Transcript Balance of Payments and Exchange Rates

Balance of Payments
and
Exchange Rates
Ch1/BP&ER
1
Introduction:
Open vs closed economy
Three kinds of openness:
• Free trade in goods and services
Restrictions:
,
etc.
• Free movements of capital (financial)
Restrictions:
• Free movements of factors: plants,
labor
Restrictions:
Ch1/BP&ER
2
Various Measurements of openness
• EXPORTS/GDP or IMPORTS/GDP
• (EXPORTS + IMPORTS)/GDP
• TRADABLES/GDP
Tradables are goods that compete with foreign goods
on either domestic or foreign markets e.g.
This last ratio (high for the US) reflects the fact that
if a country is competitive it does not need to
import much.
Ch1/BP&ER
3
X/GDP (in 2000)
US
UK
Belgium
Japan
China
11%
27%
84%
10%
23%
Some determinants of openness:
Geographical: how far a country is from specific
markets
Size: the extent of the range and choice of goods
produced domestically
Ch1/BP&ER
4
Differences between international
trade and international macro
International trade
•
•
•
•
Based on micro
Full employment of
factors
Total C = total Y each
year
Value of imports =
values of exports
Relative prices (T/T)
Ch1/BP&ER
International macro
•
•
•
•
Based on macro
Economy can be
_____ PPF
S
and b
at country level
Trade can be -balanced
Price ________
5
A
The Balance of Payments
• The national income accounts
revisited (econ 301)
• The balance of payments accounts
Ch1/BP&ER
6
National Income Accounts - Review
In principle
However
Because
Value of Production = Value of income
GNP ≠ National Income
•
GNP does not subtract economic depreciation
•
Income includes gifts from abroad
•
National income is based on prices producers receive
while GNP is based on prices purchasers pay
difference = indirect taxes
Ch1/BP&ER
7
GNP - Deprec + Net unilateral transfer - indirect taxes
= Natl Y
with: net unilateral transfer = gifts to us - gifts from us
Ch1/BP&ER
8
Gross domestic product vs
gross national product
• GDP is the value added ________ - ignoring who owns the
factors of production - i.e. income generated by activity
within the border
• GNP is the value added by __________ owned factors of
production - i.e. total income received by domestic
residents
GDP
less income on assets owned by foreigners in the country
plus income on assets owned by US residents abroad
equal GNP
If a country invests heavily abroad:
GNP
If a country uses a lot of foreign labor: GDP
Ch1/BP&ER
GDP
GNP
9
GNP = GDP + Net receipts of factor income from ROW
GDP
US Res
+
Non US Res
in country
Includes income
generated by foreign
owned wealth and
foreign labor.
Res stands for residents
Ch1/BP&ER
GNP
US Res
Income
US Res
only
generated
abroad
US owned factor income
so includes income on
US wealth invested
abroad and
income to US workers
abroad
10
The Balance of Payments
• Definition: Record of the transactions
between residents and
residents
a year.
• Double entry accounting:
– Credit entry: any transaction that gives rise to a
payments
(by the foreigners) and that is a
payment
+
– Debit entry: any transaction that gives rise to a
payments
(to the foreigners) and that is a
payment
Ch1/BP&ER
11
Characteristics of B/P
• 2 types of international transactions:
– Exports (sales) and imports (purchases) of goods & services
accounts CA
– Sales and purchases of assets
accounts FA
– Balance = sales - purchases
Note:
A section called the capital account was created recently to complement the shift from GNP to GDP
•
book keeping
–
–
–
2 sides to all transactions
one
entry (+) and one
entry (-)
so Sum of credits (+) + Sum of debits (-) = 0
i.e. BP = 0
Ch1/BP&ER
12
I Current Account
• Affects income ( as
)
• Measures direction and size of
CA > 0 S
- country is a
CA < 0 D
- country is a
So CA = ∆ in a country’s foreign assets (or debt)
C + I + G is absorption or
demand for
goods (produced at home or imported)
Y - (C + I + G) =
i.e. if a country consumes more than it produces, it
must
from abroad as it runs a CA
Ch1/BP&ER
13
Intertemporal interpretation
• Borrowers must repay their debt in the future
• A country with a CA deficit imports present
consumption and exports future consumption
Other interpretations
• Chronic CA deficits result in large foreign debt
and high interest payments on the debt which
further erode the CA
• Chronic surpluses could have inflationary effects
Ch1/BP&ER
14
National saving and the CA
By definition
Sn  Y - C - G
• Closed economy
as Y = C + I + G
in equil: Sn =

