Book keeping & balance of payment
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Book keeping & balance of payment

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Book keeping & balance of payment Book keeping & balance of payment Presentation Transcript

  • Balance of payment : Book Keeping The balance of payment is essentially an application of double entry book keeping, since it records both transactions and the money flow associated with those transactions.
  • Balance of payment
    • Definition: balance of payment is a systematic record of all transactions between the residents of the country and the rest of the world during a given period.
    • Current Account: Transfer of real income.
    • Capital Account : Transfer of funds without effecting a shift in real income.
  • CURRENT ACCOUNT
    • Export and import of services, income on investments and unilateral payments (gifts, remittances for family maintenance etc.)
    • Current Account Receipts:
    • Export of goods
    • Invisibles: Services, unilateral transfers, investment income
    • Non-Monetary movement of gold.
    • Current Account Payments:
    • Import of goods
    • Invisibles: Services, unilateral transfers, investment income
    • Non-Monetary movement of gold.
    • Current account surplus = X-M (Export-Import)
  • CAPITAL ACCOUNT
    • Capital Account Receipts:
    • Long term inflow of funds
    • Short term inflow of funds
    • b) Capital Account Payments :
    • Long term outflow of funds
    • Short term outflow of funds
  • Balance of Trade
    • Favorable balance of trade(surplus)= export > import
    • Unfavorable balance of trade (deficit) = import > export
  • The basic balance
    • Defined as the sum of the current account balance and the net balance account on long term capital, which were then seen as the most stable elements in the balance of payments.
    • This is one of the indicators of the economy’s position of the country.
  • OFFICIAL SETTLEMENT CONCEPT
    • The official settlement concept is to settle the balance of payment.
    • 1) If the net transfer is negative, i.e. there is an outflow, then the balance of payment is deficit then the monetary authorities may finance a deficit by depleting their reserves of foreign currencies, by borrowing from the IMF, or by borrowing from monetary authorities .
  • The External Wealth Account
    • The external wealth accounts of a country shows the stocks of these assets and liabilities, recorded usually in the end of the calendar year.
    • Assets: BOP reflect changes in the foreign assets held by the country (claims on foreigners)
    • Liabilities: BOP reflect changes in domestic assets held by foreign investors (i.e. liabilities to foreigners)
  • Stock Theory of the Capital Account
    • This theory is based on how rational individuals would distribute their wealth between different assets in order to maximize their utility.
    • Asset holders are depended on
    • Expected return to an asset
    • Uncertainty of the actual return
    • Expected Return of an asset depends on,
    • Interest Rate
    • Expected profit
  • RATE OF INTEREST AND INVESTMENT DEMAND
    • INVESTMENT DEMAND CURVE
    • I curve is MEC
    • I1,i2,i3 = rate of interest
    • So, when i1 is rate of interest, Ia is Investment
    • When it falls to i3, investment increases to Ic.
    INVESTMENT I MEC & RATE OF INTEREST Ia Ib Ic i1 i2 i3 o
  • RATE OF INTEREST AND INVESTMENT DEMAND
    • Investment demand curve shifts when the marginal efficiency of capital or profit expectations differ.
    • SHIFTS IN INVESTMENT DEMAND CURVE
    INVESTMENT RATE OF INTEREST & MEC O I’’ I I’ I’’ I I’ r
  • Optimum Portfolio Stock Models
    • Suppose, two interest bearing assets are available for investors, each with same expected yield a1=a2=a but with different yield variances.
    • Assumptions: a1 is less risky than a2 and the correlation between the yields offered by the two assets is p.
    • Let the proportion of wealth of investor holds in a1 is ¶ and his total wealth is 1.
    • Since, the two assets have the same expected yield, the investor will enjoy that expected yield no matter what the value of ¶
    • Assumption : p is negatively correlated then the gain from diversifying the portfolio is greater. In this case he would hold the combination of assets rather than money, which has zero yield.
    • Assumption: p is positive then the gain in risk reduction from diversification is reduced. The investor will choose to put all his wealth in the low risk asset, if the correlation between the two yields of the two assets is greater than 4times.
