HE206 Lecture 1 Student Notes

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HE2006/206

n erna ona mone aryeconom csLecturesandTutorials1to6

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HE2006/206InternationalMonetary

Economics Youcanfindthelecturenotesandassignedquestionsin

ve re. ecturenotesw eava a et e ay e ore

thelecture.

th

InternationalEdition.(Oldereditionsmaybeusedbut

pleasecheckthecorrectquestionnumberstobediscussed

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Lecture1:C apter13

NationalIncomeAccountingandtheBalance

Chapter14ThebasicsofexchangeratesExchangeratesandthepricesofgoods

Copyright 2012 Pearson Addison-Wesley. All rights reserved.


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Preview Review:Nationalincomeaccounts measuresofnationalincome(earnedbythenationsfactorsof

production,e.g.,labor,capital,land)

measuresofvalueofproduction(GNPorGDP),representedasY

= +

Inmacro,weusethecircularflowdiagramtoillustratetheassumption

thatproduction

=income

=Y

, , ,

Nationalsaving,investment,andthecurrentaccount

a anceo paymentsaccounts

Review: ExchangeRateandPrices


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GNP=ExpenditureonaCountrys

GoodsandServices

economyis = =C+I+G + CA

Expenditure by domestic

individuals and

institutions

Net expenditure by foreign

individuals and institutions

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Ex enditureandProductioninanO enEconom

CA= EX IM = Y (C+ I + G )

Whenproduction>domesticexpenditure,exports>imports:currentaccount>0andtradebalance>0

w enacoun ryexpor smore an mpor s, earnsmore ncome rom

exportsthanitspendsonimports

netforeign

wealth

isincreasing

Whenproduction


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Nationalsavin S =nationalincome Y thatisnots enton

consumption(C)orgovernmentpurchases(G).

S=Y C GS=(Y C T)+(T G)S=Sp +Sg

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HowIstheCurrentAccountRelatedtoNationalSaving?

con .

= = Countriescanfinanceinvestmenteitherbysavingorby

.

acurrentaccountdeficitimpliesafinancialassetinflowornegative

netforeigninvestment.

WhenS>I,thenCA>0sothatnetforeigninvestmentandfinancialcapitaloutflowsforthedomesticeconomyare

positive.

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HowIstheCurrentAccountRelatedtoNationalSaving?

con .

= p + g

=Sp governmentdeficitI

Governmentdeficitisnegativegovernment

savingequaltoG T

Ahi h overnmentdeficitcausesanegativecurrentaccountbalancewhenotherfactorsremainconstant.

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250000

200000

SGPCurrentaccountbalance(currentmillionsUS$)

SGPNetforeignassets(currentmillionsUS$)

150000

50000

100000

0

976

977

978

979

980

981

982

983

984

985

986

987

988

989

990

991

992

993

994

995

996

997

998

999

000

001

002

003

004

005

006

007

008

009

010

50000


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Acountr sbalanceof a mentsaccountsaccounts forits

paymentstoand

itsreceipts

from

foreigners.

Anytransactionresultinginareceiptfromforeignersis

enteredascredit(+)

Anytransactionresultingtopaymenttoforeignersisenteredasdebit

Aninternationaltransactioninvolvestwoparties,andeach

u

w :

onceasadebit().

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BalanceofPa mentsAccounts cont.

Thebalanceof a mentsaccountsarese arated

into3broadaccounts:currentaccount: accountsforflowsof oodsand

services(importsandexports).

financialaccount: accountsforflowsoffinancialassets(financialcapital).

capitalaccount: flowsofspecialcategoriesofassetscapita : typica ynonmar et,nonpro uce ,or

intangibleassetslikedebtforgiveness,copyrightsandtrademarks.

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Example

of

Balance

of

Payments

Accounting

USresidentimportsafaxmachinefromOlivetti.

OlivettidepositsUSresidentscheckinaU.S.bank.

ax mac ne curren accoun , . . goo mpor

$80

Bank deposit (financial account, U.S. asset sale)

+$80

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Example

of

Balance

of

Payments

Accounting

(cont.)

USresidentbuyslunchinFranceandpaysbycreditcard.

FrenchrestaurantreceivespaymentfromUSresidents

creditcardcompany.

ea purc ase curren accoun , . . serv ce mpor

$30

Sale of credit card claim (financial account, U.S. asset sale)

+$30

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Exam leofBalanceofPa mentsAccountin cont.

USresidentbuysashareofBP. . . .

Stock purchase (financial account, U.S. asset purchase)

$90

Bank deposit (financial account, U.S. asset sale)

+$90

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HowDotheBalanceofPa mentsAccountsBalance?

Duetothedoubleentr ofeachtransaction thebalanceof

payments

accounts

will

balance

by

the

following

equation:currentaccount+

financialaccount+capitalaccount=0

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The3broadaccountsaremorefinelydivided:

Currentaccount:importsandexports1. merchandise oodslikeDVDs

2. services(paymentsforlegalservices,shippingservices,

touristmeals,etc.)3. incomereceipts(interestanddividendpayments,

earningsoffirmsandworkersoperatinginforeign

countries

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BalanceofPa ments

Accounts

cont.

Currentaccount:netunilateraltrans ers gifts(transfers)acrosscountriesthatdonotpurchasea

goodorservicenorserveasincomeforgoodsand

serv cespro uce

Capitalaccount:recordsspecialtransfersofassets,butthisisaminoraccountfortheU.S.

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BalanceofPa ments

Accounts

cont.

