Principles of Macroeconomics · 2017. 2. 2. · Balance of Payments • Current Account: The value...

PrinciplesofMacroeconomicsModule7.1

UnderstandingBalanceofPayments

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BalanceofPaymentsBalanceofPaymentsarethemeasurementofeconomicactivityacountryconductsinternationally

• CurrentAccount:• CapitalAccount:

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BalanceofPayments• CurrentAccount:Thevalueoftradeofgoodsandservicesacrossboarders

• CapitalAccount:Themonetaryflowsbetweencountriesusedtopurchasefinancialassetssuchasstocks,bonds,realestateandotherrelateditems

CapitalAccount+CurrentAccount=0

IfCurrentAccountisindeficit,thenCapitalAccountisinsurplus

IfCurrentAccountisinsurplus,thenCapitalAccountisindeficit

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BalanceofPayments• CurrentAccount:Thevalueoftradeofgoodsandservicesacrossboarders

• CapitalAccount:Themonetaryflowsbetweencountriesusedtopurchasefinancialassetssuchasstocks,bonds,realestateandotherrelateditems

CapitalAccount+CurrentAccount=0

IfCurrentAccountisindeficit,thenCapitalAccountisinsurplus

IfCurrentAccountisinsurplus,thenCapitalAccountisindeficit

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BalanceofPayments

CapitalAccount+CurrentAccount=0

IfCurrentAccountisindeficit,thenCapitalAccountisinsurplus

IfCurrentAccountisinsurplus,thenCapitalAccountisindeficit

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CurrentAccount

• Netexportsofgoodsandservices, (thedifferenceinvalueofexportsminusimports,whichcanbewrittenas) NX,(1)

• Netinvestmentincome

• Nettransfers

à Largestcomponent:NetExports

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FactorsthatDetermineCurrentAccount

1. ChangeinEconomicGrowthRates/NationalIncome• Higherdomesticgrowthàmoredemandoverallàmoredemandforimportstoo!• Higherforeigngrowthà moredemandforexports• Relativeeconomicgrowthratesdetermineifimportsorexportsrise

2. Changeinrelativepricesorinflation3. Changeintastesandpreferences4. Changeincomparativeadvantage

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FactorsthatDetermineCurrentAccount

1. ChangeinEconomicGrowthRates/NationalIncome

2. Changeinrelativepricesorinflation• Relativepricesdeterminecomparativepriceofimportsandexports• Higherdomesticinflation

• Exportsarerelativelymoreexpensiveforforeignersnow:Exportswillfall• Importsarerelativelycheaperfordomesticconsumers:Importswillrise

3. Changeintastesandpreferences4. Changeincomparativeadvantage

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FactorsthatDetermineCurrentAccount

1. ChangeinEconomicGrowthRates/NationalIncome2. Changeinrelativepricesorinflation

3. Changeintastesandpreferences• Ifbuyers’preferenceschangeforagood– ifitisatradedgood,thennetexportswillbeimpacted

• PerceptionthatChineseproductsareofpoorqualityà buyer’sdemandforthemmaydecline

4. Changeincomparativeadvantage

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FactorsthatDetermineCurrentAccount

1. ChangeinEconomicGrowthRates/NationalIncome2. Changeinrelativepricesorinflation3. Changeintastesandpreferences

4. Changeincomparativeadvantage• Increasesinproductivityviatechnologicaladvancements,lowerproductioncosts,andimprovedhumancapitalchangecomparativeadvantageandmayimpactnetexports

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CapitalAccount

Becausethecapitalaccountdealswithfinancialflows,themostimportantfactoraffectingitwillbeinterestrates

• Determinethereturnonfinancialassetsinacountry• Investorschasing“highestreturn”willmovefinancialassetstocountrieswithhighestinterestrates

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KeyTakeaways

• Thebalanceofpaymentsmeasurestheeconomicinteractionacountryhaswithglobalmarkets

• ItiscomprisedoftheCurrentAccountandCapitalAccount

• CurrentAccount– tradeingoodsandservices• CapitalAccount– financialflows

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PrinciplesofMacroeconomicsModule7.2

