International Economic Linkages and The Balance of Payments

By group 5 :

Tiaradipa Amanda (1010532072)

Yodra Suyama (1010532066)

CHAPTER OVERVIEW

I. BALANCE-OF-PAYMENT CATEGORIES

II. THE INTERNATIONAL FLOW OF GOODS, SERVICES, AND CAPITAL

III. COPING WITH CURRENT ACCOUNT DEFICITS

THE BALANCE OF PAYMENTS (B-O-P)1. PURPOSE:Measures all financial and economic transactions over a specified period of time.

2. Double-entry bookkeeping

a. Currency inflows = credits (earn foreign exchange)

b. Currency outflows = debits (expend foreign exchange)

BALANCE-OF-PAYMENT CATEGORIES

BALANCE-OF-PAYMENT CATEGORIESSources of fund = decrease in assets or an increase in

liabilities

Uses of fund = increase in assets or an decrease in liabilities

In example: Suppose a Batik Indonesia company exports 100 Batik

to U.S at price of $100,000. At current rate Rp1= $9,800, this order is Rp.980.000.000

Debit Credit

Batik Indonesia export Rp.980.000.000

Private foreign assets Rp.980.000.000

BALANCE-OF-PAYMENT CATEGORIES

3. Three principal balance- of payment categories :

a. Current accountb. Capital accountc. Financial account

BALANCE-OF-PAYMENT CATEGORIES

4. Balance-of-payment Measuresa. Definitions:1. Basic Balancefocuses on transactions considered to be fundamental to the economic health of currency. It includes the balance on current account and long term capital.

2. Net liquidity balance measures the change in private domestic borrowing or lending that is required to keep payments in balance without adjusting official reserves.

BALANCE-OF-PAYMENT CATEGORIES

3. Official Reserve Transactions BalanceMeasures adjustments required in official reserves to achieves balance-of-payments equilibrium.

THE INTERNATIONAL FLOW OF GOODS, SERVICES, AND CAPITAL

LINKS FROM INTERNATIONAL TO DOMESTIC FLOWS

A. Global Linkagesset of basic macroeconomic identities

which link: domestic spending and production to saving, consumption, and investment behavior and thence to financial account and current account balances.

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 (1)

b. National spending (NS) is divided into personal spending C

and investment (I)NS = C + I (2)

THE INTERNATIONAL FLOW OF GOODS, SERVICES, AND CAPITALc. Subtracting (1) (2)

NI - NS = S - I (3)

If NI >NS, S > I which implies that surplus ,capital spent overseas.

THE INTERNATIONAL FLOW OF GOODS, SERVICES, AND CAPITALC. THE LINK BETWEEN THE CURRENT AND

CAPITAL ACCOUNTS1. Beginning identity

Y - E = X - Mwhere X = exports M = imports

X-M = current account balance (CA)

2. Combining S - I = X - M

3. If S - I = Net Foreign Investment (NFI)NFI = X - M

D. GOVERNMENT BUDGETS AND CURRENT ACCOUNT DEFICITS

1. CURRENT ACCOUNT BALANCE

CA = Saving Surplus - Gov’t budget deficit2. CA Deficit meansthe 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.

COPING WITH THE CURRENT ACCOUNT DEFICIT

A. Currency DepreciationB. ProtectionismC. Ending Foreign Ownership of Domestic AssetsD. Current account deficit and unemployement

CURRENCY DEPRECIATIONA. U.S. Experience: Does not improve the trade deficit.B. Depreciations 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.

THE J - CURVE

TIME

Net changein trade balance

0

Currency depreciation

Trade balance initially deteriorates

Trade balanceimproves

COPING WITH THE CURRENT ACCOUNT DEFICIT

B. PROTECTIONISMA. Trade Barriers used:

1. Tariffs2. Quotas

B. Results:Most likely will reduce both X and M.

C. Ending Foreign Ownership of Domestic Assetsone protectionist solution would place limits on or eliminate foreign ownership leading to capital inflows.

Continue...D. Current account deficit and unemployement is dilemma in our country, because have pro and contra argument.