Balance of Payments and Exchange Rates

1
Balance of Payments and Exchange Rates
2
The Balance of Payments Account

• Meaning of the balance of payments
• The current account

3
The Balance of Payments Account

• Meaning of the balance of payments
• The current account
• trade in goods

4
UK balance of payments 2001 ( millions)
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The Balance of Payments Account

• Meaning of the balance of payments
• The current account
• trade in goods
• trade in services

6
UK balance of payments 2001 ( millions)
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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

8
UK balance of payments 2001 ( millions)
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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

10
UK balance of payments 2001 ( millions)
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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

12
UK balance of payments 2001 ( millions)
13
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

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UK balance of payments 2001 ( millions)
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Current account balance as ofGDP in selected
countries 19702003
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Current account balance as ofGDP in selected
countries 19702003
UK
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Current account balance as ofGDP in selected
countries 19702003
UK
USA
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Current account balance as ofGDP in selected
countries 19702003
Japan
UK
USA
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The Balance of Payments Account

• The capital account

20
UK balance of payments 2001 ( millions)
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The Balance of Payments Account

• The capital account
• The financial account

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The Balance of Payments Account

• The capital account
• The financial account
• investment

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The Balance of Payments Account

• The capital account
• The financial account
• investment
• direct

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The Balance of Payments Account

• The capital account
• The financial account
• investment
• direct
• portfolio

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UK balance of payments 2001 ( millions)
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The Balance of Payments Account

• The capital account
• The financial account
• investment
• direct
• portfolio
• other financial flows (mainly short term)

27
UK balance of payments 2001 ( millions)
28
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

29
UK balance of payments 2001 ( millions)
30
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
• financial account balance

31
UK balance of payments 2001 ( millions)
32
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
• financial account balance
• Overall balance of payments

33
UK balance of payments 2001 ( millions)
34
UK balance of payments 2001 ( millions)
35
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
• financial account balance
• Overall balance of payments
• Assessing balance of payments figures

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Exchange Rates

• The rate of exchange
• individual rates of exchange
• exchange rate index

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Sterling exchange rates 19802003
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Sterling exchange rates 19802003
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Sterling exchange rates 19802003
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Sterling exchange rates 19802003
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Exchange Rates

• The rate of exchange
• individual rates of exchange
• exchange rate index

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The weights of the currencies of various
countriesin the sterling exchange rate index
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Exchange Rates

• The rate of exchange
• individual rates of exchange
• exchange rate index
• Determination of exchange rates

44
Exchange Rates

• The rate of exchange
• individual rates of exchange
• exchange rate index
• Determination of exchange rates
• the equilibrium exchange rate

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Determination of the rate of exchange
price of
Q of
46
Determination of the rate of exchange
price of
D by USA
Q of
47
Determination of the rate of exchange
S by UK
price of
D by USA
Q of
48
Determination of the rate of exchange
S by UK
price of
D by USA
Q of
49
Exchange Rates

• The rate of exchange
• individual rates of exchange
• exchange rate index
• Determination of exchange rates
• the equilibrium exchange rate
• appreciation and depreciation

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Exchange Rates

• The rate of exchange
• individual rates of exchange
• exchange rate index
• Determination of exchange rates
• the equilibrium exchange rate
• appreciation and depreciation
• shifts in currency demand and supply

51
Floating exchange rates movement to a new
equilibrium
S1
? /
D1
Q of
52
Floating exchange rates movement to a new
equilibrium
S1
S2
? /
D1
Q of
53
Floating exchange rates movement to a new
equilibrium
S1
S2
? /
D1
D2
Q of
54
Exchange Rates

• The rate of exchange
• individual rates of exchange
• exchange rate index
• Determination of exchange rates
• the equilibrium exchange rate
• appreciation and depreciation
• shifts in currency demand and supply
• differences in interest rates

55
Floating exchange rates movement to a new
equilibrium
S1
S2
? /
D1
D2
Q of
56
Exchange Rates

• The rate of exchange
• individual rates of exchange
• exchange rate index
• Determination of exchange rates
• the equilibrium exchange rate
• appreciation and depreciation
• shifts in currency demand and supply
• differences in interest rates
• differences in inflation rates

57
Floating exchange rates movement to a new
equilibrium
S1
S2
? /
D1
D2
Q of
58
Exchange Rates

• The rate of exchange
• individual rates of exchange
• exchange rate index
• Determination of exchange rates
• the equilibrium exchange rate
• appreciation and depreciation
• shifts in currency demand and supply
• differences in interest rates
• differences in inflation rates
• relative investment prospects

