ModuleCapitalFlows and theBalance of Payments

KRUGMAN'SMACROECONOMICS for AP*

41

Margaret Ray and David Anderson

What you will learn

in this Module:

• The meaning of the balance of payments accounts

• The determinants of international capital flows

Balance of Payments Accounts

•Current Account• Net Exports• Trade Balance• Factor Income• Transfers

•Financial Account

•Current/Financial Relationship

• If a the current account is in deficit the financial account must be in surplus and vice versa

Modeling the Financial Account

Savings will flow toward higher returns

r%

QLF USA

SLF USA

DLF Japan

r%

QLF Japan

SLF Japan

DLF China

SLF 1 USA

SLF 1 Japan

Debit to the US Financial Account or Capital Outflow

Credit to the Japanese Financial Account or Capital Inflow

5%3%

5%

7%

Underlying Determinants of International Capital Flows

•Differences in economic growth rates• A country with a rapidly growing economy,

tends to offer more investment opportunities than a country with a slowly growing economy. So, because demand is higher they will offer higher interest rates

•Differences in savings rates• This may be the result of differences in

private savings rate or the result of government budget deficits

Two-way Capital Flows

•Capital moves in both directions• Differences in individual investor's incentives

(higher interest rates vs. higher stock returns)

• Financial specialization (firms may sell shares of stock to foreign investors and at the same time invest in foreign companies)

•Countries can be both creditors and debtors simultaneously