Financialaccount:thedifferencebetweensalesofdomesticassetstoforeignersandpurchasesofforeignassetsby

domesticcitizens.

nanc a n ow Foreignersloantodomesticcitizensbybuyingdomesticassets.

Domesticassetssoldtoforeignersareacredit(+)becausethedomesticeconomyacqu resmoney ur ng t e transact on.

Financialoutflow Domesticcitizensloantoforeignersbybuyingforeignassets.

Foreignassetspurchasedbydomesticcitizensareadebit()becausethedomesticeconomygivesupmoneyduringthetransaction.

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BalanceofPa ments

Accounts

cont.

Financialaccounthasatleast3subcate ories:1. Official(international)reserveassets

2. Allotherassets

3. Statisticaldiscrepancy

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BalanceofPa ments

Accounts

cont.

Statisticaldiscre anc Datafromatransactionmaycomefromdifferentsourcesthatdifferin

coverage,accuracy,andtiming.

Thebalanceofpaymentsaccountsthereforeseldombalancein

practice.

The statistical discre anc is the account added to or subtracted from

thefinancialaccounttomakeitbalancewiththecurrentaccountand

capitalaccount.

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BalanceofPa ments

Accounts

cont.

Official(international)reserveassets:foreignassetsheldbycentralbankstocushionagainstfinancialinstability.

Assetsincludegovernmentbonds,currency,gold,andaccountsattheInternational Monetar Fund.

Officialreserveassetsownedby(soldto)foreigncentralbanksareacredit(+)becausethedomesticcentralbankcanspendmoremoneytocushiona ainstinstabilit .

Officialreserveassetsownedby(purchasedby)thedomesticcentral

bankareadebit()becausethedomesticcentralbankcanspendless.

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BalanceofPa ments

Accounts

cont.

Thene ativevalueoftheofficialreserveassetsis

calledthe

official

settlements

balanceor

balance

ofpayments.

Itisthesumofthecurrentaccount,thecapitalaccount,thenonreserveportionofthefinancialaccount,andthe

statisticaldiscre anc .Anegativeofficialsettlementsbalancemayindicate

thatacountry

s

ep et ng

tso c a

nternat ona

reserve

assets,

or

maybeincurringlargedebtstoforeigncentralbankssothatthedomesticcentralbankcanspendalottoprotectagainst

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nanc a nsta ty.


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4. Officialinternationalreserveassetsareacomponentofthefinancial

account,whichrecordsofficialassetsheldbycentralbanks.

5. Theofficialsettlementsbalanceisthenegativevalueofofficial

foreignassetsrelativetoforeigncentralbanksholdingsofdomestic

assets.

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Exchangeratesandthepricesofgoods

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Exchan eratesare uotedasforei ncurrenc erunitof

domesticcurrencyordomesticcurrencyperunitofforeign

currency.

Howmuchcanbeexchangedforonedollar?89.40

Howmuchcanbeexchangedforoneyen?$0.011185/

xc angera esa owus o enom na e ecos orpr ceo a

goodorserviceinacommoncurrency.

HowmuchdoesaNissancost?2 500 000

Or,2,500,000x$0.011185/=$27,962.50

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De reciationisadecreaseinthevalueofa

currencyrelative

toanother

currency.

Ade reciatedcurrenc islessvaluable lessexpensive)andthereforecanbeexchangedfor(canbuy)asmalleramountofforeigncurrency.

$1/$1.20/ meansthatthedollarhasdepreciatedrelativetotheeuro.Itnowtakes$1.20tobuyone

Theeurohasappreciatedrelativetothedollar:itisnowmorevaluable.

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A reciationisanincreaseinthevalueofacurrencyrelativetoanothercurrency.

Anappreciatedcurrencyismorevaluable(moreexpens ve an t ere orecan eexc ange or canbuy)alargeramountofforeigncurrency.

. relativetotheeuro.Itnowtakesonly$0.90tobuyoneeuro,sothatthedollarismore

Theeurohasdepreciatedrelativetothedollar:itisnowlessvaluable.

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Ade reciatedcurrenc islessvaluable andthereforeitcan

buyfewerforeignproducedgoodsthataredenominatedin

foreigncurrency.

ANissancosts2,500,000= 25,000at 0.010

becomesmoreexpensive$27,962.50at$0.011185/

eprec a e currencymeans a mpor saremore

expensiveanddomesticallyproducedgoodsandexportsare

lessexpensive.

Adepreciatedcurrencylowersthepriceofexportsrelativeto

thepriceofimports.

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Ana reciatedcurrenc ismorevaluable andthereforeit

canbuymoreforeignproducedgoodsthataredenominated

inforeigncurrency.

, , = , . .

becomeslessexpensive$25,000at$0.010/

expensiveanddomesticallyproducedgoodsandexportsare

moreexpensive.

Anappreciatedcurrencyraisesthepriceofexportsrelativetothepriceofimports.

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Table142: $/ExchangeRatesandtheRelativePriceofAmerican

DesignerJeansandBritishSweaters

. = .

(50 * $1.5/) /$45 = 1.67

(50 * $1.75/) /$45 = 1.94

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1. Anexchan erateisthe riceofonecountr scurrenc in

termsofanothercountryscurrency.

Itenablesustotranslatedifferentcountriespricesintocomparable

erms.

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2. Depreciationofacurrencymeansthatitbecomesless

valuableandgoodsdenominatedinitarelessexpensive:

exportsarecheaperandimportsmoreexpensive.

. valuableandgoodsdenominatedinitaremoreexpensive:exportsaremoreexpensiveandimportscheaper.

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Thankyouforyourattention

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HE206 Lecture 1 Student Notes

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