59
Floating exchange rates movement to a new
equilibrium
S1
S2
? /
D1
D2
Q of
60
Exchange Rates

• The rate of exchange
• individual rates of exchange
• exchange rate index
• Determination of exchange rates
• the equilibrium exchange rate
• appreciation and depreciation
• shifts in currency demand and supply
• differences in interest rates
• differences in inflation rates
• relative investment prospects
• change in aggregate demand

61
Floating exchange rates movement to a new
equilibrium
S1
S2
? /
D1
D2
Q of
62
Exchange Rates

• The rate of exchange
• individual rates of exchange
• exchange rate index
• Determination of exchange rates
• the equilibrium exchange rate
• appreciation and depreciation
• shifts in currency demand and supply
• differences in interest rates
• differences in inflation rates
• relative investment prospects
• change in aggregate demand
• speculation

63
Floating exchange rates movement to a new
equilibrium
S1
S2
? /
D1
D2
Q of
64
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

65
Exchange Rates and Balance of Payments

• Exchange rates and the balance of payments
  government intervention
• reducing 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

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Fixed versus Floating Exchange Rates

• Advantages of fixed exchange rates
• certainty
• no speculation (if rate is absolutely fixed)
• prevents 'irresponsible' government policies
• Disadvantages of fixed exchange rates
• conflicts with other macro objectives
• danger of competitive deflations
• problems of international liquidity
• difficulties in adjusting to shocks
• speculation

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Fixed versus Floating Exchange Rates

• Advantages of free-floating rates
• automatic correction
• no problem of international liquidity
• insulation from external events
• less constraint on domestic macro policy
• Disadvantages of free-floating rates
• possibly unstable exchange rates
• speculation
• uncertainty for business
• but use of forward markets
• lack of discipline on economy

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/ exchange rate and exchange rate index
1976-2003
/
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/ exchange rate and exchange rate index
1976-2003
/
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/ exchange rate and exchange rate index
1976-2003
Index 1990100
/
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/ exchange rate and exchange rate index
1976-2003
Index 1990100
/
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The Origins of the Euro

• Post-war regulation of exchange rates
• the Bretton Woods system
• its collapse in the early 1970s
• dirty floating
• The ERM
• features of the ERM
• the 1980s
• crisis in the ERM
• events of 1992
• events of 1993
• a return of calm

73
The Origins of the Euro

• The Maastricht Treaty
• the timetable for EMU
• the convergence criteria
• inflation
• interest rates
• budget deficits
• general government debt
• exchange rates
• Birth of the euro
• meeting the convergence criteria
• role of the European Central Bank (ECB)

74
European Economic and Monetary Union

• How desirable is EMU?
• Advantages of a single currency
• eliminating conversion costs
• increased competition and efficiency
• elimination of exchange-rate uncertainty
• increased inward investment
• lower inflation and interest rates
• Disadvantages of EMU
• political arguments
• adjustment to shocks
• problem of asymmetric shocks
• EU12 may not be an optimal currency area
• regional problems

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Fluctuations between the euro and the dollar
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Fluctuations between the euro and the dollar
US interest rate
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Fluctuations between the euro and the dollar
US interest rate
ECB interest rate
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Fluctuations between the euro and the dollar
US interest rate
/ ?
ECB interest rate
/ ?
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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

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Globalisation and the Problem of Instability

• The need for policy co-ordination
• the search for policy co-ordination
• G7/G8 meetings attempts at harmonisation
• but lack of convergence
• Difficulties in achieving harmonisation
• differences in budget deficits and debt
• interest rate divergence
• different internal structures of economies
• politicians more concerned with domestic issues

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Debt and Developing Countries

• The debt problem

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Debt ratios average of all developing countries
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Debt ratios average of all developing countries
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Debt ratios average of all developing countries
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Debt and Developing Countries

• Origins of the debt problem
• borrowing to finance development
• the 1973/4 oil shock
• the 1979/80 oil shock
• world recession ? fall in export earnings
• fall in commodity prices (exports)
• high interest rates ? cost? of servicing debt
• Rescheduling debt
• rescheduling official loans
• rescheduling commercial bank loans

86
Debt and Developing Countries

• Dealing with debt
• structural reforms
• IMF 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