  • IS-LM CURVE INCOME/GDP INTEREST RATE
    • LM- IS THE LIQUIDITY PREFERENCE CURVE
    • includes-transaction money, precautionary and speculative money
    • the independent variable is income and the dependent variable is the interest rate
    • IS curve-Investment supply curve
    • Depends on, independent variable is the interest rate and the dependent variable is the level of income
  • Mundell-Fleming Model (ISLM-BP Model) The Balance of Payments
    • Policy Analysis with Partial Capital Mobility
    • Currency Crises
    • International Capital Flows & Indebtedness
  • Policy Analysis with the BP Curve
    • The intersection of the IS-LM curves
    • establishes internal equilibrium.
    • The BP curve establishes external equilibrium.
    • If joint internal and external equilibrium does
    • not exist, then either:
    • The currency must appreciate or depreciate, or
    • The central bank must intervene to stabilize the
  • The slope of the BP line indicates the
    • Degree of capital mobility in a country
    • Horizontal: perfect capital mobility
    • Domestic Rate of Interest = World R
    • Vertical: complete capital immobility
    • Domestic R completely independent of world R
    • Upward sloping: partial capital mobility
    • Domestic R differs from the world R
  • Policy Analysis with Perfect Capital Mobility
    • Expansionary fiscal policy, fixed exchange rates
    • IS curve shifts right, Y and R increase.
    • Higher R increases foreign capital inflow.
    • Creates BP surplus and upward pressure on currency.
    • Central bank intervenes in the foreign exchange market.
    • Buys excess foreign currency.
    • Increases foreign exchange reserves.
    • Sells domestic currency.
    • Increases the domestic money supply.
    • That is, non-sterilized intervention.
    • LM curve shifts right, Y increases, R decreases to its original level.
    • Result is much higher Y and constant R.
  • Mundell-Fleming Model (ISLM-BP Model) Perfect capital mobility National Income Rate Of INTEREST An increase in government spending forces the monetary authority to supply the market with local currency to keep the exchange rate unchanged. Shown here is the case of perfect capital mobility, in which the BoP curve (or, as denoted here, the FE curve) is horizontal
  • Mundell-Fleming Model (ISLM-BP Model) complete capital immobility RATE OF INTEREST & MEC O Y’’ Y’ BP’’ BP’ LM’’ IS’’ IS’ LM’ National Income In case of monetary expansion, LM’’ SHIFT TO LM’ then new equilibrium will form at intersection of LM’ and IS’’. Then BOP deficit, hence IS’’ shifts to IS’ With floating exchange rate, both IS and BP will shift to the right. Hence new equilibrium at E2 and rate of Interest also falls. The level of output increases to Y’ E2 E1
  • Policy Analysis with Partial Capital Mobility
    • Expansionary fiscal policy, fixed exchange rates
    • IS curve shifts right, Y and R increase.
    • Higher R increases foreign capital inflow.
    • Creates BP surplus and upward pressure on currency.
    • Central bank intervenes in the foreign exchange market.
    • Buys excess foreign currency.
    • Increases foreign exchange reserves.
    • Sells domestic currency.
    • Increases the domestic money supply.
    • That is, non-sterilized intervention.
    • LM curve shifts right, Y increases, R decreases to its original level.
    • Result is higher Y and R.
  • Mundell-Fleming Model (ISLM-BP Model) Partial capital mobility RATE OF INTEREST & MEC O Y BP IS LM National Income E
  • Determination of Exchange Rate
    • PPP- Purchasing Power Parity.
    • ER = Er x Pd/Pf,
    • Where, ER= equilibrium exchange rate
    • Er= exchange rate in the reference period.
    • Pd= domestic price index
    • Pf= foreign country’s price index.
  • Determination of exchange rate
    • International Fisher effect (IFE)
    • The country with higher nominal interest rate should have higher inflation and hence that country’s currency will weaken in future.
    • Nominal interest rate= real interest rate + inflation
  • Dornbusch Sticky Price
    • Dornbusch model is a an hybrid: short-run features as the Mundell-Fleming model and long-run features as in the Monetary Model.
    • Sticky price model: prices are fixed in the short run and they adjust slowly towards the long run equilibrium