international economics 5th by gerber ch09

Chapter Trade and the Balance of Payments Copyright © 2011 Pearson Addison-Wesley All rights reserved 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 Copyright © 2011 Pearson Addison-Wesley All rights reserved 9-2 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 Copyright © 2011 Pearson Addison-Wesley All rights reserved 9-3 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 Copyright © 2011 Pearson Addison-Wesley All rights reserved 9-4 TABLE 9.1 Components of the Current Account Copyright © 2011 Pearson Addison-Wesley All rights reserved 9-5 TABLE 9.2 The U.S Current Account Balance, 2008 Copyright © 2011 Pearson Addison-Wesley All rights reserved 9-6 TABLE 9.2 (continued) The U.S Current Account Balance, 2008 Copyright © 2011 Pearson Addison-Wesley All rights reserved 9-7 FIGURE 9.1 U.S Current Account Balances, 19502008 Copyright © 2011 Pearson Addison-Wesley All rights reserved 9-8 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 Copyright © 2011 Pearson Addison-Wesley All rights reserved 9-9 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 abroad – Net changes in the foreign-based assets in US – Net change in financial derivatives Copyright © 2011 Pearson Addison-Wesley All rights reserved 9-10 Types of Financial 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 • There is no tracking of total reserve assets available Copyright © 2011 Pearson Addison-Wesley All rights reserved 9-18 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 – Holders of FDI have longer time horizons Copyright © 2011 Pearson Addison-Wesley All rights reserved 9-19 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 Copyright © 2011 Pearson Addison-Wesley All rights reserved 9-20 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 Copyright © 2011 Pearson Addison-Wesley All rights reserved 9-21 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 Copyright © 2011 Pearson Addison-Wesley All rights reserved 9-22 TABLE 9.6 The U.S Financial Accounts, 2007-2008 (millions of dollars) Copyright © 2011 Pearson Addison-Wesley All rights reserved 9-23 TABLE 9.6 (continued) The U.S Financial Accounts, 2007-2008 (millions of dollars) Copyright © 2011 Pearson Addison-Wesley All rights reserved 9-24 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 matter where they produce Copyright © 2011 Pearson Addison-Wesley All rights reserved 4-25 Table 9.7 Variable Definitions Copyright © 2011 Pearson Addison-Wesley All rights reserved 9-26 FIGURE 9.2 U.S Savings and Investment, 1990–2007 Copyright © 2011 Pearson Addison-Wesley All rights reserved 9-27 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 opyright © 2011 Pearson Addison-Wesley All rights reserved 9-28 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 Copyright © 2011 Pearson Addison-Wesley All rights reserved 9-29 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 Copyright © 2011 Pearson Addison-Wesley All rights reserved 9-30 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 Foreign lending behavior Copyright © 2011 Pearson Addison-Wesley All rights reserved 9-31 TABLE 9.8 The Five Largest Developing Country Debtors, 2007 Copyright © 2011 Pearson Addison-Wesley All rights reserved 9-32 ... 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... confidence by foreigners • Increased foreign owned assets in country can lead to sudden surge in capital outflows Copyright © 2011 Pearson Addison-Wesley All rights reserved 9-29 International. .. country´s borders – Gross national product (GNP): the value of all final goods and services produced by a country’s resources no matter where they produce Copyright © 2011 Pearson Addison-Wesley All