Transcript Lecture 24

Balance of Payments
Lecture 24
Dr. Jennifer P. Wissink
©2016 Jennifer P. Wissink, all rights reserved.
November 15, 2016
TABLE 20.1 United States Balance of Payments, 2011
All transactions that bring foreign exchange into the United States are credited (+) to the current
account; all transactions that cause the United States to lose foreign exchange are debited (−) to
the current account
Current Account
Goods exports
Goods imports
(1) Net export of goods
Exports of services
Imports of services
(2) Net export of services
Billions of dollars
1,497.4
−2,235.8
−738.4
606.0
−427.4
178.6
Income received on investments
744.6
Income payments on investments
−517.6
(3) Net investment income
(4) Net transfer payments
(5) Balance on current account (1 + 2 + 3 + 4)
Capital Account
(6) Change in private U.S. assets abroad (increase is −)
(7) Change in foreign private assets in the United States
(8) Change in U.S. government assets abroad (increase is −)
227.0
−133.1
−465.9
−364.1
789.2
−119.5
(9) Change in foreign government assets in the United States
(10) Balance on capital account (6 + 7 + 8 + 9)
517.4
(11) Net capital account transactions and financial derivatives
37.7
(12) Statistical discrepancy
(13) Balance of payments (5 + 10 + 11 + 12)
211.8
−89.2
0
TABLE 20.1 United States Balance of Payments, 2011
All transactions that bring foreign exchange into the United States are credited (+) to the current
account; all transactions that cause the United States to lose foreign exchange are debited (−) to
the current account
Current Account
Goods exports
Goods imports
(1) Net export of goods
Exports of services
Imports of services
(2) Net export of services
Billions of dollars
1,497.4
−2,235.8
−738.4
606.0
−427.4
178.6
Income received on investments
744.6
Income payments on investments
−517.6
(3) Net investment income
(4) Net transfer payments
(5) Balance on current account (1 + 2 + 3 + 4)
Capital Account
(6) Change in private U.S. assets abroad (increase is −)
(7) Change in foreign private assets in the United States
(8) Change in U.S. government assets abroad (increase is −)
227.0
−133.1
−465.9
−364.1
789.2
−119.5
(9) Change in foreign government assets in the United States
(10) Balance on capital account (6 + 7 + 8 + 9)
517.4
(11) Net capital account transactions and financial derivatives
37.7
(12) Statistical discrepancy
(13) Balance of payments (5 + 10 + 11 + 12)
211.8
−89.2
0
Example 1:

The Wissinks go to France.

Hotel/food/train/gifts costs €5,000 Euros
– The Wissinks need to buy Euros
– € 1 Euro = $1.33 USD OR $1 USD = € 0.75 Euro
– So... it all costs $6,650 USD
– Cool currency converter site:
http://www.xe.com/ucc/full/

The Wissinks are importing goods
and services.
– There will be 2 entries
in the Balance of Payments.
Example 1:




In the Current Account,
“Imports of goods and services”
shows a - $6,650. (Note: a debit
item, since we use up foreign
exchange!)
I take $6,650 US dollars and
purchase € 5,000 Euros from a
French private bank to pay the
hotel/tour bill.
In the Capital Account, line (7)
“Change in foreign private
assets in the United States” (in
this case, French holdings of US
dollars) are increased by
+$6,650. (Note: this is a credit
item!)
The net wealth position of the
US vis-à-vis the rest of the world
has decreased by $6,650.
Example 2:

Prof. Wissink decides to buy a British
bond from a non-government (private)
British issuer.

The bond costs £10,000.
– £1 GBP = $1.54 USD OR $1 USD = £0.65
GBP
– I take $15,400 USD and purchase the £10,000
GBP bond
(which has a US dollar value of $15,400).

The Wissinks are dealing with buying a
foreign asset.
– There will be 2 entries in the Balance of
Payments
Example 2:

“Change in foreign private
assets in the US” (in this
case, British holdings of US
dollars) show a +$15,400 in
the Capital Account.
– (Reminder: increases in this
item get recorded as a “+” item
in line (7) of the Capital
Account.)

But now I hold this bond so
there is a “change in private
U.S. assets abroad”, that is
an increase in US assets
abroad (the U.S.(me!) now
holds more British bonds)
and so we show this as a $15,400 in the Capital
Account.
– (Reminder: increases in this
item get recorded as a “–” item
in line (6) of the Capital
Account.)

