International Finance - 3 DAYS DUE
vzan0903
ch051.pptMultinational Financial Management
Alan Shapiro
7th Edition
J.Wiley & Sons
Power Points by
Joseph F. Greco, Ph.D.
California State University, Fullerton
CHAPTER 5
THE BALANCE OF PAYMENTS AND INTERNATIONAL LINKAGES
CHAPTER OVERVIEW
I. BALANCE-OF-PAYMENT CATEGORIES
II. THE INTERNATIONAL FLOW OF GOODS, SERVICES,AND CAPITAL
III. COPING WITH CURRENT ACCOUNT DEFICITS
PART I. BALANCE-OF-PAYMENT
CATEGORIES
A. THE BALANCE OF PAYMENTS (B-O-P)
1. PURPOSE:
Measures all financial and economic transactions over
a specified period of time.
BALANCE-OF-PAYMENT
CATEGORIES
2. Double-entry bookkeeping
a. Currency inflows = credits
earn foreign exchange
b. Currency outflows = debits
expend foreign exchange
BALANCE-OF-PAYMENT
CATEGORIES
3. Three Major Accounts:
a. Current
b. Capital
c. Official Reserves
4. Current Account
records net flow of goods, services, and unilateral transfers.
BALANCE-OF-PAYMENT
CATEGORIES
5. Capital Account
a. Function: records public and private investment and lending.
b. Inflows = credits
c. Outflows = debits
BALANCE-OF-PAYMENT
CATEGORIES
5. Capital Account (con’t)
d. Transactions classified as
1.) portfolio
2.) direct
3.) short term
BALANCE-OF-PAYMENT
CATEGORIES
6. Official Reserves Account
a. Function:
1.) measures changes in
international reserves
owned by central banks.
2.) reflects surplus/deficit of
a.) current account
b.) capital account
BALANCE-OF-PAYMENT
CATEGORIES
6. Official Reserves Account (con’t) b. Reserves consist of
1.) gold
2.) convertible securities
BALANCE-OF-PAYMENT
CATEGORIES
7. Net Effects:
a. Sum of all transactions must be zero:
1.) current account
2.) capital account
3.) official reserves
BALANCE-OF-PAYMENT
CATEGORIES
8. The Balance-of-payment measures
a. Some Definitions:
1.) Basic Balance
a.) consists of current
account and long- term capital flows.
BALANCE-OF-PAYMENT
CATEGORIES
1.) Basic Balance (con’t)
b.) emphasizes long- term trends.
BALANCE-OF-PAYMENT
CATEGORIES
1.) Basic Balance (con’t)
c.) excludes short-term capital flows that heavily depend on temporary factors.
BALANCE-OF-PAYMENT
CATEGORIES
2.) Net Liquidity Balance:
measures the change in
private domestic borrowing
or lending require to keep
payments equal without
adjusting official reserves.
BALANCE-OF-PAYMENT
CATEGORIES
3.) Official Reserve Transactions
Balance
- measures adjustments
needed by official reserves.
PART II. THE INTERNATIONAL FLOW OF GOODS, SERVICES, AND CAPITAL
II. LINKS FROM INTERNATIONAL TO DOMESTIC FLOWS
A. Global Linkages
set of basic macroeconomic identities which link:
domestic spending and production to current and capital accounts
THE INTERNATIONAL FLOW OF GOODS, SERVICES, AND CAPITAL
B. Domestic Savings and Investment
and the Capital Account
1. National Income Accounting
a. National Income (NI) is either spent (C) or saved (S)
NI = C + S (5.1)
THE INTERNATIONAL FLOW OF GOODS, SERVICES, AND CAPITAL
b. National spending (NS) is
divided into personal spending (C) and investment (I)
NS = C + I (5.2)
THE INTERNATIONAL FLOW OF GOODS, SERVICES, AND CAPITAL
c. Subtracting (4.2) - (4.1)
NI - NS = S - I (5.3)
If NI >NS, S > I which implies
that surplus capital spent overseas.