CapitalFlows,TradeandGlobalMarkets

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Inthisvideo…

• InthisvideowewilldiscussNetExports,NetCapitalFlows,andhowthetwoarelinked

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Imports,ExportsandTrade

•NetExports=Exports– Imports

• NetExports<0:Tradedeficità Exports<Imports

• NetExports>0:Tradesurplusà Exports>Imports

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FactorsthatdetermineExportandImportVolumes

• Tastesandpreferencesathomeandabroad• Pricesofgoodsathomevs.abroad• Exchangerates• Incomeofhouseholds• Transportationcosts• Gov’tpoliciestowardstrade

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• FactorsthatdetermineExportandImportvolumes:

• Tastesandpreferencesathomeandabroad• Pricesofgoodsathomevs.abroad• Exchangerates• Incomeofhouseholds• Transportationcosts• Gov’tpoliciestowardstrade

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• FactorsthatdetermineExportandImportvolumes:

• Tastesandpreferencesathomeandabroad• Pricesofgoodsathomevs.abroad• Exchangerates• Incomeofhouseholds• Transportationcosts• Gov’tpoliciestowardstrade

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• FactorsthatdetermineExportandImportvolumes:

• Tastesandpreferencesathomeandabroad• Pricesofgoodsathomevs.abroad• Exchangerates• Incomeofhouseholds• Transportationcosts• Gov’tpoliciestowardstrade

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• FactorsthatdetermineExportandImportvolumes:

• Tastesandpreferencesathomeandabroad• Pricesofgoodsathomevs.abroad• Exchangerates• Incomeofhouseholds• Transportationcosts• Gov’tpoliciestowardstrade

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• FactorsthatdetermineExportandImportvolumes:

• Tastesandpreferencesathomeandabroad• Pricesofgoodsathomevs.abroad• Exchangerates• Incomeofhouseholds• Transportationcosts• Gov’tpoliciestowardstrade

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FlowsofFinancialResources:NetCapitalFlows• Capitalflowsàmovementoffinancialassetsbetweenhomeandabroad

• Stocks,bonds,realestate,ect.

NetCapitalFlows=PurchaseofForeignAssets– PurchaseofDomesticAssetsbyDomesticResidentsbyForeignResidents

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FlowsofFinancialResources:NetCapitalFlows

• NetCapitalInflow:Homecountryisreceivingmoreforeignfinancialinvestmentthanitissendingouttoothercountries

• NetCapitalOutflow:Homecountryissendingoutmorefinancialinvestmentthanitisreceiving

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FlowsofFinancialResources:NetCapitalFlows

• NetCapitalInflow:Homecountryisreceivingmoreforeignfinancialinvestmentthanitissendingouttoothercountries

• NetCapitalOutflow:Homecountryissendingoutmorefinancialinvestmentthanitisreceiving

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TypesofForeignInvestments

• ForeignDirectInvestmentà Foreignentity’sinvestmentincapital/machines/factoriesindomesticmarket(businessoperationsbyforeignentity)

• ForeignPortfolioInvestmentà Foreignentity’sinvestmentinfinancialassetsindomesticmarket(businessoperationsbydomesticentity)

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FactorsthatinfluenceNetCapitalFlows

• Therealinterestratesbeingpaidonforeignassets.

• Therealinterestratesbeingpaidondomesticassets.

• Theperceivedeconomicandpoliticalrisksofholdingassetsabroad.

• Thegovernmentpoliciesthataffectforeignownershipofdomesticassets. 301

FactorsthatinfluenceNetCapitalFlows

• Therealinterestratesbeingpaidonforeignassets.

• Therealinterestratesbeingpaidondomesticassets.

• Theperceivedeconomicandpoliticalrisksofholdingassetsabroad.

• Thegovernmentpoliciesthataffectforeignownershipofdomesticassets.

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FactorsthatinfluenceNetCapitalFlows

• Therealinterestratesbeingpaidonforeignassets.

• Therealinterestratesbeingpaidondomesticassets.

