Module 41: The Open Economy: International Trade. Duffka School of Economics

Transcription

1 Module 41: The Open Economy: International Trade

2 Key Economic Concepts A country s balance of payments accounts are a summary of the country s transactions with other countries. Transactions that don t create future liabilities are recorded in the current account. Transactions that do create future liabilities are recorded in the financial account. The balance on the current account plus the balance on the financial account must sum to zero. If one nation has a higher real interest rate than another nation, it will attract an inflow of financial

3 Module Layout of Payments A. Balance Accounts B. Modeling the Financial Account C. Underlying Determinants of International Capital Flows D. Two-way Capital Flows

4 A. Balance Accounts Row 1 of Table 41-2 shows payments that arise from sales and purchases of goods and services. The U.S. exports cars to be sold in Canada. This is a payment from foreigners for goods and services The U.S. imports oil from Venezuela. This is a payment to foreigners for goods and services..

5 A. Balance Accounts Row 2 shows factor income payments for the use of factors of production owned by residents of other countries. This can be interest on loans from overseas, profits of foreign-owned corporations or labor income from native-born workers who work overseas. Wal-mart, an American company, earns profit from stores in Europe. This is a factor income payment from foreigners. Honda, a Japanese company, produces and sells cars in Indiana and other U.S. states. This is a factory income payment to

6 A. Balance Accounts Row 3 shows international transfers funds sent by residents of one country to residents of another. Money sent from the US to another nation. *Notice that Table 41-2 only shows the net value of transfers. That s because the U. S. government only provides an estimate of the net, not a breakdown between payments

7 A. Balance of Payments Accounts Row 4 shows transactions that involve governments or government agencies, mainly central banks. When the central bank of China purchases a U.S. Treasury, cash flows

8 A. Balance Accounts Row 5 shows private sales and purchases of assets. When Coca-Cola buys a factory in Mexico, this is an asset purchase and payment to foreigners. If a Brazilian company buys an apartment building in Boston, this

9 A. Balance Accounts--SUMMARY Transactions that don t create liabilities are considered part of the balance of payments on current account: the balance of payments on goods and services plus factor income and net international transfer payments. The most important part of the current account: the balance of payments on goods and services, the difference between the value of exports and the value of imports during a given period. The merchandise trade balance, (or simply trade balance) is the difference between a country s exports School of Economics and imports of goodsduffka alone not including services.

10 A. Balance Accounts SUMMARY Current account (CA) + Financial account (FA) = 0 or CA = FA Why must this be true? In total, the sources of cash must equal the uses of cash.

11 Practice Question #1

12 1. The current account includes which of the following? I. payments for goods and services II. transfer payments III. factor income a. I only b. II only c. III only d. I and II only

13 Practice Question #2

14 2. The balance of payments on the current account plus the balance of payments on the financial account is equal to a. zero. b. one. c. the trade balance. d. net capital flows.

15

16 3. The trade balance includes which of the following? I. imports and exports of goods II. imports and exports of services III. net capital flows a. I only b. II only c. III only d. I and II only

17 A. Balance Accounts B. Modeling the Financial Account What determines whether money flows into a nation s financial account? The financial account(formerly known as the capital account) is a measure of capital inflows, of foreign savings that are available to finance domestic investment spending. In using this model, we make two important simplifications: We simplify the reality of international capital flows by assuming that all flows are in the form of loans. We also ignore the effects of expected changes in exchange rates, the relative values of different national currencies.

18 Practice Question #4

19 4. The financial account was previously known as the a. gross national product. b. capital account. c. trade deficit. d. investment account.

20 A. Balance Accounts B. Modeling the Financial Account Loanable Funds Market

21 A. Balance Accounts B. Modeling the Financial Account DRAW ON UPAD TWO LF MARKETS

22 A. Balance Accounts B. Modeling the Financial Account When two nations have differing real interest rates in their domestic loanable funds markets, savers begin to look for countries where the return on a financial asset is higher. Individuals and firms begin to purchase financial assets, sending pounds as payment. Another way to think about it is that Britain. is exporting pounds and importing financial assets. US is exporting the financial assets and importing pounds. US to Pounds

23 A. Balance Accounts B. Modeling the Financial Account These dollars serve as capital inflow in US, and capital outflow from the Britain. The flow of dollars ends when the interest rate disparity is gone, at a level of about 4%.

