international economics 5th by gerber ch09

Introduction: The Current Account • Current account: record of the goods and services into and out of the country • Financial account: record of the flow of financial capital to and from

Chapter 9

Trade and

the Balance

of Payments

Introduction:

The Current Account

• Current account: record of the goods and services into and out of the country

• Financial account: record of the flow of financial capital to and from the country

• Capital account: record of some specialized types of relatively small capital flows

The Trade Balance

• Trade balance- measures the difference between exports and imports of goods and services

– Trade deficit: negative trade balance

– Trade surplus: positive merchandise trade

balance

The Current Account Balance

• Current account balance: Measures all current, non-capital

transactions between a nation and the rest of the world

– Goods and services = Exports of goods and services –

Imports

– Investment income = income from investments abroad –

income paid to foreigners on U.S investments

– Unilateral transfers = any foreign aid or other transfers

received by foreigners – that given to foreigners

TABLE 9.1

Components of the Current Account

TABLE 9.2

The U.S Current Account Balance,

2008

TABLE 9.2 (continued)

The U.S Current Account Balance,

2008

FIGURE 9.1

U.S Current Account Balances,

1950-2008

U.S Current Account Deficit

• Current account deficit is not a sign of weakness

– In 90s, foreign demand for US exports

grew less rapidly than US demand for

imports

• U.S deficit is not sustainable in the long term

Financial Account

• Financial account: A record of the flow of financial capital to and from a country

• Financial account is divided into three categories:

– Net changes in the U.S owned assets

Financial Account

• Net changes measure monetary value of the

change in country’s financial stake

• Domestic financial outflows are payments for

purchase of foreign-owned assets (debit)

• Financial inflows are receipts from sale of

domestic country’s assets to foreigners

(credit)

Capital Account

• Capital account: A record of the transfers of specific types of capital, such as:

– Debt forgiveness

– Personal assets that migrants take

with them abroad

– The transfer of real estate and other

fixed assets, such as a military base or

an embassy building

The Three Accounts are

Interdependent

• Current account measures flow of goods and services

• Capital and financial accounts measure flow of financing

• Sum of capital account and financial accounts equal current account with the opposite sign

TABLE 9.3

The U.S Balance of Payments, 2008

TABLE 9.3 (continued)

The U.S Balance of Payments, 2008

Table 9.4 Components of the U.S Financial

Account, 2008

Types of Financial Flows

• Financial flows originate in the public and private sectors

• Some financial flows are very mobile

– Brings economic volatility

– Sudden financial outflows can create a financial crisis

– Volatility of financial flows has increased concern about the various types of flows

• Official reserve assets: mainly currencies of

largest and most stable economies in world;

dollars, euros, pounds, and yen

• Reserve assets are used to settle international

debts and used by central banks and treasuries

as store of value

• Scarce official reserves is sign of problems

Types of Financial Flows

Largest Share of Financial Flows:

Private Assets

– Foreign Direct Investment (FDI): tangible items,

physical assets

– Securities and loans can be considered foreign

portfolio investment—paper assets such as stocks

and bonds

– Both FDI and foreign portfolio investment give their holders a claim in a foreign economy’s future output

Role of Expectations in

Financial Flows

• Sudden stop refers to shifts in expectations can lead to sudden stoppages of financial inflows

• Leads to destabilization of outflows of financial capital

• Sudden stops have been involved in most financial crises in last 30 years

• Can’t have current account deficit with negative financial account

Limits on Financial Flows

• In past most nations limited the movement of financial flows across their borders

• Nations have started to liberalize financial flows across borders

– Desirable because restrictions on financial flows limits availability of financial capital

– Thought to improve developing countries’

access to financial capital flows

Limits on Financial Flows

• Increased financial flows across borders should improve economic efficiency

• Recent volatility suggests more regulation is needed

• Key is to capture benefits of more investment while limiting risks of capital flight

TABLE 9.6

The U.S Financial Accounts, 2007-2008

(millions of dollars)

TABLE 9.6 (continued)

The U.S Financial Accounts, 2007-2008

(millions of dollars)

The National Income and

Product Accounts

• National income and product accounts: accounting system for a country’s total production and

income

– Gross domestic product (GDP): the

value of all final goods and services

produced within a country´s borders

– Gross national product (GNP): the

value of all final goods and services

produced by a country’s resources no

Table 9.7 Variable Definitions

FIGURE 9.2

U.S Savings and Investment, 1990–2007

Understanding National Accounts

• Nation’s savings is source for domestic investment and foreign investment

• No fixed relationship between the variables

• Each of four variables are determined by the other

three

• A change in any one of them influences all of them

Are Current Account

Deficits Harmful?

• Not necessarily sign of weakness or harmful

• Enables more investment than otherwise which leads to higher standards of living

• CA deficits are vote of confidence by foreigners

• Increased foreign owned assets in country can lead to sudden surge in capital outflows

International Debt

• Current account deficits must be financed through inflows of financial capital (loans)

• External debt is money owed to individuals outside of the domestic country.

• External debt isn’t any worse than any debt

• Loaned funds must be used to expand production capacity while servicing debt

International Debt

• In many low and middle income countries, external debt leads to financial problems

• Unsustainable debt occurs for numerous reasons:

– Falling commodity prices

– Natural disasters

– Corruption

TABLE 9.8

The Five Largest Developing Country

Debtors, 2007