INTERNATIONAL FINANCE IMQF course in International Finance Caves

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INTERNATIONAL FINANCE IMQF course in International Finance Caves, Frankel and Jones (2007) World Trade

INTERNATIONAL FINANCE IMQF course in International Finance Caves, Frankel and Jones (2007) World Trade and Payments, 10 e, Pearson

Introduction USD to GBP FX rate Oil price (USD per barrel)

Introduction USD to GBP FX rate Oil price (USD per barrel)

Introduction • International finance – macroeconomic side of international economics (international macroeconomics) – •

Introduction • International finance – macroeconomic side of international economics (international macroeconomics) – • Strong internationalization (globalization) of the economies in the last 50 years boosts importance of foreign sector – – • Examination of behaviour of monetary variables – quantity of money and various prices measured in currency units (wage rates, price levels, foreign exchange (FX) rates, etc. ) Shift to market-based exchange rate regime (1973), oil prices volatility, integration of developing countries in global economy, EMU, currency crises New developments in macroeconomic theory: rational expectations in financial markets, credible commitment in monetary policy, intertemporal optimization of saving behavior, etc. By inserting foreing sector into analysis, important assumptions get altered – Rigid (or „sticky“) prices and wages; free movement of capital; market-determined exchange rates, etc.

Introduction • Microeconomics – explaining individual-level decisions on use of resources, to maximize utility

Introduction • Microeconomics – explaining individual-level decisions on use of resources, to maximize utility • Macroeconomics – explaining effective use of scarce resources at the macro level, i. e. how economies’ overall levels of employment, production and growth are determined – How can economic policy ensure that production factors are fully employed? – How economy’s capacity to produce changes over time? • International macroeconomics – how interactions between national economies shape macroeconomic activity

Introduction MACROECONOMICS FOCUSED ON FOUR ISSUES • Unemployment – what are the causes and

Introduction MACROECONOMICS FOCUSED ON FOUR ISSUES • Unemployment – what are the causes and remedies? – • Saving – saving/borrowing, economic activity, employment, net wealth – • Intl. macroeconomics: the world saving rate and growth of productive capital Trade imbalances – • Intl. macroeconomics: ensuring full employment in economies open to intl. trade Intl. macroeconomics: trade imbalances redistribute wealth across the countries – this is how econ. policy of one country affects its trading partners Money and price level – barter economy vs. money transactions – Intl. macroeconomics: change in money supply/demand in one country can have a crossborder spillover effects. Stability in money price is important!

Outline of the Course • Topics: – – – Balance of payments accounts (Chapter

Outline of the Course • Topics: – – – Balance of payments accounts (Chapter 15) FX market and trade elasticities (Chapter 16) Monetary Systems (ppt) National income and trade balance (Chapter 17) Spending and the exchange rate in the Keynesian model (Chapter 18) Money supply, price level and the balance of payments (Chapter 19) Developing counties and other small open economies with nontraded goods (Chapter 20) Mundell-Fleming model with partial international capital mobility (Chapter 22) Fiscal and monetary policy under modern financial market conditions (Chapter 23) Crises in emerging markets (Chapter 24. 1 and 24. 2) Supply and inflation (Chapter 26. 1) Expectations, money and determination of FX rate (Chapter 27. 1 and 27. 2)

Lectures, Literature and Examination • Lectures (3+5) • Mandatory readings – • Additional readings:

Lectures, Literature and Examination • Lectures (3+5) • Mandatory readings – • Additional readings: – • Caves, R. , Frankel, J. , and R. Jones, (2007) World Trade and Payments: an Introduction, 10 th edition, Pearson International Edition Krugman, P. R. (2008). International economics: Theory and policy, 10/E. Pearson Education. Examination and grading – – – Written exam – 100 points Clasroom discussion – up to 5 points Homework?