24 A. Balance Accounts B. Modeling the Financial Account C. Underlying Determinants of International Capital Flows International differences in the demand for funds reflect underlying differences in investment opportunities. A country with a rapidly growing economy, other things equal, tends to offer more investment opportunities than a country with a slowly growing economy. So a rapidly growing economy typically though not always has a higher demand for capital and offers higher returns to investors than a slowly growing economy in the absence of capital flows. As a result,

25 Practice Question #5

26 5. Which of the following will increase the demand for loanable funds in a country? a. economic growth b. decreased investment opportunities c. a recession Duffka School of Economics d. decreased private savings rates

27 A. Balance Accounts B. Modeling the Financial Account C. Underlying Determinants of International Capital Flows International differences in the demand for funds reflect underlying differences in investment opportunities. International differences in the supply of funds reflect differences in savings across countries. These may be the result of differences in private Duffka School ofwidely Economics savings rates, which vary among

28 A. Balance Accounts B. Modeling the Financial Account C. Underlying Determinants of International Capital Flows International differences in the demand for funds reflect underlying differences in investment opportunities. They may also reflect differences in savings by governments. In particular, government budget deficits, which reduce overall national savings, can lead to capital inflows.

29 A. Balance Accounts B. Modeling the Financial Account C. Underlying Determinants of International Capital Flows D. Two-way Capital Flows The flow of financial capital is a two-way street. Financial investors in the U.S. are sending money to Japan because interest rates might be higher, but Japanese investors are sending money to the U.S. stock market because they believe the U.S. economy has a brighter future. School of Economics Corporations diversifyduffka financial risk by both selling

30 Key Economic Concepts A country s balance of payments accounts are a summary of the country s transactions with other countries. Transactions that don t create future liabilities are recorded in the current account. Transactions that do create future liabilities are recorded in the financial account. The balance on the current account plus the balance on the financial account must sum to zero. If one nation has a higher real interest rate than another nation, it will attract an inflow of financial

31 Mod 41 Practice FRQ-Online 1. How would the following transactions be categorized in the U.S. balance of payments accounts? How will the balance of payments on the current and financial accounts change? An American college student decides to spend a year studying (and paying tuition) at a university in Australia. A German telecommunications firm purchases microprocessors from an American firm. An American bank purchases shares of

32 Mod 41 Practice FRQ-Online 1. How would the following transactions be categorized in the U.S. balance of payments accounts? How will the balance of payments on the current and financial accounts change? An American college student decides to spend a year studying (and paying tuition) at a university in Australia. Answer: The college student is essentially buying a service from Australia. This would be an import of services into the U.S., so this is

33 Mod 41 Practice FRQ-Online 1. How would the following transactions be categorized in the U.S. balance of payments accounts? How will the balance of payments on the current and financial accounts change? A German telecommunications firm purchases microprocessors from an American firm. ANSWERS: The German firm is buying products from America. This is an American export, so this is recorded as a payment from foreigners,

34 Mod 41 Practice FRQ-Online 1. How would the following transactions be categorized in the U.S. balance of payments accounts? How will the balance of payments on the current and financial accounts change? An American bank purchases shares of stock in Japanese firms traded on the Tokyo stock exchange. ANSWERS: The American bank has purchased a foreign asset so dollars are sent to foreigners. Thus the balance on the financial account would

35 APE U6 L3 A52 *A record of foreign transactions, called the BALANCE OF PAYMENTS, is essential for making sense of a nation s position in the global economy. *Three accounts within the balance of payments: current, capital, and official transactions (reserve accounts). *Current account: records a nations imports and exports of goods, services, net investment income and net transfers. *Financial (capital) account: records the flow of money from the purchase and sale of real and financial assets domestically and abroad. *For the current & capital accounts, if the international transaction USES foreign currency to complete the transaction, it is a debit (negative). If it earns foreign currency, it is a credit (positive). *The official transactions account is a counterbalancing account: A country uses foreign assets or currency to offset a balance of payments deficit, and this is recorded as a credit (positive). Similarly, when there is a balance of payments surplus, the earned foreign currency is recorded as a debit (negative).

36 APE U6 L3 A52 Transactions on the US Balance PART A Credit + Debit - Current Acct Capital Acct 1. HD USA buys $25m in machinery from a Japan firm 2. US investor invests $50m to theme park in Malaysia 3. A Chinese comp sells $1m of goods to US Army 4. BMW pays $1m to US shipper for moving cars 6. Bank of America pays $5m in interest to French dep 7. Ramos from Spain buys a mall in Florida. 8. Brazilian investor buys 5 $10,000 US bonds 9. German tourists spend $3m in the US; US $5m in G 10. London record store spends $10,000 CDs from US 11. Sam from US buys stock in a Chilean ice rink 5. Ima sends money to her sister in Poland.

37

38

39