Long Run International Macroeconomics The Balance of Payments

Transcription

1 Long Run International Macroeconomics The Balance of Payments 1

2 Accounting Y = C + I + G + (X M) implies [Y (C + G)] I = S I = X M Recall National Saving is defined as S = [Y (C + G)] (X M) Net Exports (NX); trade of goods, services (S I) Net Capital Flows, public and private 2

3 Balance of Payments Current Account + (Private) Capital Account + Official Reserve Settlements = 0 Algebraically c/acc + k/acc + ORS = 0 Current Account: net sales of goods and services Capital Account [sometimes Financial Account ]: net sales of privately held assets (debt, equity, real estate) ORS: net sales of public assets (money for foreign exchange intervention) Works at any level of aggregation (including individual) 3

4 Balance of Payments Accounting Rule Anything (goods/services/assets) that gives rise to a receipt from (payment to) the rest of the world is a credit (debit) and enters as a positive (negative) entry Ex: exports of goods, services, or assets 4

5 Small Open Economy (SOE) A Small Economy takes international prices as given Key: takes price of money as given from abroad (interest rate exogenous) Most countries are small Note: We treat phenomena like country size as a discrete feature a country is either small or large (not medium), when it is really continuous 5

6 Large Economies Interest Rate Setters US, EMU (Germany before 1999), and Japan US and Germany/EMU are interest rate makers over sphere of financial influence (small open economies) 6

7 Open Economy No (substantial) barriers to international flows of (private) capital Why not barriers to international trade of goods (and services)? Richer countries are open, but only recently Growing Number of Emerging Markets recently too Can measure openness by examining: a) de jure rules/capital restrictions ( inputs ), or b) prices ( outcomes ) of similar assets in different locations Examining quantities implies most countries closed; home bias 7

8 Floating Nominal Exchange Rate e measured as foreign exchange/domestic currency a bilateral nominal exchange rate Rise in e: appreciation of the domestic currency Fall: depreciation A floating nominal exchange rate implies that the authorities (government and central bank) do not intervene on the foreign exchange markets to affect the level of the exchange rate (so ORS = 0) Assume: floating exchange rate is not expected to change (reasonable empirically for many countries Meese and Rogoff) 8

9 Exchange Rate Regimes Many countries float (vis à vis a large economy), often with inflation target Ex: Canada, Korea, UK Many economies fix the nominal exchange rate Ex: Saudi Arabia, Hong Kong, Denmark Deal with later In practice, clean float and perfect fix are end points on a continuous distribution of degree of intervention 9

10 Real Exchange Rate ε ep/p* where P* denotes foreign prices Nominal exchange rate adjusted for inflation (both home and abroad) Increase in ε is a real appreciation/loss in competitiveness Domestic goods become more expensive compared to foreign goods Real exchange rate is always flexible in long run (since prices flexible) 10

11 Purchasing Power Parity Real exchange rate (ε) = 1 PPP value (ep=p*) Same goods cost same home and abroad Easily testable with good specific data Usually rejected, except for highly tradables Perhaps valuable for long run, or short run for homogeneous goods 11

12 Modeling International Flows Capital flows react fast Interaction between S(avings) I(nvestment) and (exogenous large open economy) interest rate Exchange rate affected by capital flows Current Account affected by real exchange rate (ε=ep/p*; nominal exchange rate matters) 12

13 Perfect Capital Mobility Leads to i = i* (set by large open economy) or r=r* (without inflation) Otherwise massive capital flows Implicit: assets compared are similar in other respects, including risk, liquidity, taxes 13

14 Capital Account Consumption (hence savings) depends only on (disposable) income, so independent of interest rate Interest rate given from abroad (relevant large open economy) So investment is determined (by foreign=domestic interest rate) Thus capital flows determined by gap between savings and investment High foreign interest rate leads to high domestic interest rate, domestic savings in excess of investment, capital outflow 14

15 r S = Y C(Y) - G r* B B autarky I(r) Capital Flows: S I S, I 15

16 Current Account Exports determined by X=X(ε, Y*) ε (=ep/p*) as relative price Demand by foreigners for our goods (often luxuries, sometimes intermediates) Similarly, imports M=M(ε, Y) Our demand for foreign goods Net exports determined by NX = (, Y, Y*) Foreign income is exogenous Rise in real exchange rate is loss in competitiveness, lower net exports 16

17 Graphically ε A Current account = NX Deficit Surplus 0 = balance c/acc 17

18 Domestic Fiscal Expansion Raise direct government spending (G), implicitly financed via bonds S falls, (S I) falls, NX falls, ε rises Twin Deficits 18

19 Graphically: Capital Account r S = Y C(Y) - G r* C A B I(r) 0 = balance S, I 19

20 Current Account ε C B 0 = balance c/acc 20

21 Foreign Fiscal Expansion Foreign interest rate (of large economy) rises I falls, (S I) rises, NX rises, ε falls r r*' B S = Y C(Y) - G B r* A A I(r) S, I 21

22 Current Account ε A B 0 = balance c/acc 22

23 Key Takeaways The Balance of Payments: an accounting framework Countries differ in: a) size (small/large); b) openness (open/closed); c) exchange rate regime (fixed/floating) PPP: a poor model of the real exchange rate Savings, Investment and the foreign interest rate jointly determine capital flows; these then drive the real exchange rate and thus the current account 23