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33 Cards in this Set
- Front
- Back
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Define: balance of payments |
A record of a country's trade with other countries in goods, services and assets and is the sum of its three accounts. |
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What are the three accounts of the balance of payments? |
1. Current Account 2. Financial Account 3. Capital Account |
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Define: current account. What does it include? |
The short-term flow of funds in and out of a country. 1. Net exports (balance of trade and service) 2. Net income on investment 3. Net transfers |
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Define: balance of trade. What is its difference to net exports? |
The difference between the value of goods that a country exports and imports. It excludes services. |
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What does net exports equal to? |
Sum of balance of trade and services. |
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Define: financial account |
A record of the purchases of foreign assets by domestic investors and of domestic assets by foreign investors. |
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What does capital refer to in the financial account? |
Both real and financial assets. |
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Define: net foreign investment. What does it equal to and why? |
The capital outflows less the capital inflows. It equals the negative capital flows because they measure the same things. I.e. capital inflows and outflows. |
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Define: capital account |
The minor transactions of migrant transfers and sales and purchases of nonfinancial nonproduced assets. |
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Why does the current account roughly equal to the financial account. Hence, what does this imply regarding the balance of payments? |
Buying imports uses the foreign currency. This requires the simultaneous exchange of assets. As such, they are identical. Thus, it is zero. |
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What does a balance of payments being zero imply for the current and financial account? |
If one is at surplus, the other must be at deficit. Think seesaw. |
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Define: nominal exchange rate |
The value of a currency expressed in another. |
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What are the three sources of foreign currency demand of a currency? |
1. Importers of US products 2. Investors 3. Speculators |
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From which perspectives do the supply and demand represent? |
The demand represents the foreigner, while the supply represents the domestic. |
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What causes a shift in the demand and supply of a foreign currency? What are the two key factors which affect this? |
Changes of demand and supply by the sources of foreign buyers of the local currency. Relative incomes and interest rates. |
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Define: real exchange rate. Formula? |
The value of domestic goods in terms of foreign goods. Nominal exchange rate * (Domestic price level/foreign price level) |
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What occurs when net exports are negative? What does it imply regarding the balance of payments? |
It must be financed by selling assets or borrowing. In either case, there will be a financial account surplus. |
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What does the net exports roughly equal to? Why? |
Net foreign investment as the current account (roughly net exports) plus the financial account (roughly net capital flows) equal zero. |
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Given an open economy, what does saving equal to? Thus, what does it imply if what it equals to were negative? |
Investment plus net foreign investment, or net capital outflows. Thus, an economy is saving less than it invests if it is negative. |
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Define: capital outflow |
When a domestic investor purchases foreign financial assets or directly invests physically outside. |
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If the government runs a budget deficit, what must occur? |
Either investment or net exports will fall (net foreign investment). |
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Why does a budget deficit cause investments or net foreign investments to fall? |
Selling treasury bonds to finance it requires higher interest rates and lower investment. Also, this leads to higher exchange rate via a higher demand for currency. Thus, net exports (NFI) falls. |
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What is the implication of an open economy to monetary policies? Why? Give an example. |
Monetary policies are much more effective as net exports amplify its effects. E.g. lower interest rates lower exchange rates, which increases net exports. |
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What is the implication of an open economy to fiscal policies? Why? Give an example. |
Fiscal policies are less effective as net exports offset its intended effects. E.g. lower government spending increases saving leading to lower interest rates and higher net exports. |
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Define: statistical discrepancy |
The difference of the three accounts of the Balance of Payments |
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What does a positive Net Foreign Investment imply regarding saving and investment? Why? |
Saving is greater than investment as the excess loanable funds flow abroad instead of being invested domestically. |
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If saving is less than investment, why is NFI negative? |
As the economy must borrow abroad. Thus, the capital inflows is greater than outflows. Thus, NFI is negative. |
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Based on intuition, what does the exchange rate mean? As such, when the rate increases, what occurs for the local currency? |
The amount of the foreign value that can be exchanged per unit of the local currency. It appreciates. |
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If local interest rates decrease, ceteris paribus, what occurs in thee exchange rate? |
It will fall as demand for the local currency falls. |
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Define: twin deficit. |
A budget deficit leads to a trade deficit. |
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What is the intuition behind the real exchange rate? |
The relative price level of foreign goods converted to the local currency. |
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Define: Purchasing Price Parity. What does it imply? |
A unit of currency should buy the same quantity of goods in all countries. It implies that the real exchange rate should be 1. |
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What is the explanation behind the twin deficit? |
1. A budget deficit raises the equilibrium real interest rate, which decreases capital outflow. 2. As more investors hold domestic assets, the supply for the currency drops, thereby increasing the exchange rate. 3. A higher interest rate increases imports, which creates a trade deficit. |
