External Sector Econ 102 _2015

External Sector How is a country linked with other countries in the global world? 1)There are exchange of Goods and Services 2)There are exchange of Assets What is different? We have Turkish Lira (TL), US has US dollars ($) and European Union has Euro(€)

Foreign currency Exchange rate is the TL price of a foreign currency in Turkey. Eg. 1 $= 2.65 TL (TL price of one dollar) or $ = 1 TL ( dollar price of one TL) If TL price of a $ increases, TL depreciates (TL becomes less valuable compared to $)

Exchange of Goods and Services Exports are the goods that we sell (and foreign economies buy). Hence, it is a source of foreign exchange. Exports= F( Y foreign, exchange rate) Imports are the good that we buy (foreign sell to us). Hence we use foreign exchange to purchase imports Imports= F( Y domestic, exchange rate)

Net Exports Net Exports = value of Exports- value of imports Net Exports = F( Y domestic, Y foreign, exchange rate) This is also called the Trade Balance

Exchange of Financial Assets We exchange Bonds, Shares, other assets. Asset demand depends on relative returns, i.e. interest rates, hence investors compare domestic interest rate foreign interest rates i i*

Asset demand Example: Turkish treasury TL bonds: i = 10%, German treasury Euro bonds: i* = 8% (if all the conditions in the economy, such as the risk and expectations are the same in both economies) Which one will the investors prefer to buy?

Asset demand Example: Turkish treasury TL bonds: i = 10%, German treasury Euro bonds: i* = 8% Which one will the investors prefer? What if during this period it is expected that e will increase by 5 %, that is TL depreciates by 5 %, will you still prefer to buy Turkish Bonds.?

Asset demand Example: Turkish treasury TL bonds: i = 10%, German treasury Euro bonds: i* = 8% Which one will the investors prefer? i EURO = i TL - expected % change in e. 8% = 10 % - expected  % in e

How are the foreign transaction recorded? Balance of Payments: (Ödemeler Dengesi) Accounting method of all monetary transactions, with double entry system. Every transaction is recorded in different parts of the Balance of Payments.

Balance of Payments 1.Current Account 2.Financial Account 3.Central Bank reserve positions 4.Errors and Omissions All adds up to zero.

Current Account -Exports of goods (+) -Imports of goods (-) -Balance of trade -Exports of services(+) -Imports of services(-) -Balance of services -Income received on investment (+) -Income payments on investment (-) -Net income on investment -Net transfers (+) (-) -Balance on current account

Current Account in Turkey

Financial Account -Increase in foreign holdings of assets in Turkey (+) -Increase in Turkey’s holding of assets in foreign countries (- ) -Balance on Financial Account -Details -Foreign Direct Investment -Portfolio Investment -Other Investment

Capital Account -Statistical Discrepancy -Balance of Payments

Financial Account in Turkey

BOP of Turkey

Foreign Exchange Market Systems of Foreign Exchange: 1.Fixed Exchange Rate System: Central Bank determines the rate at which domestic currency is exchanged in to foreign currency. 2.Flexible Exchange Rate System: market determines the the rate at which domestic currency is exchanged in to foreign currency

US Dollar in Turkish Lira ( )

US Dollar in Turkish Lira ( )

Foreign Exchange Market TL price of foreign currency Quantity of Foreign Currency Demand for foreign currencySupply of Foreign Currency

Foreign Exchange Market TL price of $ Quantity of $ Demand for $Supply of $

The Change in Foreign Exchange Market Equilibrium when Turkish Imports increase TL price of foreign currency Quantity of Foreign Currency Demand for foreign currencySupply of Foreign Currency The TL price of US dollar increases, i.e. TL depreciates

The Change in Foreign Exchange Market Equilibrium when Turkish residents purchase Foreign Bonds TL price of foreign currency Quantity of Foreign Currency Demand for foreign currencySupply of Foreign Currency The TL price of US dollar increases, i.e. TL depreciates

Summary of BOP

Exports of Good and Services

External Total Debt