Transcript PPT chapter 15 - McGraw Hill Higher Education

Chapter 15
The balance of
payments:
Net exports and
international capital
flows
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Learning objectives
1. What types of transactions are recorded in the current
account of the balance of payments?
2. What types of transactions are recorded in the capital
account of the balance of payments?
3. How do capital flows relate to the current and capital
account balances?
4. What factors influence the international flows of capital?
5. What is the effect that international capital flows have on
the relation between national savings and investment?
6. How are a country’s savings, trade imbalance and current
account balance related?
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Chapter organisation
15.1
The balance of payments
15.2
Capital flows and the relationship between the
capital and the current accounts
15.3
The determinants of international capital flows
15.4
Saving, investment and capital inflows
15.5
The saving rate and the trade and current
account deficits
Summary
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The balance of payments
• The balance of payments (BoP) s a record of all the
transactions made between the residents of one
country with the residents of all other countries.
• These sorts of transactions include:
– imports and exports of goods and services
– monetary gifts sent to Australian students by relatives
living overseas
– Australian firms borrowing money from overseas financiers.
• The BoP consists of the current account and the
capital account.
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The structure of the current account
Figure 15.1 The structure of the current account
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The current account
• This records all transactions that involve a transfer of
goods and services or a direct transfer of income.
• Exports and imports are measured free on board
(f.o.b.) which means the freight and insurance
charges are assumed to be borne by the purchasers.
• The difference between imports and exports is known
as the balance on merchandise trade. If negative,
imports exceed exports.
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The current account (cont.)
• Net services records the freight, insurance and
other charges associated with buying and selling
commodities.
• The net services balance is the difference between
the amount the domestic country spends on these
services in other countries and the amount foreign
residents spend on them domestically.
• The net income balance comprises direct income
payments, such as interest, dividend and royalty
payments, and also labour and property income.
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The current account (cont.)
• Current transfers record one-off transactions in the
current account that aren’t easily classified
elsewhere, for example, the funds newly arrived
migrants bring with them.
• The balance of the merchandise trade, net income
and net current transfers gives the current account
balance.
– When the balance is negative, it is known as a current
account deficit.
– When the balance is positive, it is known as a current
account surplus.
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Australia’s current account balance
and its components
Figure 15.2 Australia’s current account balance and its components
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The structure of the capital account
Figure 15.3 The structure of the capital account
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The capital account
• The capital account records all international
transactions that involve the acquisition of either an
asset or a liability.
• As with the current account, an inflow of foreign
currency is recorded as a credit, and an outflow of
foreign currency is a debit. For example, an
Australian firm negotiating a loan from a foreign firm
is recorded as a credit. A foreign firm buying shares
in an Australian company is recorded as a debit.
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The capital account (cont.)
• The capital account is divided between two sectors.
1. The official sector records the transactions of the
government sector and the central bank.
2. The non-official sector records the transactions of privatesector firms, financial institutions and households.
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The capital account (cont.)
• Net capital transfers balance records the cancellation
of debts of poor countries and funds taken in and out
by migrants.
• The net acquisition/disposal of non-produced, nonfinancial assets records sales of embassy land or
patents and copyrights, etc.
• These balances comprise the capital account, which
is a relatively small component of the whole capital
account!
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The capital account (cont.)
• The important part of the capital account is the
balance on the financial account, which records direct
and portfolio investment balances of net foreign
investment in Australia and Australian investment
abroad, plus changes in the Reserve Bank’s holdings
of foreign exchange and gold.
• The balance on the capital account will be the same
value as the balance on the current account, though
with the opposite sign.
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Chapter organisation
15.1
The balance of payments
15.2
Capital flows and the relationship between
the capital and the current accounts
15.3
The determinants of international capital flows
15.4
Saving, investment and capital inflows
15.5
The saving rate and the trade and current
account deficits
Summary
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Capital flows
• Purchases and sales of real and financial assets
across international borders are called international
capital flows.
• From the perspective of a particular country,
purchases of domestic assets by foreigners are
called capital inflows, and purchases of foreign
assets by domestic households and firms are called
capital outflows.
• The difference between the two flows are net capital
inflows, or net capital outflows.
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Capital flows (cont.)
• International capital flows allow countries to invest in
more productive investment opportunities than would
be possible relying only on national savings.
• In a closed economy, we have seen that national
saving and investment are equal.
• In an open economy, where capital flows are
possible, savings from other countries can finance
investments.
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Capital flows and the current account
balance
• In any given period, the current account balance and
the balance on the capital account sum to zero:
CAB + KAB = 0
• This is true by definition. In practice, due to errors of
measurement and the non-reporting of some
transactions, a balancing item makes this identity
correct.
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Example: Capital flows and the current
account balance
•
Suppose an Australian resident purchases a
$40 000 Japanese car and writes a cheque
for $40 000. The Japanese company can manage
the money in one of the following ways:
1. They could use the $40 000 to buy Australian-produced
components for their plant, or holidays for their executives,
or some other Australian goods, or
2. They could buy a real asset, financial asset or shares in an
Australian company, or simply leave the money in the bank
(an asset acquired by foreigners), or
3. They could swap the $AU40 000 with a third party for
another currency (e.g. yen), but the third party would
still have the same two choices with that money as
described above.
