The Balance of Payments Account Meaning of the balance of payments

The current account

The Balance of Payments Account Meaning of the balance of payments

The current account

trade in goods

UK balance of payments: 2001 (£ millions)UK balance of payments: 2001 (£ millions)

The Balance of Payments Account Meaning of the balance of payments

The current account

trade in goods

trade in services

UK balance of payments: 2001 (£ millions)UK balance of payments: 2001 (£ millions)

The Balance of Payments Account Meaning of the balance of payments

The current account

trade in goods

trade in services

balance of trade in goods and services

UK balance of payments: 2001 (£ millions)UK balance of payments: 2001 (£ millions)

The Balance of Payments Account Meaning of the balance of payments

The current account

trade in goods

trade in services

balance of trade in goods and services

income flows

UK balance of payments: 2001 (£ millions)UK balance of payments: 2001 (£ millions)

The Balance of Payments Account Meaning of the balance of payments

The current account

trade in goods

trade in services

balance of trade in goods and services

income flows

current transfers of money

UK balance of payments: 2001 (£ millions)UK balance of payments: 2001 (£ millions)

The Balance of Payments Account Meaning of the balance of payments

The current account

trade in goods

trade in services

balance of trade in goods and services

income flows

current transfers of money

balance on current account

UK balance of payments: 2001 (£ millions)UK balance of payments: 2001 (£ millions)

The Balance of Payments Account The capital account

UK balance of payments: 2001 (£ millions)UK balance of payments: 2001 (£ millions)

The Balance of Payments Account The capital account The financial account

The Balance of Payments Account The capital account The financial account

investment

The Balance of Payments Account The capital account The financial account

investment○ direct

The Balance of Payments Account The capital account The financial account

investment○ direct○ portfolio

UK balance of payments: 2001 (£ millions)UK balance of payments: 2001 (£ millions)

The Balance of Payments Account The capital account The financial account

investment○ direct○ portfolio

other financial flows (mainly short term)

UK balance of payments: 2001 (£ millions)UK balance of payments: 2001 (£ millions)

The Balance of Payments Account The capital account The financial account

investment○ direct○ portfolio

other financial flows (mainly short term)flows to and from reserves

UK balance of payments: 2001 (£ millions)UK balance of payments: 2001 (£ millions)

The Balance of Payments Account The capital account The financial account

investment○ direct○ portfolio

other financial flows (mainly short term)flows to and from reservesfinancial account balance

UK balance of payments: 2001 (£ millions)UK balance of payments: 2001 (£ millions)

The Balance of Payments Account The capital account The financial account

investment○ direct○ portfolio

other financial flows (mainly short term)flows to and from reservesfinancial account balance

Overall balance of payments

UK balance of payments: 2001 (£ millions)UK balance of payments: 2001 (£ millions)

UK balance of payments: 2001 (£ millions)UK balance of payments: 2001 (£ millions)

The Balance of Payments Account The capital account The financial account

investment○ direct○ portfolio

other financial flows (mainly short term)flows to and from reservesfinancial account balance

Overall balance of payments Assessing balance of payments figures

Exchange Rates

The rate of exchangeindividual rates of exchangeexchange rate index

Sterling exchange rates: 1980–2003Sterling exchange rates: 1980–2003

Sterling exchange rates: 1980–2003Sterling exchange rates: 1980–2003

Sterling exchange rates: 1980–2003Sterling exchange rates: 1980–2003

Sterling exchange rates: 1980–2003Sterling exchange rates: 1980–2003

Exchange Rates

The rate of exchangeindividual rates of exchangeexchange rate index

The weights of the currencies of various countriesin the sterling exchange rate indexThe weights of the currencies of various countriesin the sterling exchange rate index

