Balance of Payments and Exchange Rates
The meaning of balance of payments
The balance of payments refers to the systematic recording of income and payments between residents and non-residents of an economy due to various economic transactions.
Balance of payments is an economic concept.
The balance of payments reflects all international economic transactions recorded in monetary quantities. Buying and selling of goods and services, barter, exchange between financial assets, gratuitous transfer of individual products and services, gratuitous transfer of individual financial assets.
The balance of payments records economic transactions between residents and nonresidents. Resident is an economic concept, including natural persons and legal persons. It takes the place of residence as the standard and includes four categories: personal income, government), non-profit organizations and enterprises. According to the International Monetary Fund (IMF) definition of balance of payments, natural person residents refer to those individuals who have lived in the country for more than one year . Therefore, citizens of other countries may also be considered residents of the country if they have been engaged in production and consumption in the country for a long time. Legal person residents refer to all levels of government agencies, enterprises and non-profit groups engaged in economic activities in the country, but international organizations, such as the United Nations, IMF and other organizations, are non-residents of any country.
International Economic Relations Reflected by the Balance of Payments
trade in goods and services
There is a wide range of trade in goods and services between countries or regions, including both export and import, collectively referred to as international trade.
Capital flow
There are two routes for capital inflows. Indirect investment behavior through the purchase of domestic asset inflows. Inflow through investment and establishment of factories, direct investment (foreign direct investment). The inflow of capital is the import of goods and services.
Capital outflow: purchasing overseas assets and directly investing and setting up factories abroad. Capital outflows mean exports of goods and services.
Net capital inflow = capital inflow - capital outflow
Net capital outflow = capital outflow - capital inflow
If the net capital inflow is greater than zero, domestic foreign exchange reserves will increase. A net capital inflow of less than zero will reduce foreign exchange reserves.
Exchange Rates and Exchange Rate Regime
exchange rate
The exchange rate refers to the ratio of exchange between two currencies , and can also be regarded as the value of one country's currency against another currency . Specifically, it refers to the ratio or parity between one country's currency and another country's currency, or the price of another country's currency expressed in one country's currency.
nominal exchange rate
The nominal exchange rate is the relative price of the currencies of two countries (or regions), that is, the amount that one currency can be exchanged for another, expressed by e.
Direct price method, the price of foreign currency expressed in the form of domestic currency, also known as payable price method. The domestic currency appreciates, the exchange rate falls, and the exchange rate rise and fall is inversely proportional to the level of the country's external value.
Indirect pricing method, that is, using foreign currency to express the price of domestic currency, also known as receivable pricing method. The value of foreign currency is inversely proportional to the rise and fall of the exchange rate.
real exchange rate
The real exchange rate is the exchange rate adjusted by the price level of the two countries (or regions) to the nominal exchange rate, denoted by ε. Compared with the nominal exchange rate, it can better explain the real purchasing power of a country (or region) currency.
Exchange Rate System
The exchange rate system refers to a series of institutional arrangements or regulations made by the monetary authority of a country (or region) on the basic way of changing the country's exchange rate.
fixed exchange rate system
The fixed exchange rate system is the exchange rate system prevailing under the gold standard system and the Bretton Woods system. This system stipulates that a fixed ratio is maintained between the domestic currency and the currencies of other countries, and exchange rate fluctuations are limited within a certain range.
double peg
On the basis of double pegs, the exchange rates of currencies of various countries against the U.S. dollar generally can only fluctuate within 1% of the exchange rate parity, and the currencies of the member states of the International Monetary Fund must maintain a fixed parity with the U.S. dollar.
A fixed exchange rate system centered on the US dollar or an adjustable pegged exchange rate system.
floating exchange rate system
Floating Exchange Rates System (Floating Exchange Rates System) refers to the exchange rate system that does not stipulate currency parity for the domestic currency and foreign currencies, nor does it regulate the fluctuation range of the exchange rate.
balance of payments
The balance of international payments means that the net balance of payments of a country, that is, the difference between net exports and net capital outflows is zero. That is: net balance of payments = net exports - net capital outflows; or BP = NX - F. Measures a country's transaction payments to all other countries over a specified period of time. The balance of payments is positive if the inflow of its currency is greater than the outflow. Such transactions arise from the current account , financial account or capital account . The balance of payments is considered another economic indicator of a country's relative value , including trade balance , foreign investment and foreign investment.
When exports are greater than imports , the difference is called a surplus ; when net exports are negative, it is called a deficit . Trade balance , also known as net export and trade balance , refers to the difference between the total value of exports and the total value of imports of a country within a certain period of time (such as one year, half a year, one season, one month). For the sake of convenience in economics, it is often replaced by the symbol NX (Net Exports, that is, net exports). When the total value of exports is equal to the total value of imports, it is called a " trade balance ".
NX=X-M
Factors that affect a country's balance of trade are:
1. The price of domestic goods and foreign goods.
2. Exchange rate .
The above formula is called the net export function, where q, γ and n are all parameters. The parameter γ is called the marginal propensity to import , which is the ratio of the change in net exports to the change in income that gave rise to that change.
It can be seen from the above formula that an increase in the exchange rate will increase net exports. However, the extent to which an exchange rate rise or a domestic currency depreciation can increase exports and reduce imports, thereby changing the balance of payments , depends on the elasticity of demand for the country's exports in the world market and the elasticity of demand for imports in the country's domestic market .
