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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
  • 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
  • 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

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
  • 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
  • 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
  • I. POSSIBLE SOLUTIONS UNLIKELY TO WORK:
  • A. Currency Depreciation
  • B. Protectionism
coping with the current account deficit
COPING WITH THE CURRENT ACCOUNT DEFICIT
  • 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
  • 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

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