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Balance of payments (BOP) statement

An income statement för an entire country that records all income and expenditures for that country in its transactions with the ROW over a period of time.


What have to balance in BOP?

The cash inflows and outflows have to be equal over time.


What will generate income?

Selling three things: goods, services and assets - all generate capital inflow.


Key to BOP accounting?

"Follow the money".


What makes BOP accounting hard?

-The magnitude of transactions are huge
- The illegal ones are covered and therefore hard to measure
- More and more intangible services are traded...
- Developing countries do not have sufficient resources to do this correctly.


3 main accounts of BOP:

1. Current account
2. Capital account - private and public
3. Errors & omissions


Current account

Measures the trade balance - the value of G&S over time.
Current account balance = X-IM.
If X>M = net seller ( CA surplus)
If X


Capital account

Financial account. Trading of assets. Private measures trade by private firms and individuals while public measures the governmental trade.
Surplus = seller
Deficit = buyer.


Errors & Omissions

Inevitably transactions will be missed and will not sum up to zero - here the adjustments are made. A very big post can indicate that the economy is illa ute... Not enough control.



= Foreign exchange reserves. The value of foreign assets held by the country's CB - buying/selling is recorded in the public capital account.


3 ways to interpret + and - in BOP:

1. + is surplus, - is deficit.
2. + is net cash inflow, - is net cash outflow.
3. + is net seller, - is net buyer.

All these interpretations are equivalent.


Are G&S and capital moving in the same directions?

YES! If G&S are leaving the country (net seller) then capital is also moving the country (net buyer of assets instead).


Why must the balance of payments balance? Algebraic?

Because NII says that.


NII: National Income Identity

We know that aggregate income is equal to aggregate spending: Y =C + I + G + (X-M).
Manipulating this can give us:
(Y-C-G) - I = (X-M)
And we know that income minus consumptions is equal to savings so:
(S-I) = (X-M)
--> (X-M) + (I-S) = 0

Must balance!!


What does NII tell su about current account deficits?

Tat if X-M <0 then (I-S) must be >0. So a deficit in trade means a surplus in capital and vice versa.


Debit entry in BOP

A negative entry in the BOP that records a transaction resulting in a payment abroad by aa domestic resident.


Credit entry in BOP

A positive entry in the BOP that records a transactions resulting in a payment from abroad to a domestic resident.


Double-entry bookkeeping system

In the BOP, an international transaction always results in a credit and an offsetting debit entry - therefore the sum of all entries equal zero.


Two types of capital flows between countries:

1. Portfolio investment = assets that results in less than a 10% ownership share in the entity.

2. FDI = assets with 10% or greater ownership.


What does a BOP deficit mean? Overall it sum to zero, right?

Yes, thats right. Overall it will sum to 0, but a deficit refers to a situation when the public capital account is positive (and current account + private capital account sum to negative). Private payments made to foreigners are greater than the received ones.


BOP surplus then?

It must be a situation where the public capital account is negative due to a trade surplus.


BOP equilibrium:

When the sum of the current account and the private account is zero so that the official settlements balance is also zero.


Is it necessarily good/bad to be a net debtor/creditor?

No, it all depends on a lot of things. For ex a debtor have less claims on foreigners than they have on us, but that means that capital is flowing into our nation today. If we use these money well, productive investments, it can payoff in the future with higher welfare. It is all about using the situation right. If the inflows are used for today's consumption - then the future might be bad when you have to pay back the "loans".


Interpret (S-I)>0

Okay, so domestic savings exceeds domestic investment, so when investments are done, there are savings over. This excess will be invested abroad --> capital is exported (importing assets). So home country is exporting capital which results in a capital account deficit. --> I-S <0 so we have a deficit. (and trade surplus instead).


Interpret S< I

Okay, so savings is now insufficient for our investments. We have to import savings/capita that results in a capital account surplus.
If (S-I) is negative, then (X-M) must also be negative so this comes along with a trade deficit.


Will a policy change have any effect in the trade balance?

Maybe, only if it also affects S or I. According to NII, X and M cannot change if not S or I changes too.

If S goes up by the policy, then (S-I) goes up and so (X-M) cam also rise.


Are CA surplus desirable?
2 theories

Conventional wisdom says yes. Surpluses are always good.

Empirical evidence/modern theory is not so clear. Countries with trade deficits can have very strong economy. It all depends on what they do with their money.


Are transactions a zero-sum game?

Conventional wisdom says again yes. Whatever I win, you lose.

BUT modern theory says that trade is mutually beneficial. Both parties are better off, otherwise you would not have engaged in the transaction. A borrowers do not lose - a borrower can invest in a house to his family, how is that a loss?


To understand trade imbalances you must first...

...understand why capital leave some countries and enter other. International capital flows.


Exchange rate=

The market price of foreign exchange. It is a relative price of a currency in terms of another. Always stated in pairs, therefore named bilateral rates.