chapter 3 the balance of payments management 3460 institutions and practices in international...
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Chapter 3 The Balance of Payments
Management 3460 Institutions and Practices in
International Finance
Fall 2003Greg Flanagan
September 30, 2003 2
Chapter Objectives:
The student will be able to:Explain the balance of payments accounts; interpret the accounts;
explain the BP effect on floating exchange rates;
Explain the effect of government intervention on the FE market;
Be aware of the trends in international BP.
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Outline Balance of Payments Accounts
The Current Account The Capital Account Statistical Discrepancy Official Reserves Account
The Balance of Payments Identity Canadian Balance of Payments Data The effect of BP on exchange rates Balance of Payments Trends in Major Countries
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Balance of Payments Accounting
The Balance of Payments is the statistical record of a specific country’s international transactions over a certain period of time (annual) using double-entry bookkeeping.
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Balance of Payments Accounts
records all transactions between the residents of a country and residents of all foreign nations.
composed of the following:The Current Account
The Capital Account
The Official Reserves Account
Statistical Discrepancy
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The Current Account iMports and eXports of goods
“balance of merchandise trade”mercantalism
and imports and exports of services including:investment income;unilateral transfers (foreign aid).
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The Current Account
Current account balanceIf balance < 0 (debits exceed
credits), then a country is running a trade deficit.
If balance > 0 (credits exceed debits), then a country is running a trade surplus.
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The Capital Account
The capital account measures the difference between sales of assets to foreigners and purchases of foreign assets.
The capital account is composed ofdirect investment (FDI); portfolio investments and; other investments.
Reported as Canadian Assets Abroad and Canadian Liabilities to non-residents
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Difference between Capital and Current account balance
The balance of payments (BP) must balance!
Official reserves can rise and fall assets include gold, foreign currencies,
SDRs, reserve positions in the IMF. Statistical discrepancy
some omissions and errors therefore a estimate makes the accounts balance.
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The Balance of Payments Identity
BCA + BKA + BRA = 0 Where:
BCA = balance on current account
BKA = balance on capital account
BRA = balance on the reserves account
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Cdn Balance of Payments 2002
Goods & services
-1,853 of which: travel
-8,330 Balance
66,653 Payments
58,323 Receipts
Services
57,846 Balance
356,459 Payments
414,305 Receipts
Goods
49,516 Balance
423,112 Imports
472,628 Exports
1,361 Balance
Current transfers
-27,511 Balance
29,643 of which: interest
59,149 Payments
31,638 Receipts
Investment income
1
3
2
$'000,000
4 23,366 Balance
487,902 Payments
511,268 Receipts
Total
1+2+3=4
Current Account
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62,864 Total Canadian liabilities to non-residents
9,464 Other investments
3,782 Money market
18,712 Bonds
-1,436 Stocks
Portfolio liabilities
32,342 Direct investment in Canada
-80,825 Total Canadian assets abroad
-10,657 Other investment assets
-6,243 Bonds
-18,707 Stocks
Portfolio assets
-45,217 Direct investment abroad
-17,961 Financial account
-13,145 Total
3
4
1
2
5
1+2 = 3
3+4 = 5
$'000,000
Capital and Financial Account
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Effect of Balance of Payments on the Foreign Exchange Market
Reciprocal markets
Demand for foreign goods (imports) = demand for FE
Demand for Cdn goods (exports) = supply of Cdn$
Debits = demand for foreign exchange/ supply of Cdn$.
Credits = supply of foreign exchange/ demand for Cdn$.
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Floating Foreign Exchange Market
If the current account + capital account > 0
i.e. Trade surplus Qs > Qd Cdn$
If the current account + capital account < 0
i.e. Trade deficit Qd > Qs Cdn$
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Foreign Exchange Market
BP < 0 (Trade deficit)Cdn$
QUS$
S
D
Cdn$
QUS$
BP > 0 (Trade surplus)
S
Qd
D
A floating exchange rate adjusts automatically
QsQdQs
Cdn$ depreciates Cdn$ appreciates
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Intervention in the Foreign Exchange Market
the current account + capital account < 0 Qs < Qd Cdn$
Bank of Canada sells foreign exchange = increase in supply of FE Cdn$
If the current account + capital account > 0 If Qd < Qs Cdn$
Bank of Canada buys foreign exchange = increase in demand of FE Cdn$
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Foreign Exchange Market
B of C sells FECdn$
QUS$US$
S
D
B of C buys FE
S
US$
D
D*
S*
The Bank of Canada can intervene in the FE market
Cdn$ appreciates
Cdn$ depreciates
QUS$
Cdn$
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Balance of Payments Trends
Canada has usually experienced surpluses on the current account and deficits on the capital account.
Since 1982 the U.S. has experienced continuous deficits on the current account and continuous surpluses on the capital account.
During the same period, Japan has experienced the opposite of the U.S., similar to Canada.
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Balances on the Current (BCA) and Capital (BKA) Accounts of the United States
-500
-400
-300
-200
-100
0
100
200
300
400
500
1982 1984 1986 1988 1990 1992 1994 1996 1998 2000
U.S. BCA
U.S. BKA
Source: IMF International Financial Statistics Yearbook, 2000
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Balances on the Current (BCA) and Capital (BKA) Accounts of United Kingdom
-50
-40
-30
-20
-10
0
10
20
30
40
1982 1984 1986 1988 1990 1992 1994 1996 1998 2000
UK BCA
UK BKA
Source: IMF International Financial Statistics Yearbook, 2000
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Balances on the Current (BCA) and Capital (BKA) Accounts of Japan
-150
-100
-50
0
50
100
150
1982 1984 1986 1988 1990 1992 1994 1996 1998 2000
Japan BCA
Japan BKA
Source: IMF International Financial Statistics Yearbook, 2000
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Balances on the Current (BCA) and Capital (BKA) Accounts of Germany
-80
-60
-40
-20
0
20
40
60
80
1982 1984 1986 1988 1990 1992 1994 1996 1998 2000
Germany BCA
Germany BKA
Source: IMF International Financial Statistics Yearbook, 2000
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Balances on the Current (BCA) and Capital (BKA) Accounts of China
-15
-10
-5
0
5
10
15
20
25
30
35
1982 1984 1986 1988 1990 1992 1994 1996 1998 2000
China BCA
China BKA
Source: IMF International Financial Statistics Yearbook, 2000
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Balance of Payments Trends
Germany traditionally had current account surpluses, since 1991 Germany has been experiencing current account deficits.
This is largely due to German reunification and the resultant need to absorb more output domestically to rebuild the former East Germany.
What matters is the nature and causes of the disequilibrium.
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Balances on the Current (BCA) and Capital (BKA) Accounts of Five Major Countries
-500
-400
-300
-200
-100
0
100
200
300
400
500
1982 1984 1986 1988 1990 1992 1994 1996 1998 2000
China BCA
China BKA
Japan BCA
Japan BKA
Germany BCA
Germany BKA
UK BCA
UK BKA
U.S. BCA
U.S. BKA
Source: IMF International Financial Statistics Yearbook, 2000