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Economies are becoming more open (in terms of trade as % of GDP), but some countries are more open than others
Exports and imports as % of GDP
1990 Mauritius Zambia Chile China UK 153 99 64 29 51 2003 121 76 68 66 54
Argentina
Bangladesh India Brazil
15
20 17 14
40
37 31 30
United States
20
23
Higher degree of openness => structure of production and employment, and economic growth, are more likely to be affected by external events The balance of payments provides and indication of how international trade and external events feed back into the macroeconomy This presentation describes how balance of payments accounts are recorded and then explores the link between the balance of payments and a countrys exchange rate
The Capital Account is further divided into short-term and long-term capital flows
The exchange rate is the price of the in terms of other currencies (e.g. $)
If the exchange rate is freely floating then it will adjust to ensure that the demand for s = the supply of s inflows = outflows in the BoP BoP is exactly = zero Since BoP = Current Account + Capital Account:
a Current Account surplus => a Capital Account deficit
=> If the exchange rate is freely floating, then the balance for official financing is zero
The balance of payments must always balance since the accounts are constructed such that this must be true by definition
However, there can be measurement error and unreported borrowing from abroad and other illegal activities The discrepancy represents a combination of unrecorded current and capital account transactions
This requires the inclusion of what is referred to as a balancing item, to ensure the accounts balance in practice
(M - X) trade deficit
An increase in govt. expenditure (G), or a reduction in private saving (S) worsens the trade balance (i.e. raises trade deficit)
However, if a country persistently runs a trade deficit this is something to worry about (e.g. vulnerability to loss of foreign investors confidence)
excessive borrowing on capital account to finance consumption on current account will incur higher interest payments and eventually lead to reduction consumption