THE INTERNATIONAL FLOW OF GOODS, SERVICES, AND CAPITAL
d. In a freely-floating system,
excess saving = the capital account balance
e. Implications:
1. A nation which produces more than it spends will save more than it invests domestically with a net capital outflow producing a capital account deficit.
THE INTERNATIONAL FLOW OF GOODS, SERVICES, AND CAPITAL
2. A nation which spends more than it produces has a net capital inflow producing a capital account surplus.
3. A healthy economy will tend to
run a current account deficit.
THE INTERNATIONAL FLOW OF GOODS, SERVICES, AND CAPITAL
C. THE LINK BETWEEN THE CURRENT AND CAPITAL ACCOUNTS
1. Beginning identity
NI - NS = X - M (5.4)
where X = exports
M = imports
X-M=current account balance (CA)
THE INTERNATIONAL FLOW OF GOODS, SERVICES, AND CAPITAL
2. Combining (5.3) + (5.4)
S - I = X - M (5.5)
3. If S - I = Net Foreign Investment (NFI)
NFI = X - M (5.6)
THE INTERNATIONAL FLOW OF GOODS, SERVICES, AND CAPITAL
4. Implications:
a. If CA is in surplus, the nation must be a net exporter of capital.
b. If CA is a deficit, the nation is a major capital importer.
c. When NS > NI, the excess must be acquired through foreign trade.
THE INTERNATIONAL FLOW OF GOODS, SERVICES, AND CAPITAL
d. Solutions for Improving CA deficits:
1.) Raise national income (output)
relative to domestic investment (I).
2.) Increase (S) relative to domestic investment (I).
THE INTERNATIONAL FLOW OF GOODS, SERVICES, AND CAPITAL
D. GOVERNMENT BUDGETS AND
CURRENT ACCOUNT DEFICITS
1. CURRENT ACCOUNT BALANCE
CA = Saving Surplus - Gov’t budget deficit
THE INTERNATIONAL FLOW OF GOODS, SERVICES, AND CAPITAL
2. CA Deficit means
the nation is not saving enough to finance (I) and the deficit.
3. CA Surplus means
the nation is saving more than needed to finance its (I) and deficit.
PART III. COPING WITH THE CURRENT ACCOUNT DEFICIT
I. POSSIBLE SOLUTIONS UNLIKELY TO WORK:
A. Currency Depreciation
B. Protectionism
COPING WITH THE CURRENT ACCOUNT DEFICIT
II.CURRENCY DEPRECIATION
A. U.S. Experience:
Does not improve the trade deficit.
COPING WITH THE CURRENT ACCOUNT DEFICIT
B. Depreciations are ineffective because
1. It takes time to affect trade.
2. J-Curve Effect
states that a decline in currency value will initially worsen the deficit before improvement.
THE J - CURVE
TIME
Net change
in trade
balance
0
Currency
depreciation
Trade balance
initially deteriorates
Trade balance
improves
COPING WITH THE CURRENT ACCOUNT DEFICIT
III. PROTECTIONISM
A. Trade Barriers used:
1. Tariffs
2. Quotas
B. Results:
Most likely will reduce both X and M.
COPING WITH THE CURRENT ACCOUNT DEFICIT
C. FOREIGN OWNERSHIP
one protectionist solution would place limits on or eliminate foreign ownership leading to capital inflows.
COPING WITH THE CURRENT ACCOUNT DEFICIT
D. STIMULATE NATIONAL SAVING
change the tax regulations and rates.
COPING WITH THE CURRENT ACCOUNT DEFICIT
III. SUMMARY: CURRENT-ACCOUNT
DEFICITS
- neither bad nor good inherently
1. Since one country’s exports are another’s imports, it is not possible for all to run a surplus
COPING WITH THE CURRENT ACCOUNT DEFICIT
2. Deficits may be a solution to the problem of different national propensities to save and invest.
