Transcript 8.2. Balancing International Payment (BOP)

8.2. Balancing International Payment (BOP)
International trade concerns the (X –M) component of the Aggregate Demand. It
concerns the external economy.
1.
2.
3.
4.
5.
Having a positive BOP is a macro objective of government.
To obtain a positive BOP, a country needs to export more than import. If
this is not so, then the country will suffer a negative BOP or BOP deficit.
When we talk about the BOP, we say that there is balance of goods as well
as balance of service to the BOP.
The balance of trade would be concern with visible goods while the balance
of service would be concern with invisible goods (mostly services).
Together the make up the Balance of Trade and Service of the BOP.
Balance of Trade (BOT)
Balance of Services (BOS)
Concerns visible goods. Concerns services.
Eg. Computers, shoes, Eg. Banking services,
cellphones
consultancy services etc.
8.2. Balancing International Payment (BOP)
The government monitors the Balance of Payment
through 3 national accounts and they are:
1. The current account – visible, invisible, income in and out of the country due to
factors of production and net transfer (like grants and donation from other
governments.
2. The capital accounts – international capital transfer from of non-financial assets eg.
Land factories, buildings. and machinery between its residents and the rest of the
world.
3. The financial accounts – international monetary flow of funds related to
investments in business, government bonds, loan stocks and company shares and
foreign direct investments in factories and businesses that would yield profits.
8.2. Balancing International Payment (BOP)
Exchage Rate Mechanism
Money Market For Singapore Dollars
Sing Dollar In
terms of
US Dollar
S
0.90
Appreciation of Singapore
0.85
Depreciation of Singapore
0.80
D
Q0
Quantity of
Sing Dollars
8.2. Balancing International Payment (BOP)
Exchage Rate Mechanism
Money Market For Singapore Dollars
Sing Dollar In
terms of
US Dollar
S
0.90
1. Assume there is an increase in demand
for Singapore Dollars owing to increase
demand for Singapore exports. This will shift
the DD curve to Shift to the right.
2. This causes the Singapore Dollars to
appreciate from 0.85 to 0.90 USD for 1 SGD.
0.85
0.80
D1
Q0
Q1
Quantity of
Sing Dollars
3. With this SGD appreciation, this means
that more USD will be needed to buy a SGD
dollar. (used to be 0.85 now 0.95. You now
need USD0.1 more to buy 1 SGD)
8.2. Balancing International Payment (BOP)
Exchage Rate Mechanism
Money Market For Singapore Dollars
Sing Dollar In
terms of
US Dollar
S
Money Market For US Dollars
US Dollar In
terms of
Sing Dollar
0.90
1.25
0.85
1.20
0.80
1.15
S1
S
D1
Q0
Q1
Quantity of
Sing Dollars
D
Q0
Q1
Quantity of
US Dollars
An appreciation in the Singapore Dollars would imply a depreciation in the US
Dollar and vice versa.
8.2. Balancing International Payment (BOP)
Exchage Rate Mechanism
TEASER 1
Using exchange rate diagram(s), explain how the US exchange rate would
change when there is an increase in demand for US goods by the Chinese.
(US/RMB exchange is currently at USD1 = RMB6.2)
Presentation:
Bank of China
To hand up : Charmaine,
Eunice, SAQuek, Melvin,
LSNing, Adi, Kim, Felicia,
Dylan, Kenneth.
Exchage Rate Mechanism
What Gives Rise to the Demand For A Currency
1.
2.
3.
4.
Changes in the current account ie. Due to imports and export trades.
Where there is a demand for a country's exports, foreigners have first
to buy the Singapore currency to purchase Singapore exports.
Inflation can cause the price of Singapore produced exports to be
more expansive and Singaporean would instead buy cheaper imports.
Thus we sell SGD and buy RMB to purchase Chinese exports.
Change in interest rate – This will attract foreign direct investment as a
higher interest rate then their country would bring better returns on
their deposit for these FDIs.
Speculation – Hot money moving in and out of a country looking for
quick returns.
