Lecture Notes

Current Account -Records transactions arising from trade in goods and services -consists of: - trade account : Payments and receipts arising from import and export of goods and services - Capital-service account (investment income) : Payment and receipts from income on assets (e.g. interest and dividends) Capital Account -Records international transactions in assets (bonds, shares, real estate) -ie. net change in national owner ship of assets -consists of: - Foreign direct investment - Portfolio investment - Other investment - Reserve account Current Account: CA = NX GDP = C + I + G + NX = C + S + T CA = S+ (T-G) - I VARIABLES THAT AFFECT S/D in FX MARKET 1) FX rate - increase value of dollar ( increase imports, decrease exports) -> BOP deficit 2) Income - increase in income -> Buy more, increase imports (M) -> BOP deficit but* -> increase foreign investment -> BOP surplus 3) Interest rates - increase real interest rate -> increase in foreign investment -> BOP surplus 4) Increase in price level - decrease exports -> BOP deficit 5) Relative price change - If stuff we export increases in price relative to our imports -> BOP surplus 6) Expectations - If foreigners expect increase in the value of the dollar -> BOP surplus FISCAL POLICY (reaction ^ G-> ^ AD for g&s -> K-multiplier -> ^ income -> ^ imports -> BOP deficit -> ^ money demand -> ^ interest rates -> ^ capital inflows ....-> BOP surplus Net effect: -> BOP surplus Flexible Fx -> ^ FX -> ^ M v X -> v AD for g&s -> weakens the fiscal policy In a Fixed FX: -> ^ M/S -> ^AD for g&s -> fiscal policy is stronger

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Reaction to Monetary policy: ^ M/S -> Fed buys bonds -> ^ price of bonds -> v Int. rate -> ^ AD for g&s -> k-mult -> ^ income -> ^ Imports -> BOP deficit from v Int. rate -> v capital inflows -> BOP deficit Net effect: -> BOP deficit Flexible FX -> v FX -> v M ^X -> ^ AD for g&s -> Monetary policy is stronger In a Fixed FX: -> v M/S -> v AD for g&s -> weakens the monetary policy but v M/S continues until original increase is offset

Sterilization policy (under fixed fx) BOP deficit -> deplete foreign reserves -> Major drop in FX BOP surplus -> accumulate foreign reserves -> ?? Non interest rate, inflation parity -> based case and new case, ignore that question, quiz is moved the week after

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Current Account -Records transactions arising from trade in goods and services -consists of: - trade account : Payments and receipts arising from import and export of goods and services - Capital-service account (investment income) : Payment and receipts from income on assets (e.g. interest and dividends) Capital Account -Records international transactions in assets (bonds, shares, real estate) -ie. net change in national owner ship of assets -consists of: - Foreign direct investment - Portfolio investment - Other investment - Reserve account Current Account: CA = NX GDP = C + I + G + NX = C + S + T CA = S+ (T-G) - I VARIABLES THAT AFFECT S/D in FX MARKET 1) FX rate - increase value of dollar ( increase imports, decrease exports) -> BOP deficit 2) Income - increase in income -> Buy more, increase imports (M) -> BOP deficit but* -> increase foreign investment -> BOP surplus 3) Interest rates - increase real interest rate -> increase in foreign investment -> BOP surplus 4) Increase in price level - decrease exports -> BOP deficit 5) Relative price change - If stuff we export increases in price relative to our imports -> BOP surplus 6) Expectations - If foreigners expect increase in the value of the dollar -> BOP surplus FISCAL POLICY (reaction ^ G-> ^ AD for g&s -> K-multiplier -> ^ income -> ^ imports -> BOP deficit -> ^ money demand -> ^ interest rates -> ^ capital inflows ....-> BOP surplus Net effect: -> BOP surplus Flexible Fx -> ^ FX -> ^ M v X -> v AD for g&s -> weakens the fiscal policy In a Fixed FX: -> ^ M/S -> ^AD for g&s -> fiscal policy is stronger

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