So there is still “balance” in the Balance
of Payments accounts.
Trade Policy: Free vs. Protection



Free Trade - the practice of leaving the markets alone and
letting the invisible hand of the price mechanism do its work.
Protection - the practice of shielding a sector of the
economy from foreign competition via various policies.
So…
– Should we? (Protectionist Policies)
– Should we not? (Free Trade Policies)

Common protectionist policies
– A tariff is a tax on imports.
» The average tariff on imports into the United States is about 5 percent.
– A quota is a limit on the quantity of imports.
– Export subsidies are government payments made to domestic firms
to encourage exports.
– Dumping refers to when a firm or industry sells products on the
world market at prices below the cost of production.
» The Comprehensive Trade Act of 1988 contains clauses that permit the president
to impose trade sanctions when investigations reveal dumping by foreign
companies or countries.
The Case For Free Trade
The case for free trade is based on the theory of
comparative advantage.
 When countries specialize and trade based on
comparative advantage, consumers pay less
and consume more, and resources are used
more efficiently.
 When tariffs and quotas are imposed, some of
the gains from trade are lost.
 Why did The Economist favour free trade?

– Sep 6th 2013, 13:55 by C.R. | LONDON
– http://www.economist.com/blogs/freeexchange/2013/
09/economic-history
The Case For Protection
 Protection
saves jobs at home.
 Some
countries engage in unfair trade
practices, so we need to protect against
that.
 Cheap
foreign labor makes competition
unfair.
 Protection
safeguards national security.
 Protection
discourages dependency.
 Protection
safeguards infant industries.
 Often
Special Issues emerge with
developing economies.
U.S. Trade Policies
 Long
and complicated history.
 Affected by:
– economic conditions
– political conditions
– social conditions

High water mark: the Smoot-Hawley tariff was
the U.S. tariff law of the 1930s, which set the
highest tariffs in U.S. history (average tariff rate
reached 60%).
– It set off an international trade war and caused the
decline in trade that is often considered a cause of the
worldwide depression of the 1930s.
– President-elect Trump and tariffs
U.S. Trade Policies with the World

The General Agreement on Tariffs and Trade (GATT) is an
international agreement originally singed by the United States and 22
other countries in 1947 to promote the liberalization of foreign trade.
– GATT was supposed to be temporary but lasted a long time and in 1995
spawned the WTO through the Uruguay Round negotiations. For all
intents and purposes, GATT now lives vicariously through the WTO.
[Special Thanks to Barrett Lane (S08) for great detective work provided to
me on the history between GATT and the WTO.]

The World Trade Organization (WTO) is the only global
international organization dealing with the rules of trade between
nations. At its heart are the WTO agreements, negotiated and signed
by the bulk of the world’s trading nations and ratified in their
parliaments. The goal is to help producers of goods and services,
exporters, and importers conduct their business.
–
–
–
–
–
Location: Geneva, Switzerland
Established: 1 January 1995
Created by: Uruguay Round negotiations (1986-94)
Membership & Observers: 160 countries on 26 June 2014
http://www.wto.org/index.htm
Economic Integration


Economic integration occurs when two or more nations join
to form a free-trade zone.
Two Examples:
– The European Union (EU)
» Initially, the EU consisted of just six countries: Belgium, Germany,
France, Italy, Luxembourg and the Netherlands.
» In 1991 they signed the Maastricht Treaty  the EURO, which 16 of the
EU countries adopted.
http://europa.eu/index_en.htm
– The North American Free-Trade Agreement (NAFTA)
» An agreement signed by the United States, Mexico, and Canada in 1994
in which the 3 countries agreed to establish all North America as a freetrade zone.

President Elect Trump and Trade.
– http://www.npr.org/2016/11/10/501537342/how-u-s-trade-policycould-change-under-the-trump-administration
– NAFTA and Trans-Pacific Partnership
The EU Today

The European Union is now composed
of 28 independent sovereign
countries which are known as
member states, they are:

Members: Austria, Belgium, Bulgaria, Croatia, Cyprus,
the Czech Republic, Denmark, Estonia, Finland, France,
Germany, Greece, Hungary, Ireland, Italy, Latvia,
Lithuania, Luxembourg, Malta, the Netherlands, Poland,
Portugal, Romania, Slovakia, Slovenia, Spain, Sweden,
and the United Kingdom.
– BREXIT VOTE on June 23, 2016

Candidates: Albania, FYROM, Iceland, Montenegro,
Serbia, Turkey
Our Model and Simple Policy Prescriptions…?

