INTERNATIONAL FINANCE
INTERNATIONAL FINANCE ECONOMICS 332 Ingrid Liu
ABSTRACT An analysis of the main issues in international finance. Topics include international borrowing and lending, intertemporal gains from trade, current account and balance of trade movements, the determination of exchange rates and foreign exchange markets.
CHAPTER 13 NATIONAL INCOME ACCOUNTING AND THE BALANCE OF PAYMENTS Four aspects of international economics I. Unemployment II. Saving III. Trade imbalances IV. Money and price level Two tools in international trade I. National Income Accounting Records all expenditures that contribute to country’s income and output II. Balance of Payments Accounting Keeps track of changes in country’s indebtedness to foreigners Keeps change of fortunes of its export and import-competing industries Shows connection between foreign transactions and national money supplies THE NATIONAL INCOME ACCOUNTS Gross National Product (GNP) Value of all final G&S produced by the country’s factors of production and sold on market in a given time period Different expenditures that make up GNP I. Consumption: amount consumed by private domestic residents II. Investment: amount put aside by private firms to build new plant and equipment for future use III. Government Purchases: amount used by government IV. Current Account Balance: amount of net exports of G&S to foreigners Nation’s income = Nation’s output National Product and National Income GNP over a time period must equal its national income (income earned in period by factors of production) One person’s output is another person’s income Capital Depreciation and International Transfers More accurate measure of national income is GNP adjusted with: I. Depreciation (economic loss due to tendency of machinery and structures to wear out as they are used) subtracted from GNP GNP – Depreciation = Net National Product (NNP) II. Unilateral transfers changes national income (to and from other countries – ex. Foreign aid sent to expatriate countries)
National Income = GNP – Depreciation + Net Unilateral Transfers Gross Domestic Product Gross Domestic Product (GDP) Volume of production within a country’s borders GNP = GDP + net receipts of factor income from rest of world NATIONAL INCOME ACCOUNTING FOR AN OPEN ECONOMY Consumption Portion of GNP purchased by private households to fulfill current wants Investment Part of output used by private firms to produce future output Government Purchases Any goods and services purchased by federal, state, or local governments National Income Identity for an Open Economy For CLOSED ECONOMY, all output must be consumed, invested, or bought by government. Y=C+I+G
where C I G
consumption investment government purchases
For OPEN ECONOMY, residents can spend on imports and exports. Y = C + I + G + EX – IM
where EX IM
exports imports
The Current Account and Foreign Indebtedness Current Account Balance (CA) – difference between exports and imports of G&S CA = EX – IM IM > EX EX > IM
Current Account Deficit Current Account Surplus
A country’s current account balance = change in its net foreign wealth Y – (C + I + G) = CA Saving and the Current Account National Saving: portion of output, Y, that is not devoted to consumption (C), or government purchases (G). In close economy, national saving always EQUALS investment.
Let S stand for national saving. S=Y–C–G Since Y= C + I + G can be written as I = Y – C – G, then S=I In addition, S = Y – C – G and CA = EX – IM, therefore S = I + CA Because country A’s savings can be borrowed by country B in order to increase B’s stock of capital, a country’s current account surplus can also be called net foreign investment. Private and Government Saving Private Saving: part of disposable income that is saved rather than consumed Disposable income = National Income (Y) – Net Taxes (T) Private savings can be denoted as:
S P = Y -T - C
Government Saving: government’s income net tax revenue (T) – government purchases (G)
Sg = T - G Since S = Y – C – G, then
S = Y -C -G = (Y -T -C)+ (T - G) = S p + S g Because S = S p + S g = I +CA ,
S p = I + CA - S g = I +CA - (T -G) = I +CA + (G -T)
Government Budget Deficit when government saving is negative THE BALANCE OF PAYMENTS ACCOUNTS 3 types of international transaction recorded in balance of payments I. Transactions that arise from EX/IM of G&S – into current account II. Transactions that arise from purchase or sale of financial assets Asset: any one of forms in which wealth can be held Financial account of balance payment records all international purchases/sales of financial assets III. Certain other activities resulting in transfers of wealth between countries are recorded in capital account Every international transaction automatically enters balance of payments twice – credit & debit
The Fundamental Balance of Payments Identity Current account + capital account = Financial account Current Account Measures country’s net EX of G&S Balance of payments accounts divide EX and IM into 3 categories i. Goods trade: EX or IM of merchandise ii. Services: items such as payments for legal assistance, shipping fees, etc iii. Income: international interest, dividend payments and earnings of domestically owned firms operating abroad Capital Account Net change in national ownership of assets Change in foreign ownership of domestic assets – change in domestic ownership of foreign assets Financial Account Measures difference between acquisitions of assets from foreigners and buildup of liabilities to them Official Reserve Transactions Central Bank Institution responsible for managing supply of money Official International Reserves Foreign assets held by central banks as cushion against national economic misfortune Official Foreign Exchange Intervention Official transactions where central banks buy/sell international reserves in private asset markets to affect macroeconomic conditions in their economies Official Settlements Balance (Balance of Payments) Level of net central bank financial flows
CHAPTER 14 EXCHANGE RATES AND THE FOREIGN EXCHANGE MARKET An Asset Approach Exchange Rate: price of one currency in terms of another EXCHANGE RATES AND INTERNATIONAL TRANSACTIONS Exchange rate quotations: I. Direct – “American” terms II. Indirect – “European” terms Domestic and Foreign Prices At exchange rate of $1.25 per pound, sweater would cost: (1.25 $/£) x (£50) = $62.50 assuming its price in terms of pounds remained the same.
