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Internatonal economics
Week 4
Balance of payments:
• current account = accounts for flows of goods and services
• financial account = accounts for flows of financial assets
• capital account = flows of special categories of assets (capital)
• errors and emisions
• official reserves
Balance of payments = detailed record of all the countries payments
to and its receipt from foreigners -> international transaction involves
2 parties and each transaction enters the account twice: credit and
debit
Current account + financial account + (capital account) = 0
So when the current account is negative, financial account should
be positive, because both add up to 0
Current account
The sub accounts are:
1. Merchandise (goods) account: imports and exports:
1b. Services account: imports and exports
2. primary income: interest and dividend payments, earning of firms
and workers operating in forgeign countries
3. secondary income: gifts across countries (development aid)
National income identify for an open economy is
Current
~
Y = C + I + G + EX - IM
Expenditure by Net expenditure by
account
domestic individuals foreign individuals
When a country exports more than it imports, it earns more
income from export than it spends on imports -> net foreign
wealth is increasing
,When a country exports less than it imports, it earns less income from
exports than it spends on imports -> net foreign wealth is decreasing
National savings (S) = national income that is not spent on consumption
(C) or government purchases (G)
S = Sp + Sg Sp = private savings
Sp= Y - C - T Sg = government savings
Sg = T - G
S = (Y - C - T) + (T - G) Y = income
S=Y+C+G T = taxes
CA = EX - IM = Y - (C + I + G)
CA = ( Y - C - G) - I
CA = S - I
Countries CA deficit: I > S
Closed economy: CA = 0 -> S = I Countries CA surplus: S > I
CA = national saving - investment
CA = net foreign investment
a country that exports more than it imports has high national savings
relative to investment
Financial account
= the difference between sales of domestic assets to foreigners and
purchases of foreign assets by domestic citizens
1. financial inlow
> foreigners lend to domestic citizens by buying domestic assets
> domestic assets sold to foreigners are credit
2. Financial outflow
> domestic citizens lend to foreigners by buying foreign assets
> foreign assets purchases by domestic citizens are a debit
Subbacounts:
> Foreign direct investment (FDI) -> acquire control of the firms
management, are long term investments
> Portfolio investments -> acquire a reasonable return given the risk
involved. Stocks and bonds, goal is to make financial return, short term.
>other financial flows
, > other financial flows -> bank loans etc
Official reserves
foreign assets held by central banks to
cushion against financial instability
- assets include government bonds, currency etc
- Official reserve assets sold by the own central bank are credit
- Official reverse assets purchased bu the domestic central bank
are debit
- Intervention on the currency market: is to get control of the
currency
Erros and omissions
there was cash outflow but the purpose of the outflow wasn't
clear (they didn't know for what) -> so in order to keep the current
account account balanced with the capital and financial account,
they add it.
Receipts -> Payments -> money
money flowing flowing out of a
in a country Balance of payments country
- Credit (+) Debit (-)
-
Exports Imports
Decrease net foreign Increase net foreign
wealth (assets) wealth (assets)
Decrease in official Increase in official
reserves reserves
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