BALANCE OF PAYMENTS ACCOUNTS IMQF course in International Finance Caves, Frankel and Jones (2007)

BALANCE OF PAYMENTS ACCOUNTS IMQF course in International Finance Caves, Frankel and Jones (2007) World Trade and Payments, 10 e, Pearson

Outline: Balance of Payments Accounts • Topics: – Breakdown of accounts – Recording individual

Outline: Balance of Payments Accounts • Topics: – Breakdown of accounts – Recording individual transactions – Double-entry bookkeeping – Balances – Statistical errors REAL SECTOR GOVERNMENT SECTOR FINANCIAL SECTOR FOREIGN SECTOR

Structure of the Economy • Economy consists of four interconnected sectors: – Real sector

Structure of the Economy • Economy consists of four interconnected sectors: – Real sector • production of goods and non-financial services – Financial sector • provision of financial services to other sectors – Government sector • provision of goods and services to individuals and companies – Foreign sector • exports and imports of goods and services, cross-border flows of capital

The Balance of Payments - Breakdown of Accounts • The Balance of Payments (Bo.

The Balance of Payments - Breakdown of Accounts • The Balance of Payments (Bo. P) accounts definition – Statistical record of all economic transactions taking place between its residents and the rest of the world • • Who are residents in Serbia? Three types of accounts within Bo. P: – Current account (CA): record of trade in goods and services and other current transactions (no trade in assets) – Private capital account (KA): record of assets traded among private entities – Official reserve transactions account (ORT): record of trade in assets when at least on one side monetary authority (central bank) is involved

Breakdown of Accounts - Current Account • Current Account (CA) components: – Merchandise balance:

Breakdown of Accounts - Current Account • Current Account (CA) components: – Merchandise balance: account of trade in goods – Services balance: transportation, tourism and business and professional services – Investment income: interest, dividends, etc. • …payment for the capital „working abroad“ (capital itself is recorded under KA) – Unilateral transfers: government grants (foreign aid) and private remittances • They appear under CA, not under KA, because they do not create any obligations in the future

Breakdown of Accounts - Private Capital Account • Private Capital Account, i. e. Capital

Breakdown of Accounts - Private Capital Account • Private Capital Account, i. e. Capital Account (KA) components: – Foreign direct investments (FDI) • • When resident of one country acquire control over a business enterprise in another country (e. g. acquisition of more than 10% of shares within 1 year timeline)…otherwise, it is recorded under portfolio investments Greenfield vs brownfield – Long-term portfolio investments: • International transactions in financial assets with maturity greater than 1 year (securities, bank loans, etc. ) – Short-term capital flows • International transactions in financial assets with maturity of less than 1 year (treasury bills, commercial papers, certificates of deposits, etc. )

Breakdown of Accounts - Official Reserve Transactions • Official Reserve Transactions (ORT) components: –

Breakdown of Accounts - Official Reserve Transactions • Official Reserve Transactions (ORT) components: – Changes in foreign central bank’s holdings of domestic assets – Changes in the domestic central bank’s holdings of foreign assets (gold, IMF credits and SDR, FX reserves)

Breakdown of Accounts CURRENT ACCOUNT (CA) Merchandise Services - transportation - tourism - business

Breakdown of Accounts CURRENT ACCOUNT (CA) Merchandise Services - transportation - tourism - business and professional services Investment income Unilateral transfers - government grants - private remittances PRIVATE CAPITAL ACCOUNT (KA) Direct investment Portfolio investment - long term - short term OFFICIAL RESERVE TRANSACTIONS (ORT) Change in foreign CB holding of domestic assets Change in domestic CB holding of foreign assets - gold - IMF credit and SDRs - FX reserves Cumulative balance …Merchandise balance …Balance of goods and services …Balance of goods, services and income …Current account balance …Basic balance …Overall Balance of Payment

Recording Individual Transactions • Key principle: whatever enters the country is recorded as debit