ABSTRACT An analysis of the main issues in international finance. Topics include international borrowing and lending, intertemporal gains from trade, current account and balance of trade movements, the determination of exchange rates and foreign exchange markets.
CHAPTER 13 NATIONAL INCOME ACCOUNTING AND THE BALANCE OF PAYMENTS Four aspects of international economics I. Unemployment II. Saving III. Trade imbalances IV. Money and price level Two tools in international trade I. National Income Accounting Records all expenditures that contribute to country’s income and output II. Balance of Payments Accounting Keeps track of changes in country’s indebtedness to foreigners Keeps change of fortunes of its export and import-competing industries Shows connection between foreign transactions and national money supplies THE NATIONAL INCOME ACCOUNTS Gross National Product (GNP) Value of all final G&S produced by the country’s factors of production and sold on market in a given time period Different expenditures that make up GNP I. Consumption: amount consumed by private domestic residents II. Investment: amount put aside by private firms to build new plant and equipment for future use III. Government Purchases: amount used by government IV. Current Account Balance: amount of net exports of G&S to foreigners Nation’s income = Nation’s output National Product and National Income GNP over a time period must equal its national income (income earned in period by factors of production) One person’s output is another person’s income Capital Depreciation and International Transfers More accurate measure of national income is GNP adjusted with: I. Depreciation (economic loss due to tendency of machinery and structures to wear out as they are used) subtracted from GNP GNP – Depreciation = Net National Product (NNP) II. Unilateral transfers changes national income (to and from other countries – ex. Foreign aid sent to expatriate countries)
National Income = GNP – Depreciation + Net Unilateral Transfers Gross Domestic Product Gross Domestic Product (GDP) Volume of production within a country’s borders GNP = GDP + net receipts of factor income from rest of world NATIONAL INCOME ACCOUNTING FOR AN OPEN ECONOMY Consumption Portion of GNP purchased by private households to fulfill current wants Investment Part of output used by private firms to produce future output Government Purchases Any goods and services purchased by federal, state, or local governments National Income Identity for an Open Economy For CLOSED ECONOMY, all output must be consumed, invested, or bought by government. Y=C+I+G
where C I G
consumption investment government purchases
For OPEN ECONOMY, residents can spend on imports and exports. Y = C + I + G + EX – IM
where EX IM
exports imports
The Current Account and Foreign Indebtedness Current Account Balance (CA) – difference between exports and imports of G&S CA = EX – IM IM > EX EX > IM
Current Account Deficit Current Account Surplus
A country’s current account balance = change in its net foreign wealth Y – (C + I + G) = CA Saving and the Current Account National Saving: portion of output, Y, that is not devoted to consumption (C), or government purchases (G). In close economy, national saving always EQUALS investment.
Let S stand for national saving. S=Y–C–G Since Y= C + I + G can be written as I = Y – C – G, then S=I In addition, S = Y – C – G and CA = EX – IM, therefore S = I + CA Because country A’s savings can be borrowed by country B in order to increase B’s stock of capital, a country’s current account surplus can also be called net foreign investment. Private and Government Saving Private Saving: part of disposable income that is saved rather than consumed Disposable income = National Income (Y) – Net Taxes (T) Private savings can be denoted as:
S P = Y -T - C
Government Saving: government’s income net tax revenue (T) – government purchases (G)
Sg = T - G Since S = Y – C – G, then
S = Y -C -G = (Y -T -C)+ (T - G) = S p + S g Because S = S p + S g = I +CA ,
S p = I + CA - S g = I +CA - (T -G) = I +CA + (G -T)
Government Budget Deficit when government saving is negative THE BALANCE OF PAYMENTS ACCOUNTS 3 types of international transaction recorded in balance of payments I. Transactions that arise from EX/IM of G&S – into current account II. Transactions that arise from purchase or sale of financial assets Asset: any one of forms in which wealth can be held Financial account of balance payment records all international purchases/sales of financial assets III. Certain other activities resulting in transfers of wealth between countries are recorded in capital account Every international transaction automatically enters balance of payments twice – credit & debit
The Fundamental Balance of Payments Identity Current account + capital account = Financial account Current Account Measures country’s net EX of G&S Balance of payments accounts divide EX and IM into 3 categories i. Goods trade: EX or IM of merchandise ii. Services: items such as payments for legal assistance, shipping fees, etc iii. Income: international interest, dividend payments and earnings of domestically owned firms operating abroad Capital Account Net change in national ownership of assets Change in foreign ownership of domestic assets – change in domestic ownership of foreign assets Financial Account Measures difference between acquisitions of assets from foreigners and buildup of liabilities to them Official Reserve Transactions Central Bank Institution responsible for managing supply of money Official International Reserves Foreign assets held by central banks as cushion against national economic misfortune Official Foreign Exchange Intervention Official transactions where central banks buy/sell international reserves in private asset markets to affect macroeconomic conditions in their economies Official Settlements Balance (Balance of Payments) Level of net central bank financial flows
CHAPTER 14 EXCHANGE RATES AND THE FOREIGN EXCHANGE MARKET An Asset Approach Exchange Rate: price of one currency in terms of another EXCHANGE RATES AND INTERNATIONAL TRANSACTIONS Exchange rate quotations: I. Direct – “American” terms II. Indirect – “European” terms Domestic and Foreign Prices At exchange rate of $1.25 per pound, sweater would cost: (1.25 $/£) x (£50) = $62.50 assuming its price in terms of pounds remained the same.