• Open economy
as Y = C + I + G + CA
in equil: Sn =

Open economy saves by building capital stock (I)
by investing abroad (if CA >0)
(A country can invest more than its saving by borrowing from abroad thus
running a CA deficit)
Ch1/BP&ER
15
Private and government saving: The twin deficit
• Sp 
and Sg 
by definition
and national saving Sn  Sp + Sg = Y - C - G
• In equilibrium
Sn = I + CA
Sp + Sg = I + CA
Sp = I + CA - Sg = I + (EX - IM) + (G - T)
So private saving can
1. Finance private investment
2. Allow the country to invest abroad
3. Finance the budget deficit
Ch1/BP&ER
16
Current Accounts Breakdown
• Exports and imports of goods and services
– Exports are
– Imports are
entries ( )
entries ( )
• Services are sometimes called
» Insurance - banking services - shipping
• Investment income received ( ) and paid ( )
– Interest etc.
– Net = investment income received less inv. inc. paid
• Unilateral Transfers (net)
– One sided transaction: Gifts to us ( ) and gifts from us ( )
– Net = Gifts to us - gifts from us
Ch1/BP&ER
17
Various balances
• Exports of goods less imports of goods:
the balance on goods
so-called the
trade balance
• Exports of services less imports of services:
the balance on services
• Exports of goods and services less imports of
goods and services:
the balance of
( or net exports)
• Balance of trade + net investment income +
net unilateral transfer:
the balance on
or
Ch1/BP&ER
18
II Capital and Financial Account
A Capital Account
•
capital transfers (migrant labor financial
transfers and debt forgiveness)
•
transactions in non-produced and nonfinancial assets (transfer of ownership in
natural resources, intellectual property
rights, franchises and leases)
Total amount is not very large.
Ch1/BP&ER
19
B Financial account
• Correspond to
in stock of assets - so they
are
(thus consistent with current accts).
• Some are
and other are
accounts.
• Some are
term and some are
term type of
assets.
• Some are
and some are government
transactions;
– the government transactions can be broken down
further into Central Bank and non Central Bank .
Ch1/BP&ER
20
Financial Account summary
• US owned assets abroad (net changes)
– Increase is a US
– So a financial
– So a
(-)
of foreign stocks/bonds
• Foreign owned assets in the US (net changes)
– Increase is a
of US assets to foreigners
– So a financial
– So a
(+)
Ch1/BP&ER
21
Financial Account detail
• US owned assets abroad (increase is (-))
– US official reserves assets (net)
• Gold - SDR - foreign currencies
– US government assets
– US private assets
• Direct investment (FDI)
• Foreign securities
• Credit balance in foreign bank and non-bank
institutions
Ch1/BP&ER
22
• Foreign owned assets in the US (increase is
(+))
– Foreign official assets in the US (net)
• US Treasury Securities - bank balances
– Other foreign assets in the US (as above)
• FDI
• US Treasury securities (gov’t bonds)
• Other stocks and bonds
• US currency
• Bank balances in US bank and non-bank
institutions
Ch1/BP&ER
23
• Net capital account transactions
+ {net increase in foreign owned assets in the US
less abs. value1 of net increase in US owned
assets abroad}
= Capital and financial account balance FA
1.
Because they are entered as a minus in BoP
• Statistical discrepancy
{ - [Current account balance + Capital and financial account
balance]}
If there was no mistakes or underreporting, the sum of the 2
balances should be equal to zero.
Ch1/BP&ER
24
Overall Interpretation
• CA balance measures
in country’s net
foreign assets (e.g. a surplus - CA > 0 corresponds to lending to ROW)
• So this will be reflected in the FA balance
where purchases of foreign assets will be
________ than sales of foreign assets.
• In sum a positive CA balance will be
matched by a
FA balance of same
absolute value
Ch1/BP&ER
25
Examples of US balance of payments
entries
Alitalia buys a Boeing 747 and pays with a
check from Banco di Lavoro
– Credit:
of Boeing (3)
accounts
– Debit:
in US owned private asset
abroad or in US claims reported by US
banks (54)
accounts
Ch1/BP&ER
26
The US government sends food as relief
to famine stricken Mali
– Credit:
– Debit:
Ch1/BP&ER
of food (3)
accounts
(gift from us) (36)
accounts
27
A French citizen buys shares of
Microsoft and pays by drawing his
account at the Key Bank
– Credit:
in foreign owned private
assets in the US (64)
accounts
– Debit:
in US liabilities reported
by US banks (69)
accounts
Ch1/BP&ER
28
B
Exchange Rates
Ch1/BP&ER
29
Various Exchange Rates
Nominal exchange rate - E
• Definition: the price of the foreign currency in
terms of the domestic currency so it is quoted as
________ of units of domestic currency
in ____ unit of foreign currency
• It fluctuates overtime
– Appreciation of the domestic currency:
units
are needed to buy 1 unit of the foreign currency
– Depreciation of the domestic currency:
units
are needed to buy 1 unit of the foreign currency
Ch1/BP&ER
30
Examples of ER fluctuation
•
•
•
•
•
January 1999
$1.17/€
September 2000
$0.85/ €
May 2002
$0.91/ €
May 2003
$1.14/ €
September 2007
$1.41/€
The euro depreciated by some 27%
against the dollar in its first 18 months and
appreciated by some 25% from 2002 to
2003. The euro has continued to appreciate
steadily since.
Ch1/BP&ER
31
Law of One Price
2 countries - each produces one good
– Switzerland produces calculator - price: 100SF
– US
produces book
- price: $25
– Nominal exchange rate: E = $.50/SF
• So price of Swiss calculator in $ is 100 * .50 = $50
– The real exchange rate RER is:

Pr iceofSwissgoodin $ 50
RER 

2
Pr iceofUSgood ($)
25
PSinSF * E $ /SF 100SF * .50$ /SF
RER 

2
PUSin$
$25
Ch1/BP&ER
32
Real Exchange Rate
• The real exchange rate is a relative price of 2
goods (calculator and book) indicating that
Swiss calculator =
US books
i.e.
US books can be exchanged for (or buy)
Swiss calculator
• With more than one good, the meaning will be
slightly different. We will need to use the
aggregate price of a basket of goods (the price
level or CPI) in each country and the RER will
become the relative price of the 2 baskets.
Ch1/BP&ER
33
RER cont.
• We now have
PS * E $ /SF
EP *
RER   =
or  
PUS
P
• The meaning is similar: the RER indicates how
many (units of a) US basket(s) can be
 exchanged for 1 foreign basket (P* is the
foreign price level).
• If either E or P or P* change, we will have a
real appreciation or a real depreciation.
Ch1/BP&ER
34
Real appreciation and depreciation
• When the RER drops, we have a real
i.e. the US needs to give up
US baskets to
acquire
foreign basket. This is a real
depreciation from the point of view of the other
country.
*
• Since
EP
=
P
A real appreciation can be caused by:
a nominal
(E drops)
or/and an
in the domestic price level (P incr)

or/and a
in the foreign price level (P* drops)
Ch1/BP&ER
35
Effect of the real appreciation on trade
• Swiss goods become
expensive for Americans
(less than 2 US baskets to buy one Swiss basket)
– So demand for Swiss good
- US Imports
• US goods become
expensive for the Swiss
(one Swiss basket buy fewer US baskets)
– So demand for US goods
- US Exports
• So the US the balance of trade (exports less
imports)
but the Swiss balance of
trade
because they experience a real
depreciation).
Ch1/BP&ER
36
In Sum:
Effect of the real appreciation on trade:
• imports are ________ and exports ___________
• the balance of trade will __________
• this results in a _______ in the country’s
international competitiveness
A real depreciation has the opposite effect as
more domestic baskets are needed to buy one
foreign basket and the balance of trade improves:
• this results in an _______ in the country’s
Ch1/BP&ER
international competitiveness
37
Illustration
• Between 1959 and 1985, inflation in
Switzerland or Germany has not been as high as
in France, so France (the French Franc)
experienced a real appreciation with respect to
these 2 currencies. However in the long run
(over the years), the nominal exchange rate
(F/DM or F/SF) also depreciated to account for
these relative price changes.
Ch1/BP&ER
38
Multilateral or trade weighted ER
Up to now we only considered bilateral exchange
rate i.e. the relative price of 2 currencies.
However one specific currency may appreciate
with respect to another currency and depreciate
with respect to a third currency: in one instance
there will be a deterioration in its international
competitiveness and in the other an
improvement.
We need to develop a way to get the whole picture.
Ch1/BP&ER
39
Construction of a trade weighted ER
• The are constructed by the IMF - but there is
more than one way to do it.
• The basic approach is
– To transform each bilateral ER into an
(indeed you can’t add ER as they are expressed in
different units)
– Decide on a
year set as 100 and calculate an
index series over time for each bilateral ER.
– Use a
scheme to aggregate the various
indices - usually the importance of trade with a
specific country as a ratio of total trade.
Ch1/BP&ER
40
Calculation of a trade weighted index
for the $ using pound and euro
Yr 0 index wght
Yr 1
.70
100
.30
.75
107
.30
€/$ 1.15
100
.70
1.10
95
.70
£/$
index wght
TW
index
The dollar appreciates w/ respect to the pound and depreciates w/
respect to the euro, but overall the dollar depreciates. Note that w/
T-W exchange rates, an increase is an appreciation.
Ch1/BP&ER
41
Real multilateral or trade weighted ER
Evidently, it is also possible to calculate a real
multilateral or trade weighted exchange rate.
It suffices to calculate the original bilateral indices
with the real bilateral exchange rates.
Ch1/BP&ER
42