital account deficit.


The international flow of goods services and capital2
THE INTERNATIONAL FLOW OF GOODS, SERVICES, AND CAPITAL CAPITAL

2. A nation which spends more than it produces has a net capital inflow producing a capital account surplus.

3. A healthy economy will tend to

run a current account deficit.


The international flow of goods services and capital3
THE INTERNATIONAL FLOW OF GOODS, SERVICES, AND CAPITAL CAPITAL

  • C. THE LINK BETWEEN THE CURRENT AND CAPITAL ACCOUNTS

  • 1. Beginning identity

  • NI - NS = X - M (5.4)

  • where X = exports, M = imports

  • X-M=current account balance (CA)

  • 2. Combining (5.3) + (5.4)

  • S - I = X - M (5.5)

  • 3. If S - I = Net Foreign Investment (NFI)

  • NFI = X - M (5.6)


The international flow of goods services and capital4
THE INTERNATIONAL FLOW OF GOODS, SERVICES, AND CAPITAL CAPITAL

  • 4. Implications:

  • a. If CA is in surplus, the nation must be a net exporter of capital.

  • b. If CA is a deficit, the nation is a major capital importer.

  • c. When NS > NI, the excess must be acquired through foreign trade.

  • d. Solutions for Improving CA deficits:

  • 1.)Raise national income (output)relative to national spending .

  • 2.)Increase (S) relative to domestic investment (I).


Part iii coping with the current account deficit
PART III. COPING WITH THE CURRENT ACCOUNT DEFICIT CAPITAL

  • I. POSSIBLE SOLUTIONS UNLIKELY TO WORK:

  • A. Currency Depreciation

  • B. Protectionism


Coping with the current account deficit
COPING WITH THE CURRENT ACCOUNT DEFICIT CAPITAL

  • II.CURRENCY DEPRECIATION

  • A. U.S. Experience:

  • Does not improve the trade deficit.


Coping with the current account deficit1
COPING WITH THE CURRENT ACCOUNT DEFICIT CAPITAL

  • B. Depreciations are ineffective because

  • 1. It takes time to affect trade.

  • 2. J-Curve Effect

  • States that a decline in currency value will initially worsen the deficit before improvement.


The j curve
THE J - CURVE CAPITAL

Tradebalance

improves

Net change

in trade

balance

Currency

depreciation

TIME

0

Trade balance

initially deteriorates


Coping with the current account deficit2
COPING WITH THE CURRENT ACCOUNT DEFICIT CAPITAL

  • III. PROTECTIONISM

  • A. Trade Barriers used:

  • 1. Tariffs

  • 2. Quotas

  • B. Results:

  • Most likely will reduce both X and M.


Coping with the current account deficit3
COPING WITH THE CURRENT ACCOUNT DEFICIT CAPITAL

  • III. SUMMARY: CURRENT-ACCOUNT

  • DEFICITS

  • - neither bad nor good inherently

  • 1. Since one country’s exports are another’s imports, it is not possible for all to run a surplus


Coping with the current account deficit4
COPING WITH THE CURRENT ACCOUNT DEFICIT CAPITAL

  • 2. Deficits may be a solution to the problem of different national propensities to save and invest.


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