Exchage Rate Mechanism
How the Government Can Us The Exchange Rate to Improve a Negative
BOP (BOP Deficit)
1. If country is suffering a negative BOP, they can depreciate their
currency ie. Sell down or give up their local currency and buy up USD
causing the SGD to depreciate and in the process making the SGD
depreciate.
2. This will make Singapore exports more competitive and thus we can
export more thereby creating an increasingly more positive BOP through
the current account.
8.2. Balancing International Payment (BOP)
Depreciating a Currency Towards A Positive BOP
Money Market For US Dollars
US Dollar In
terms of
SGD Dollar
Money Market For SGD Dollars
S
SGD Dollar In
terms of
US Dollar
0.90
1.25
0.85
1.20
0.80
1.15
S1
S
D1
Q0
Q1
Quantity of
Sing Dollars
D
Q0
Q1
Quantity of
US Dollars
A depreciation in the Singapore Dollars would imply an appreciation in the US
Dollar. When SGD is lower against the USD, Singapore exports will become more
competitive and foreigners will buy more of Singapore exports.
8.2. Balancing International Payment (BOP)
The Marshal Lerner Condition
1. This condition states that a country can correct a BOP deficit by depreciating
its currency on condition that the sum of its imports and exports is greater than
1. (price elastic in demand)
2. this means that there would be a net increase in demand for the country’s
export thereby causing a net inflow of total revenues into the country.
8.2. Balancing International Payment (BOP)
Fixed Exchage Rate Mechanism
Floating Exchage Rate Mechanism
Money Market For Singapore Dollars
Money Market For Singapore Dollars
Sing Dollar In
terms of
US Dollar
No movement in
Exchange Rate
S
Sing Dollar In
terms of
US Dollar
No Limit to appreciation.
S
0.90
0.85
0.85
0.80
D
Q0
Advantages and Disadvantages
Advantage can control exchangre rate fluctuation m
aking it good for trade. But government needs lots
of reserve to do maintain fixed ex.
Quantity of
Sing Dollars
No Limit to depreciation
Q0
D
Quantity of
Sing Dollars
Advantages and Disadvantages
Will allow the external economy to adjust price of ex
ports if its too high. However, can cause wild spectul
ation of currency and cause foreigners to lose confid
ence in the currency.
8.2. Balancing International Payment (BOP)
Managed Float Exchage Rate Mechanism (Singapore)
Money Market For Singapore Dollars
Sing Dollar In
terms of
US Dollar
The MAS will intervene when the exchange
rate is at the Upper or lower Band.
S
Upper
Band
0.90
Upper Band: When ex rate is at upper
band it means that SGD is getting
strong and affects our exports. To
prevent deficit BOP, government will
Lower Bond sell down the SGD so as to depreciate
the SGD.
0.85
0.80
D
Q0
Quantity of
Sing Dollars
Lower Band: When ex rate is at lower
band it means that SGD is getting
weaker and affects our import of high
priced resources causing cost push
inflation. To prevent this, government
will buy up the SGD in the money
markets so as to appreciate the SGD.
8.2. Balancing International Payment (BOP)
Managed Float Exchage Rate Mechanism (Singapore)
Money Market For Singapore Dollars
Sing Dollar In
terms of
US Dollar
S
0.90
0.85
The MAS would also do the folloiwng:
Upper
Band
Lower
Band
0.80
D
Q0
Quantity of
Sing Dollars
1. Steepen the slope of the band: When
prices of raw materials from other
countries, the MAS will steepen the
slope of the band to fight imported
inflation (cost push inflation)
8.2. Balancing International Payment (BOP)
Managed Float Exchage Rate Mechanism (Singapore)
Money Market For Singapore Dollars
Sing Dollar In
terms of
US Dollar
S
0.90
0.85
The MAS would also do the folloiwng:
Upper
Band
Lower
Band
0.80
D
Q0
Quantity of
Sing Dollars
2. Widen the band: When exchange
rate between SGD and its major trading
partners countries are volatile, the MAS
will widen the band.