• Theperceivedeconomicandpoliticalrisksofholdingassetsabroad.

• Thegovernmentpoliciesthataffectforeignownershipofdomesticassets.

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FactorsthatinfluenceNetCapitalFlows

• Therealinterestratesbeingpaidonforeignassets.

• Therealinterestratesbeingpaidondomesticassets.

• Theperceivedeconomicandpoliticalrisksofholdingassetsabroad.

• Thegovernmentpoliciesthataffectforeignownershipofdomesticassets.

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EquatingNetExportsandNetCapitalFlows

•RecallinBalanceofPayments• CurrentAccountà NetExports(NX)

• CapitalAccountà NetCapitalFlows(NC)

• NetExportsandNetCapitalFlowsmustoffseteachotherforBOP=0

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EquatingNetExportsandNetCapitalFlows

• Whenanationisrunningatradesurplus(NX>0),itwillbeusingtheforeigncurrencytopurchaseforeignassets.Thus,capitalisflowingoutofthecountry(NC>0).

• Whenanationisrunningatradedeficit(NX<0),itmustbefinancingthenetpurchaseofthesegoodsbysellingassetsabroad.Thus,capitalisflowingintothecountry(NC<0).

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EquatingNetExportsandNetCapitalFlows

• Whenanationisrunningatradesurplus(NX>0),itmustbeusingtheforeigncurrencytopurchaseforeignassets.Thus,capitalisflowingoutofthecountry(NC>0).

• Whenanationisrunningatradedeficit(NX<0),itmustbefinancingthenetpurchaseofthesegoodsbysellingassetsabroad.Thus,capitalisflowingintothecountry(NC<0).

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EquatingNetExportsandNetCapitalFlows

Everyinternationaltransactioninvolvesexchange:• Whenasellercountrytransfersagoodorservicetoabuyercountry(export)thebuyercountrygivesupsomeassettopayforthegoodorservice.

• Netvalueofthegoodsandservicessoldbyacountry(netexports)mustequalthenetvalueoftheassetsacquired(netcapitalflow).

• RealexchangerateswilladjusttoequateNXandNC

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EquatingNetExportsandNetCapitalFlows

Everyinternationaltransactioninvolvesexchange:• Whenasellercountrytransfersagoodorservicetoabuyercountry(export)thebuyercountrygivesupsomeassettopayforthegoodorservice.

• Netvalueofthegoodsandservicessoldbyacountry(netexports)mustequalthenetvalueoftheassetsacquired(netcapitalflow).

• RealexchangerateswilladjusttoequateNXandNC

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EquatingNetExportsandNetCapitalFlows

Everyinternationaltransactioninvolvesexchange:• Whenasellercountrytransfersagoodorservicetoabuyercountry(export)thebuyercountrygivesupsomeassettopayforthegoodorservice.

• Netvalueofthegoodsandservicessoldbyacountry(netexports)mustequalthenetvalueoftheassetsacquired(netcapitalflow).

• RealexchangerateswilladjusttoequateNXandNC

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TariffsandQuotas• Sometimes,governmentsareconcernedwithcompetitionfromabroad,especiallywhenitaffectsdomesticproduction

• Theywillsetuptradebarrierstomakeitmoredifficult/costlytoimportgoods• Tariffs:Taxesonimports• Tradequotas:Limitsonthetotalvolumeofimportsthatcanenterthecountry

• Tradebarriersmaybenefitindividualfirmsorindustriesdomestically,buttheyarecostlytotheeconomyasawhole

• Decreasethetotalamountoftradethatoccursbetweencountries• Increasethepriceofthetradedgood• Hinderthebenefitsofspecializationandcomparativeadvantage

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KeyTakeaways• Inanopeneconomy– goodsmarkets(netexports)andfinancialmarkets(netcapitalflows)arecloselylinked

• TherealexchangeratewilladjusttoequilibratetheNX-NCmarket

• Tradebarriersareusedtohelpdomesticproducers,buthurttheeconomyasawhole

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Principles of MacroeconomicsModule 7.2 (b)