Exchange Rates

The rate of exchangeindividual rates of exchangeexchange rate index

Determination of exchange rates

Exchange Rates

The rate of exchangeindividual rates of exchangeexchange rate index

Determination of exchange ratesthe equilibrium exchange rate

1.00

1.20

1.40

1.60

1.80

2.00

2.20

0

$ pr

ice

of £

Q of £

Determination of the rate of exchangeDetermination of the rate of exchange

1.00

1.20

1.40

1.60

1.80

2.00

2.20

0

$ pr

ice

of £

D by USA

Q of £

Determination of the rate of exchangeDetermination of the rate of exchange

1.00

1.20

1.40

1.60

1.80

2.00

2.20

0

$ pr

ice

of £

QS

S by UK

Q of £

Determination of the rate of exchangeDetermination of the rate of exchange

D by USA

QD

b a

1.00

1.20

1.40

1.60

1.80

2.00

2.20

0 QS QD

d$ pr

ice

of £

Determination of the rate of exchangeDetermination of the rate of exchange

S by UK

Q of £

c

D by USA

Exchange Rates

The rate of exchangeindividual rates of exchangeexchange rate index

Determination of exchange ratesthe equilibrium exchange rateappreciation and depreciation

Exchange Rates

The rate of exchangeindividual rates of exchangeexchange rate index

Determination of exchange ratesthe equilibrium exchange rateappreciation and depreciationshifts in currency demand and supply

0.60

0.80

1.00

1.20

1.40

1.60

1.80

0

Floating exchange rates: movement to a new equilibrium

€ / £

S1

D1

Q of £

0.60

0.80

1.00

1.20

1.40

1.60

1.80

0

€ / £

S1

D1

S2

Q of £

Floating exchange rates: movement to a new equilibrium

0.60

0.80

1.00

1.20

1.40

1.60

1.80

0

€ / £

S1

D1

S2

D2

Q of £

Floating exchange rates: movement to a new equilibrium

Exchange Rates

The rate of exchangeindividual rates of exchangeexchange rate index

Determination of exchange ratesthe equilibrium exchange rateappreciation and depreciationshifts in currency demand and supply

○ differences in interest rates

0.60

0.80

1.00

1.20

1.40

1.60

1.80

0

€ / £

S1

D1

S2

D2

Q of £

Floating exchange rates: movement to a new equilibrium

Exchange Rates

The rate of exchangeindividual rates of exchangeexchange rate index

Determination of exchange ratesthe equilibrium exchange rateappreciation and depreciationshifts in currency demand and supply

○ differences in interest rates○ differences in inflation rates

0.60

0.80

1.00

1.20

1.40

1.60

1.80

0

€ / £

S1

D1

S2

D2

Q of £

Floating exchange rates: movement to a new equilibrium

Exchange Rates

The rate of exchangeindividual rates of exchangeexchange rate index

Determination of exchange ratesthe equilibrium exchange rateappreciation and depreciationshifts in currency demand and supply

○ differences in interest rates○ differences in inflation rates○ relative investment prospects

0.60

0.80

1.00

1.20

1.40

1.60

1.80

0

€ / £

S1

D1

S2

D2

Q of £

Floating exchange rates: movement to a new equilibrium

Exchange Rates

The rate of exchangeindividual rates of exchangeexchange rate index

Determination of exchange ratesthe equilibrium exchange rateappreciation and depreciationshifts in currency demand and supply

○ differences in interest rates○ differences in inflation rates○ relative investment prospects○ change in aggregate demand

0.60

0.80

1.00

1.20

1.40

1.60

1.80

0

€ / £

S1

D1

S2

D2

Q of £

Floating exchange rates: movement to a new equilibrium

Exchange Rates

The rate of exchangeindividual rates of exchangeexchange rate index

Determination of exchange ratesthe equilibrium exchange rateappreciation and depreciationshifts in currency demand and supply

○ differences in interest rates○ differences in inflation rates○ relative investment prospects○ change in aggregate demand○ speculation