So... AEd = C + Id + G + EX – IM
and to get equilibirum set Y* = AEd(Y*) and solve for Y*

So… it’s good to EX and IM to make your Y* as large as
possible…

…however, this implies another country’s exports may go
and its imports may go which might not be good for them.
– Get beggar thy neighbor policies
– Exporting unemployment
– Retaliation via tariffs and quotas, etc
– Bad for international trade overall

GOOD QUESTION: What really determines EX and IM?
Determinants of Exports & Imports

The determinants of imports include the same factors
that affect consumption and investment.
– i.e., Y or Yd, r, wealth and any other stuff you think belongs in
the model
– i>clicker question: Do YOU check for where what you consume
is produced?
A. Yes.
B. No.

Imports also depend on the prices of domesticallyproduced goods relative to foreign-produced goods.
– prices at home relative to abroad
– exchange rates matter a lot here

The determinants of exports are the same – just from the
position of the rest of the world.
– US exports depend on economic activity in the rest of the world.
– I.e., If foreign output increases, U.S. exports tend to increase.
Exports and Imports and
the so-called “Trade Feedback Effect”

The trade feedback effect is the tendency for an increase
in the economic activity of one country to lead to a
worldwide increase in economic activity, which then feeds
back to that original country.

Suppose the U.S. economy starts to grow  Y*  IM 
– Because U.S. imports are somebody else’s exports, the extra
import demand from the United States raises the exports of the
rest of the world, expanding their economies.
– Some of the desire for those countries to import creates exports for
the US!  a trade feedback effect back in the U.S.

In good times, this might appear nice, but in bad times, not
so much.
Export and Import Prices
and the so-called “Price Feedback Effect”


The price feedback effect is the process by
which a domestic price increase in one country
can “feed back” on itself through export and
import prices.
Suppose...
– Inflation picks up in Italy 
– shoe prices and olive oil prices in Italy go up 
– imported shoes and olive oil from Italy are now more
expensive in the U.S. 
– in the U.S., IM and its EX 
– AD shifts right and SR-AS shifts left in the U.S.
– upward pressure on prices in the U.S. 
– a tendency for even higher prices back in Italy.


Inflation might be “exportable” and it might
“boomerang” back on you.
Need to address exchange rate determination.
The Open Economy with Flexible
Exchange Rates

Recall: The exchange rate is the ratio at which two
currencies are traded, or the price of one currency in
terms of another.

Floating, or market-determined, exchange rates
are exchange rates determined by the unregulated
forces of supply and demand.
– Haven’t always been flexible in the U.S.
– Not all countries have flexible exchange rates now.
– See Case, Fair & Oster appendix for history.
The Market for Foreign Exchange
Consider only 2 countries: the U.S. and the U.K.
 Consider the market for pounds.
 What does a pound cost in dollars?

– Suppose 1 pound costs $1.89
 (What
does a dollar cost in pounds?)
– 1 dollar costs £0.53
 The demand for pounds is comprised of
holders of dollars wishing to acquire pounds.
 The supply of pounds is comprised of holders
of pounds seeking to acquire dollars.
The Demand
for Foreign Exchange:
E.g., British Pounds
THE DEMAND FOR POUNDS: derived from the need to obtain pounds
to buy UK goods and services
1.
2.
3.
4.
5.
6.
Firms, households, or governments that import British goods into the
United States or wish to buy British-made goods and services
U.S. citizens traveling in Great Britain
Holders of dollars who want to buy British stocks, bonds, or other
financial instruments
U.S. companies that want to invest in Great Britain – build factories
there
Speculators who anticipate a decline in the value of the dollar relative to
the pound
US wanting to send foreign aid to the UK
The Demand Curve for Pounds

The demand for
pounds is downward
sloping.

When the $price of
pounds falls, British
made goods and
services appear less
expensive to U.S.
buyers.

If British prices are
constant, U.S. buyers
will buy more British
goods and services,
and the quantity
demanded of pounds
will rise.