Exchange Rates and Net Exports

Net Exports and Exchange Rates• RecallthatNetExports:Exports– Imports

• Oneofthefactorsthataffectsexportandimportvolumesareexchangerates

• Exchangerates:Valueofonecountry’scurrencyintermsofanothercountry’scurrency

Example • Youcanuse1USdollartobuy0.87Euros• Theexchangerateforis1USD:0.87EUR• OneUSDisworth0.87EURs

Example • Ifyoucanuse1USdollartobuy0.87Eurosthenyoucanalsosay:• 1Eurowillbuyyou1.15USdollars

• 1USD=0.87EURà 1EUR=1/0.87USD=1.15USD

Example • Nowassumethattheexchangeratechangesassuch:• 1USDwillnowbuyyou0.95EUR

• ThevalueofUSDhasincreased• YoucanbuymoreEuroswiththatsame1USD• TheUSDhasappreciated

Example • Thisalsotellsyouthatif:• 1USDwillnowbuyyou0.95EUR• 1EUROwillbuyyou1.05USD

• ThevalueofEurohasdecreased• YoucanbuylessUSDwiththatsame1EUR• TheEURhasdepreciated

Exchange Rate Impact on Trade• IfthevalueofUSDhasincreased:(0.87EURto0.95EUR)• ValueofEURhasdecreased:(1.15USDto1.05USD)• ThevalueofUSgoodssoldinEuropehasincreased• USgoodsaremoreexpensiveinEurope• USexportstoEuropewilldecrease

• AppreciationofUSDwillleadtoadecreaseinexports(toEurope)• DepreciationofEURwillleadtoadecreaseinimports(fromUS)

Exchange Rate Impact on Trade• IfthevalueofUSDhasincreased:(0.87EURto0.95EUR)• ValueofEURhasdecreased:(1.15USDto1.05USD)• ThevalueofEuropeangoodssoldinUShasdecreased• EuropeangoodsarelessexpensiveinUS• EuropeanimportstoUSwillincrease

• AppreciationofUSDwillleadtoanincreaseinimports(fromEurope)• DepreciationofEURwillleadtoaincreaseinexports(toUS)

Exchange Rate Impact on Trade• IfthevalueofUSDhasincreased:(0.87EURto0.95EUR)• ValueofEURhasdecreased:(1.15USDto1.05USD)

• USExportsDecrease,ImportsIncrease=NetExportsDecrease• EUExportsIncrease,ImportsDecrease=NetExportsIncrease

Exchange Rates and Trade

ValueofUSD

INCREASES

USExports DecreaseUSNetExportsDecrease

USImports Increase

ValueofEUR

DECREASES

EUExports IncreaseEUNetExportsIncrease

EUImports Decrease

Exchange Rates and Trade

ValueofUSD

DECREASES

USExports IncreaseUSNetExportsIncrease

USImports Decrease

ValueofEUR

INCREASES

EUExports DecreaseEUNetExportsDecrease

EUImports Increase

PrinciplesofMacroeconomicsModule7.3

ForeignExchangeMarketandExchangeRates

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ExchangeRates

• Exchangeratesgivethepriceofonecurrencyintermsofanothercurrency

• EUR/USDà Amountofeuros(EUR)thatcanbepurchasedwithoneUSdollar(USD)

• Exchangeratesaredeterminedbytherelativesupplyanddemandforthetwocurrencies

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Floatingvs.FixedExchangeRatePolicies

• Floatingexchangerates:valueoftheexchangerateisdeterminedbymarketforces(supplyanddemand)

• Fixedexchangerates:thevalueispredeterminedbyagovernmentbodyandthesupplyofcurrencyisalteredtomaintainthefixedexchangerate

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DemandandSupplyofForeignExchange• DemandforUSD:DemandforUSDabroadcomesfromforeignerswantingtobuyUSexports

• SupplyofUSD:SupplyofUSDtoforeignexchangemarketsisdeterminedbyUSconsumers’demandforforeigngoods,orimports