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Chapter organisation
15.1
The balance of payments
15.2
Capital flows and the relationship between the
capital and the current accounts
15.3
The determinants of international capital flows
15.4
Saving, investment and capital inflows
15.5
The saving rate and the trade and current
account deficits
Summary
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Determinants of capital flows
• Why would foreigners want to acquire Australian
assets, and conversely, why would Australians want
to acquire assets abroad?
• The factors that determine attractiveness of any asset
are return and risk.
• A higher real domestic interest rate, if all other factors
such as risk and returns abroad are held constant,
promotes net capital inflows, as money from abroad
is invested, and domestic investors reduce their
capital outflows.
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Net capital inflows and the real interest
rate
Figure 15.4 Net capital inflows and the real interest rate
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Capital flows and risk
Figure 15.5 An increase in risk reduces net capital inflows
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Chapter organisation
15.1
The balance of payments
15.2
Capital flows and the relationship between the
capital and the current accounts
15.3
The determinants of international capital flows
15.4
Saving, investment and capital inflows
15.5
The saving rate and the trade and current
account deficits
Summary
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Saving, investment and capital inflows
• In a closed economy, we have seen that national
saving and investment are equal.
• In an open economy, where capital flows are
possible, savings from other countries can finance
domestic investments.
• Therefore, we can write:
NS + KI = I
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Saving, investment and capital inflows
(cont.)
• NS = national saving, which is private saving plus
government saving, KI is the net capital inflow and I
is investment.
• If KI is negative there is a net capital outflow, which
means domestic savings are larger than required to
finance domestic investment, and the excess can be
lent to other countries.
• We have previously seen the saving–investment
diagram for a closed economy. Now we can review it
for an open economy.
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The saving–investment diagram for a
small open economy
Figure 15.6 The saving–investment diagram for a small open economy
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Benefits of capital inflows
• The Solow-Swan model for a closed economy shows
the importance of savings for a country’s economic
growth.
– Savings are also important in an open economy, and a
country that attracts significant foreign capital has a larger
pool of savings to finance more investment than just
domestic savings.
– The convergence hypothesis, where relatively poor countries
grow rapidly, applies particularly well to open economies.
• Politically stable countries that safeguard the rights of
foreign investors grow more quickly than countries
without those characteristics as capital flows are very
sensitive to risk.
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Costs of capital inflows
• Foreign financing for domestic capital formation
means that interest and dividend payments must be
made to the foreign financier.
• A debt crisis can occur if the domestic investments
made leave insufficient income to pay foreign
creditors.
• An advantage to using domestic savings only to
finance capital formation is that the returns accrue to
domestic investors, rather than go abroad.
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Chapter organisation
15.1
The balance of payments
15.2
Capital flows and the relationship between the
capital and the current accounts
15.3
The determinants of international capital flows
15.4
Saving, investment and capital inflows
15.5
The saving rate and the trade and current
account deficits
Summary
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The saving rate and the trade deficit
• Australia has often run a trade deficit, with imports
exceeding exports.
• Economists argue a low rate of saving may be the
primary cause of trade deficits.
• The link between national saving and the trade deficit
can be seen:
Y = C + I + G + NX
Y – C – G – I = NX
NS – I = NX (as Y – C – G = NS)
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The saving rate and the trade deficit
(cont.)
• Therefore, if we hold I constant, a high rate of saving
leads to a high level of net exports and a low level of
saving a low level of net exports.
• Further, if NS < I, NX will be negative, i.e. a
trade deficit.
• Therefore, for constant domestic I, low saving rates
will tend to be associated with trade deficits, and high
saving rates with trade surpluses.
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The saving rate and the trade deficit
(cont.)
• This makes sense, as a low-saving, high-spending
economy spends part of their income on imports, so
imports would be likely to be high. They also
consume a large proportion of their domestic
production, reducing goods available to export.
• If a country has a trade deficit and their net income
flows and current transfers are negative, the current
account balance will be in deficit too.
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The saving rate and the trade deficit
(cont.)
• A country with a current account deficit will be
receiving net capital inflows.
• This makes sense too. A country with a low national
saving rate will not have sufficient savings of its own
to finance domestic investment.
• Therefore, a low rate of national saving tends to
create a trade deficit, as well as promote the capital
inflows that accompany the current account deficit.
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Australia’s recent savings and
investment performance
Figure 15.7 Recent trends in national saving and investment (per cent of
GDP) in Australia
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Chapter organisation
15.1
The balance of payments
15.2
Capital flows and the relationship between the
capital and the current accounts
15.3
The determinants of international capital flows
15.4
Saving, investment and capital inflows
15.5
The saving rate and the trade and current
account deficits
Summary
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Summary
• The current account on the balance of payments
records all transactions that involve the transfer of
ownership of commodities or a direct transfer of
income between the domestic country and the rest
of the world.
• The capital account on the balance of payments
records capital inflows and outflows, as well as
changes to the central bank’s holding of gold and
foreign exchange reserves.
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Summary (cont.)
• The higher the real interest rate in a country and the
lower the risk of investing there, the higher its capital
inflows.
• A low rate of national saving is the primary cause of
trade deficits.
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