0.60

0.80

1.00

1.20

1.40

1.60

1.80

0

€ / £

S1

D1

S2

D2

Q of £

Floating exchange rates: movement to a new equilibrium

Exchange Rates and Balance of Payments

Exchange rates and the balance of payments: no government intervention

a floating exchange rate

○ how rates are determined by dealers

automatic balancing of overall balance of payments

current, capital and financial accounts may not separately balance

Exchange Rates and Balance of Payments Exchange rates and the balance of

payments: government interventionreducing short-term fluctuations

○ using reserves○ borrowing from abroad○ changes in interest rates

maintaining a fixed rate of exchange over the longer term○ deflation / reflation○ supply-side policies○ import controls

Fixed versus Floating Exchange Rates Advantages of fixed exchange rates

certaintyno speculation (if rate is absolutely fixed)prevents 'irresponsible' government policies

Disadvantages of fixed exchange ratesconflicts with other macro objectivesdanger of competitive deflationsproblems of international liquiditydifficulties in adjusting to shocksspeculation

Fixed versus Floating Exchange Rates Advantages of free-floating rates

automatic correctionno problem of international liquidity insulation from external events less constraint on domestic macro policy

Disadvantages of free-floating ratespossibly unstable exchange ratesspeculationuncertainty for business

○ but use of forward markets lack of discipline on economy

$ / £

$1.00

$1.20

$1.40

$1.60

$1.80

$2.00

$2.20

$2.40

1976 1978 1980 1982 1984 1986 1988 1990 1992 1994 1996 1998 2000 2002

70

80

90

100

110

120

130

140

150

$ / £ exchange rate and £ exchange rate index: 1976-2003

$ / £

$1.00

$1.20

$1.40

$1.60

$1.80

$2.00

$2.20

$2.40

1976 1978 1980 1982 1984 1986 1988 1990 1992 1994 1996 1998 2000 2002

70

80

90

100

110

120

130

140

150

$ / £ exchange rate and £ exchange rate index: 1976-2003

$ / £ exchange rate and £ exchange rate index: 1976-2003

$ / £Index

1990=100

$1.00

$1.20

$1.40

$1.60

$1.80

$2.00

$2.20

$2.40

1976 1978 1980 1982 1984 1986 1988 1990 1992 1994 1996 1998 2000 2002

70

80

90

100

110

120

130

140

150

$ / £ exchange rate and £ exchange rate index: 1976-2003

$ / £Index

1990=100

$1.00

$1.20

$1.40

$1.60

$1.80

$2.00

$2.20

$2.40

1976 1978 1980 1982 1984 1986 1988 1990 1992 1994 1996 1998 2000 2002

70

80

90

100

110

120

130

140

150

The Origins of the Euro Post-war regulation of exchange rates

the Bretton Woods systemits collapse in the early 1970sdirty floating

The ERMfeatures of the ERMthe 1980scrisis in the ERM

○ events of 1992○ events of 1993

a return of calm

Globalisation and the Problem of Instability

Interdependence through trade

international effects of changes in aggregate demand

vulnerability of open economies

Financial interdependence

size of international financial flows

international effects of changes in interest rates

Globalisation and the Problem of Instability

The need for policy co-ordinationthe search for policy co-ordination

○ G7/G8 meetings: attempts at harmonisation

○ but lack of convergence

Difficulties in achieving harmonisationdifferences in budget deficits and debt

interest rate divergence

different internal structures of economies

politicians more concerned with domestic issues

Debt and Developing Countries The debt problem

Debt ratios: average of all developing countriesDebt ratios: average of all developing countries

Debt ratios: average of all developing countriesDebt ratios: average of all developing countries

Debt ratios: average of all developing countriesDebt ratios: average of all developing countries

Debt and Developing Countries Origins of the debt problem

borrowing to finance developmentthe 1973/4 oil shockthe 1979/80 oil shock

○ world recession fall in export earnings○ fall in commodity prices (exports)○ high interest rates cost of servicing debt

Rescheduling debtrescheduling official loansrescheduling commercial bank loans

Debt and Developing Countries Dealing with debt

structural reformsIMF structural adjustment programmes

○ tight fiscal policies to reduce budget deficits○ privatisation and market liberalisation○ open trade policy○ hardship from IMF programmes

debt forgiveness○ HIPC initiative

successes / failures to date

○ pressure to cancel debts