• ForUSconsumerstobuyEuropeangoods, theyneedEuros• TogetEuros, theysellUSDinexchange

• EquilibriumExchangeRate:wheredemandforUSDfromabroadmeetssupplyofUSDinforeignexchangemarkets

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DemandandSupplyofForeignExchange• DemandforUSD:DemandforUSDabroadcomesfromforeignerswantingtobuyUSexports

• SupplyofUSD:SupplyofUSDtoforeignexchangemarketsisdeterminedbyUSconsumers’demandforforeigngoods,orimports

• ForUSconsumerstobuyEuropeangoods,theyneedEuros

• TogetEuros,theysellUSDinexchange

• EquilibriumExchangeRate:wheredemandforUSDfromabroadmeetssupplyofUSDinforeignexchangemarkets

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DemandandSupplyofForeignExchange• DemandforUSD:DemandforUSDabroadcomesfromforeignerswantingtobuyUSexports

• SupplyofUSD:SupplyofUSDtoforeignexchangemarketsisdeterminedbyUSconsumers’demandforforeigngoods,orimports

• ForUSconsumerstobuyEuropeangoods, theyneedEuros• TogetEuros, theysellUSDinexchange

• EquilibriumExchangeRate:wheredemandforUSDfromabroadmeetssupplyofUSDinforeignexchangemarkets

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ExchangeRateDetermination

FactorsthataffectthedemandorsupplyofUSDtoforeignexchangemarketswillinfluencetheexchangerate

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ExchangeRateDetermination

• InflationRates• IftheUShaslowerinflationthanEurope– USDwillappreciateagainsttheEuro

• Lowerinflationmeansthatthevalueofeachdollarishigher– peopleneedtoholdlessUSDtomakethesametransactions

• WithlessUSDincirculation– eachUSDismorevaluable,andthereforeitsvalueagainstothercurrenciesrise

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ExchangeRateDetermination

• InterestRates• Higherinterestrateswillattractmorefinancialcapitalfromabroad

• NetcapitalinflowincreasesdemandforUSDandthereforepushingupthevalueofUSDrelativetoothercurrencies

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ExchangeRateDetermination

• Country’sCurrentAccountBalance• Currentaccountreflectsthetradebalance– thedemandforexportsandsupplyofimports

• Currentaccountsurplusmeansthecountryisexportingmorethanimporting,leadingtoarelativelyhigherdemandforUSD–increasingthevalueofUSDrelativetoothercurrencies

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ExchangeRateDetermination

• TermsofTrade• Termsoftraderefertotherelativepriceofexportstoimports

• Highertermsoftradereflectexportpricesrisingmorethanimportprices

• Becausethiswillreflectgreaterdemandforthecountry’scurrencytopayforthoseexports,thevalueofthecurrencywillriseandtheexchangerateappreciates

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ExchangeRateDetermination

• PoliticalStability• Acountrywithmorepoliticalstabilityandlessriskwillattractmoreforeigninvestorsandforeigncapital

• Theinflowofforeigncapitalleadstoanincreaseinthevalueofthecurrency,orexchangerateappreciation

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ExchangeRateDetermination

•GovernmentDebt• Countrieswithhighlevelsofgovernmentdebtwillhaveadifficulttimeattractingforeigncapitalinflows

• Foreigninvestorssellbondsiftheypredictincreasinggovernmentdebt,therebyleadingtoaweakerexchangerate

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ExchangeRateDetermination

•Recession• Arecessioncorrespondsusuallytolowerinterestrates

• Withlowerinterestrates,foreigncapitalwillleavetheeconomy,searchingforhigherreturnselsewhere

• Thisnetcapitaloutflowleadsadecreaseinthevalueofthecurrency,orexchangeratedepreciation

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KeyTakeaways• Exchangeratesreflecttherelativepriceofonecurrencyintermsofanother

• Demandforandsupplyofcurrencyaredeterminedbymarketforces,andtheexchangerateequilibratestoclearthemarket

• Certaindomesticeconomicconditionsdeterminetheexchangerate,aswellasforcesoutsideofthedomesticeconomy

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