CONNECTIONS: BALANCE OF PAYMENTS,
FOREX MARKETS, LOANABLE FUNDS
MARKETS
Sally [email protected]
Revised byLori Leachman
Open Economy Topics (from College Board’s Course Description)
VII. Open Economy: International Trade and Finance
Balance of Payments Accounts
Foreign Exchange Market
Net Exports and capital flows
Links to financial and goods markets
Key Ideas
(Handout page 1) The exchange rate is the price of one country’s money
in terms of another- there are 2 ways to report: E= foreign price of a dollar= #FC units/$1 e=dollar price of foreign currency=$1/#FC units
Focus on money coming in as a credit (sell) and money going out as a debit (buy) – or alternatively one person’s buy is another person’s sell
2 major accounts: Current account and financial account
(Handout page 2)BP = Current Account (CA) + Financial Account(FA) = 0If BP≠0, then there is an official change in foreign currency
reserves (this role of official reserves is critical in fixed exchange rate systems) so really
BP= CA + FA + ∆ off reserves = 0
Current account deficits must be offset by financial account surpluses (increasing capital inflows)
(CA‹0)=( FA›0) so BP=0
Current account surpluses must be offset by financial account deficits (increasing capital outflows)
(CA›0) = (FA‹0) so BP=0
(Handout page 2)
All transactions impact foreign currency markets of the participants – because to buy or sell foreign goods or asset you must exchange currency
Financial account transactions impact the loanable funds market of the participants:
Capital inflows will increase the supply of loanable funds (as foreigners buy bonds)
Capital outflows will decrease the supply of loanable funds( as foreigners and domestic investors sell bonds)
Department of Commerce
www.bea.gov – International Transactions
Examples of current articles (relatively)
Bloomberg - March 19, 2009
WSJ – September 11, 2008
WSJ- Feb. 16, 2010
Balance of Payments – An Activity (Handout pages 3 – 10)
2 groups (countries)
Classifying transactions as current account or financial/capital account
Classifying transactions as inflows of money or outflows of money
Creating forex models to illustrate transactions impact on currency value
Creating loanable funds markets to illustrate impact on real interest rates from financial/capital account transactions
1.
increase D$=increase SFC; E rises or e falls
Practice Questions: (page 11)
Euros/$=E
Q USD
S$
D$
SEuros
DEuros
$/Euro=e
QEuros
D1
S1
USD appreciates and the Euro depreciates
2.
Increase S$ = increase DSGD; E falls or e rises
Practice Questions: (page 11)
SGD/$ =E
Q USD
S$
D$
SSGD
DSGD
$/SGD =e
QSGD
D1
S1
USD depreciates and the SGD appreciates
3.
Practice Questions: (page 11)
Peso/$
Q USD
S$
D$
SPeso
DPeso
$/Peso
QPeso
D1
S1
USD depreciates and the Peso appreciates
4.
Practice Questions: (page 11)
Yen/$
Q USD
S$
D$
SYen
DYen
$/Yen
QYen
D1
S1
USD appreciates and the Yen depreciates
5.
Practice Questions: (page 11)
Real Interest
rate
Q Loanable Funds
SLF
DLF
S1
Capital flows into the US (increased demand for dollars), increasing the supply of loanable funds and decreasing the real interest rate.
The US dollar would appreciate as more dollars are demanded in order to purchase US government bonds.
6.
Practice Questions: (page 11)
Real Interest
rate
Zambia’s Loanable Funds Market
Q
SLF
DLF
S1
Capital flows out of Zambia, decreasing the supply of loanable funds and increasing the real interest rate.
Zambia’s currency would depreciate as the currency is used to purchase other currencies.