1. 1 The Balance of Payments and International Economic Linkages Chapter 4

2. 2 CHAPTER OVERVIEW I.BALANCE-OF-PAYMENT CATEGORIES II.THE INTERNATIONAL FLOW OF GOODS, SERVICES,AND CAPITAL III.COPING WITH CURRENT ACCOUNT DEFICITS

3. 3 PART I. BALANCE-OF-PAYMENT CATEGORIES A.THE BALANCE OF PAYMENTS (B-O-P) 1.PURPOSE: Measures all financial and economic transactions over a specified period of time.

4. 4 BALANCE-OF-PAYMENT CATEGORIES 2.Double-entry bookkeeping a. Currency inflows = credits (earn foreign exchange) b. Currency outflows = debits (expend foreign exchange)

5. 5 BALANCE-OF-PAYMENT CATEGORIES 3.Three Major Accounts: a.Current b.Capital c.Official Reserves 4.Current Account records net flow of goods, services, and unilateral transfers.

6. 6 BALANCE-OF-PAYMENT CATEGORIES 5.Capital Account a. Function: records public and private investment and lending. b. Inflows = credits c. Outflows = debits d. Transactions classified as 1.) portfolio 2.) direct 3.) short term

7. 7 BALANCE-OF-PAYMENT CATEGORIES 6.Official Reserves Account a. Function: 1.) measures changes in international reserves owned by central banks. 2.) reflects surplus/deficit of a.) current account b.) capital account

8. 8 BALANCE-OF-PAYMENT CATEGORIES b. Reserves consist of 1.) gold 2.) convertible securities 7. Net Effects: a. Sum of all transactions must be zero: 1.) current account 2.) capital account 3.) official reserves

9. 9 BALANCE-OF-PAYMENT CATEGORIES 8.Balance-of-payment Measures a. Definitions: 1.) Basic Balance a.) consists of current account and long-term capital flows. b.) emphasizes long-term trends. c.) excludes short-term capital flows that heavily depend on temporary factors.

10. 10 BALANCE-OF-PAYMENT CATEGORIES 2.)Official Reserve Transactions Balance - measures adjustments needed by official reserves.

11. 11 T.C. BOP ODEMELER DENGESI (milyon ABD dolari) Ocak-Temmuz 2004 Carl Ilemler Dengesi -10025 Dis Ticaret Dengesi -19419 Ihracat 34406 Ithalat -53825 Sermaye ve Finans Hesaplari 8695 Finans Hesabi (Resmi Rezerv hariç) 8235 Resmi Rezervlerdeki Degisim 460 Kaynak: TCMB.

12. 12 PART II. THE INTERNATIONAL FLOW OF GOODS, SERVICES, AND CAPITAL II.LINKS FROM INTERNATIONAL TO DOMESTIC FLOWS A.Introduction: Global Linkages set of basic macroeconomic identities links: domestic spending and production to current and capital accounts

13. 13 THE INTERNATIONAL FLOW OF GOODS, SERVICES, AND CAPITAL B.Domestic Savings and Investment and the Capital Account 1.National Income Accounting a.National Income (NI) is either spent (C) or saved (S) NI = C + S(4.1)

14. 14 THE INTERNATIONAL FLOW OF GOODS, SERVICES, AND CAPITAL b. National spending (NS) is divided into personal spending (C) and investment (I) NS = C + I (4.2) c. Subtracting (4.2) - (4.1) NI - NS = S - I(4.3) If NI >NS, S > I which implies that surplus capital spent overseas.

15. 15 THE INTERNATIONAL FLOW OF GOODS, SERVICES, AND CAPITAL d.In a freely-floating system, excess saving = the capital account balance e.Implications: 1.A nation which produces more than it spends has a net capital outflow producing a capital account deficit.

16. 16 THE INTERNATIONAL FLOW OF GOODS, SERVICES, AND CAPITAL 2.A nation which spends more than it produces has a net capital inflow producing a capital account surplus. 3.A healthy economy will tend to run a current account deficit.

17. 17 THE INTERNATIONAL FLOW OF GOODS, SERVICES, AND CAPITAL C.THE LINK BETWEEN THE CURRENT AND CAPITAL ACCOUNTS 1.Beginning identity NI - NS = X - M(4.4) where X = exports M = imports X-M=current account balance (CA)

18. 18 THE INTERNATIONAL FLOW OF GOODS, SERVICES, AND CAPITAL 2.Combining (4.3) + (4.4) S - I = X - M (4.5) 3. If S - I = Net Foreign Investment (NFI) NFI = X - M(4.6)

19. 19 THE INTERNATIONAL FLOW OF GOODS, SERVICES, AND CAPITAL 4.Implications: a.If CA is in surplus, the nation must be a net exporter of capital. b.If CA is a deficit, the nation is a major capital importer. c.When NS > NI, the excess must be acquired through foreign trade.

20. 20 THE INTERNATIONAL FLOW OF GOODS, SERVICES, AND CAPITAL d.Solutions for Improving CA deficits: 1.)Raise national income (output) relative to domestic investment (I). 2.)Increase (S) relative to domestic investment (I).

21. 21 THE INTERNATIONAL FLOW OF GOODS, SERVICES, AND CAPITAL D.GOVERNMENT BUDGETS AND CURRENT ACCOUNT DEFICITS 1. CURRENT ACCOUNT BALANCE CA = Saving Surplus - Gov’t budget deficit

22. 22 THE INTERNATIONAL FLOW OF GOODS, SERVICES, AND CAPITAL 2. CA Deficit means the nation is not saving enough to finance (I) and the deficit. 3. CA Surplus means the nation is saving more than needed to finance its (I) and deficit.

23. 23 PART III. COPING WITH THE CURRENT ACCOUNT DEFICIT I.POSSIBLE SOLUTIONS UNLIKELY TO WORK: A. Currency Depreciation B. Protectionism II.CURRENCY DEPRECIATION A. U.S. Experience: Does not improve the trade deficit.

24. 24 COPING WITH THE CURRENT ACCOUNT DEFICIT B.Depreciations ineffective because 1.It takes time to affect trade. 2.J-Curve Effect states that a decline in currency value will initially worsen the deficit before improvement.

25. 25 COPING WITH THE CURRENT ACCOUNT DEFICIT III.PROTECTIONISM A.Trade Barriers used: 1.Tariffs 2.Quotas B.Results: Most likely will reduce both X and M.

26. 26 COPING WITH THE CURRENT ACCOUNT DEFICIT C.FOREIGN OWNERSHIP one protectionist solution would place limits on or eliminate foreign ownership leading to capital inflows. D.STIMULATE NATIONAL SAVING change the tax regulations and rates.

27. 27 COPING WITH THE CURRENT ACCOUNT DEFICIT III.SUMMARY: CURRENT-ACCOUNT DEFICITS - neither bad nor good inherently 1.Since one country’s exports are another’s imports, it is not possible for all to run a surplus 2.Deficits may be a solution to the problem of different national propensities to save and invest.

28. 28 US BOP Data http://www.bea.doc.gov/ briefrm/tables/ebr10.htm