principles of macroeconomics · 2017. 2. 2. · balance of payments • current account: the value...
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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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