Recording Individual Transactions • Key principle: whatever enters the country is recorded as debit (e. g. import), and whatever leaves the country is recorded as credit (e. g. export) – • Gifts and other transfers recorded under unilateral transfers – • How do we record in Serbia IT services, provided by Serbian IT company to the US-based electric power company? Remittances paid by Serbian migrants living in Austria to their relatives in Serbia: debit in Austria, credit in Serbia KA and ORT: acquisition of foreign assets – debit („import of assets from abroad“) and vice versa – – – Direct investment made by Serbian company in B&H (debit in Serbia) Investment of Scottish bank in Serbia’s T-bills (credit in Serbia) When the National Bank of Serbia buys Euro, as a reserve asset (debit in Serbia)

Double-entry Bookkeeping • Every transaction booked twice - debit and credit, because otherwise the

Double-entry Bookkeeping • Every transaction booked twice - debit and credit, because otherwise the Bo. P would imply that someone is giving up something for nothing – • Paying for imports (e. g. import of gas in Serbia from Russia) – – • Is there such case? Debit: balance of goods, in Serbia Credit: short-term capital account, in Serbia (regardless if payment is in cash, bank cheque, or loan) Paying for asset purchases (e. g. German company buys a hotel in Serbia) – – Debit: banking flows in Serbia Credit: direct investment

The Balances • Net flows usually matter more than gross flows • Positive balance:

The Balances • Net flows usually matter more than gross flows • Positive balance: when credit outweights debit – e. g. positive trade balance – the country exports more than it imports -- Mercantilistic semantic • Negative balance: when debit outweights credit • The adding-up constraint: • If country is running CA deficit and its ORT=0, than KA = -CA • If KA=0, than ORT=-CA

The Balances • BP reveals whether the country is spending beyond its means and

The Balances • BP reveals whether the country is spending beyond its means and whethere is net supply of foreign currency or net demand for domestic currency – – • Negative Balance of trade in goods and services (deficit) can be financed either by: – – – • investment income and transfers borrowings and investments (KA) or reserve loss (ORT) Negative CA balance (deficit) can be financed either by investments/borrowings (KA) or by reserve loss (ORT) – • If BP is positive, the ORT is negative, i. e. the central bank is adding on its FX reserves If BP is negative, the ORT is positive, i. e. the central bank is selling FX reserves CA is autonomous, while KA and ORT are accomodating Negative Bo. P (deficit) can be financed by reserve loss (ORT) – BP is autonomous, while ORT is accomodating

The Balances • Balance of goods and services is the point of connection between

The Balances • Balance of goods and services is the point of connection between the international payment statistics and national income accounts • Balance of goods and services (X-M) is part of GDP • Balance of goods, services and income – • Net exports of goods and services + net investment income Current account balance – Net exports of goods and services + net investment income + net transfers Bo. P National accounts Balance of goods and services Gross domestic product Balance of goods, services and income Gross national product Current account balance Total national income

Accommodating Transactions? • Traditional view: autonomous transactions (above the line) cause change in accommodating

Accommodating Transactions? • Traditional view: autonomous transactions (above the line) cause change in accommodating transaction – CA and KA alter the ORT • Modern view: as the exchange rate is floating (e. g. managed floating FX regime), can the change in ORT affect the CA? – – If a country is running short on reserves, will it reduce its import? If a country is running large KA surplus, will it be more prone to import? • Case of Yugoslavia in early 1980 s

Statistical Errors • Statistics does not observe directly debit and credit side of the

Statistical Errors • Statistics does not observe directly debit and credit side of the transactions – some transactions are valued incorrectly or one side of transaction is ommitted • Therefore, if debit does not equal credit, the difference between the sum of debit and the sum of credit is called „statistical discrepancy“ or „errors and ommissions“ – e. g. unmeasured net inflow of money (capital flights going informally) – What should be the World total sum of the current account balances?

EU: CA Statistics

EU: CA Statistics

Problem 1 (pp. 288) Transaction US imports BMW from Germany; pays by check US

Problem 1 (pp. 288) Transaction US imports BMW from Germany; pays by check US tourists spend Swiss francs in Geneva US investor buys 2 -year Canadian treasury note; pays by check China buys nuclear reactor from US; pays in gold (no CB involved) Dutch holding company buys controlling interest in an Americal firm; pays in dollars Debit Credit Effect on CA Effect on Bo. P