Multinational Financial

Management
Alan Shapiro
7th Edition
J.Wiley & Sons
Power Points by
Joseph F. Greco, Ph.D.
California State University, Fullerton
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 CHAPTER 5

THE BALANCE OF
PAYMENTS AND
INTERNATIONAL
LINKAGES 2
CHAPTER OVERVIEW
I. BALANCE-OF-PAYMENT
CATEGORIES
II. THE INTERNATIONAL
FLOW OF GOODS,
SERVICES,AND CAPITAL
III. COPING WITH CURRENT
ACCOUNT DEFICITS

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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.

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BALANCE-OF-PAYMENT
CATEGORIES
2. Double-entry bookkeeping
a. Currency inflows = credits
earn foreign exchange
b. Currency outflows = debits
expend foreign exchange

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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.
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BALANCE-OF-PAYMENT
CATEGORIES
5. Capital Account
a. Function: records public
and private investment
and lending.
b. Inflows = credits
c. Outflows = debits

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BALANCE-OF-PAYMENT
CATEGORIES
5. Capital Account (con’t)
d. Transactions classified as
1.) portfolio
2.) direct
3.) short term

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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
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BALANCE-OF-PAYMENT
CATEGORIES
6. Official Reserves Account (con’t)
b. Reserves consist of
1.) gold
2.) convertible securities

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BALANCE-OF-PAYMENT
CATEGORIES
7. Net Effects:
a. Sum of all transactions must
be zero:

1.) current account

2.) capital account
3.) official reserves

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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.

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BALANCE-OF-PAYMENT
CATEGORIES

1.) Basic Balance (con’t)

b.) emphasizes long-

term trends.

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BALANCE-OF-PAYMENT
CATEGORIES
1.) Basic Balance (con’t)
c.) excludes short-term capital
flows that heavily depend
on temporary factors.

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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.

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BALANCE-OF-PAYMENT
CATEGORIES
3.) Official Reserve Transactions
Balance

- measures adjustments

needed by official

reserves.

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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

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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)

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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)

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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.

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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.

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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.

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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)
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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)

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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.

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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).

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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

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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.

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PART III. COPING WITH THE CURRENT
ACCOUNT DEFICIT

I. POSSIBLE SOLUTIONS
UNLIKELY TO WORK:

A. Currency Depreciation

B. Protectionism

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COPING WITH THE CURRENT ACCOUNT
DEFICIT
II.CURRENCY DEPRECIATION
A. U.S. Experience:
Does not improve the
trade deficit.

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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.

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THE J - CURVE
Net Trade balance
change Currency improves
in trade depreciation
balance

0 TIME

Trade balance
initially deteriorates

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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.
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COPING WITH THE CURRENT
ACCOUNT DEFICIT
C. FOREIGN OWNERSHIP
one protectionist solution would
place limits on or eliminate
foreign ownership
leading to capital inflows.

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COPING WITH THE CURRENT
ACCOUNT DEFICIT
D. STIMULATE NATIONAL SAVING
change the tax regulations and
rates.

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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

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COPING WITH THE CURRENT
ACCOUNT DEFICIT
2. Deficits may be a solution to
the problem of different
national propensities to save
and invest.

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