Marshall-Lerner condition: If the absolute value of the sum of the two is greater than 1, the depreciation of the domestic currency can improve a country's trade balance
After the depreciation of the domestic currency , the initial situation is often just the opposite. The current account balance will be worse than before. Imports will increase and exports will decrease. After a period of time, trade income will increase. Because the function image of this movement process resembles the letter "J", this change is called "J-curve effect". Since there is a time lag of varying lengths between the depreciation of the local currency and the improvement of the trade balance, it is also called the " time lag effect ".
net capital outflow function
The difference between the amount of capital flowing from the country to foreign countries and the amount of capital flowing from foreign countries to the country is defined as the capital account difference or net capital outflow, expressed in , and expressed in a formula: = capital outflow - capital inflow.
F=F(r)
Assuming that the interest rate level of other countries is fixed, the higher the domestic interest rate, the less capital outflow and more capital inflow, that is, the less net capital outflow; and vice versa. Therefore, the net capital outflow is a decreasing function of the domestic interest rate level, or in other words, r and F have an inverse relationship.
Balance of Payments
The balance of payments is a function of the real exchange rate, domestic income and interest rates, which can be expressed as:
BP=NX(Y,eP/P)-F(r)
When a country's balance of payments is in balance, the balance of payments is equal to zero, That is, BP=0, and the external equilibrium state is reached at this time. If BP>0, it is a surplus or a surplus in the balance of payments; if BP<0, it is a deficit or a deficit in the balance of payments. Because BP=0 when the balance of payments is in balance, that is, NX-F=0, there is NX=F, and the balance of payments function can be obtained:
On the premise that other parameters are fixed, with interest rate as the ordinate and national income as the abscissa, the geometric figure of the balance of payments function is expressed as a curve of the balance of payments .
Derivation of BP curve
The points on the upper left of the BP curve (such as J) describe the net capital outflow of large net exports, that is, NX>F, and there is an imbalance in the balance of payments (surplus); the points on the lower right of the BP curve (such as K ) describes the unbalanced state of net small capital outflow, that is, NX<F, international deficit deficit).
One is when the capital flows completely (σ8), the slope of the BP curve is y/σ0, and the BP curve is a horizontal line. When the interest rate level of a small country is completely consistent with the world interest rate level, the country’s balance of payments is in a state of balance. Capital flows make up for any form of current account Unbalanced, exchange rate changes have no effect on the BP curve.
Second, when the capital does not flow at all (σ=0), the slope of the BP curve is γ/σ→8, and the BP curve is a vertical
line.
Third, when the capital flow is not complete (σ>0), the slope of the BP curve γ/σ>0.
Shift of BP curve
An increase in the overall price level means that the purchasing power of the country's currency will decline. If the overall price level of other countries remains unchanged at this time, that is, the purchasing power of other countries' currencies remains unchanged, the increase in the overall price level will cause the country's real exchange rate to decline (ie e Decrease), which will cause the BP curve to shift to the left; on the contrary, if the overall price level of a country falls, the real exchange rate will rise, which will cause the BP curve to shift to the right.
Mundell-Fleming model
Constant price Mundell-Fleming model
Assumptions
- Assuming that prices are constant in the short run, output in the economy is determined entirely by aggregate demand
- Assume that the demand for money is not only related to income but also negatively related to the real interest rate;
- Assuming that goods and capital can flow freely in the international market, the free flow of capital can eliminate any interest rate difference between domestic and foreign markets.
Mundell-Fleming Model of Price Changes
When the price level falls, lm* moves to the right, and from is*, it moves without being affected by the lower price
A demand-expansionary policy will shift the aggregate demand curve to the right; a demand-contraction policy will shift the aggregate demand curve to the left.
Policy Effects Under a Fixed Exchange Rate System
Fiscal Policy Under Fixed Exchange Rates
Expansionary fiscal policy, in which the exchange rate of the small economy is fixed at the promised level, but the output level is increased.
Contractionary fiscal policy, where the exchange rate of a small economy is fixed at the promised level, but the level of output falls
Monetary Policy at a Fixed Exchange Rate
Monetary policy is often ineffective under a fixed exchange rate system, and both expansionary and contractionary monetary policies are ineffective when capital flows completely.
trade policy
Non-Tariff Barriers to Trade: Quantitative Restrictions, Import Licensing (Institutions and Procedures), Differential Taxes, Import Quotas and Technical Barriers
same as fiscal policy
Policy Effects under the Floating Exchange Rate System
Fiscal policy
Under open conditions, small countries implement expansionary fiscal policies that increase purchasing expenditures or reduce taxes. As a result, exchange rates rise and/or net exports decrease, thereby offsetting the effects of expansionary fiscal policies. Conversely, if a contractionary fiscal policy is implemented, it will lead to a decline in the exchange rate and/or an increase in net exports, thereby offsetting the impact of the contractionary fiscal policy.
Monetary Policy
Expansionary policies increase aggregate demand. Under open conditions, the monetary policy of small countries affects output through changes in the exchange rate
trade policy
Shifting the NX curve to the right shifts the IS* curve to the right because the LM* curve is vertical, the exchange rate rises, and output remains unchanged.
The International Financial Trilemma: The Impossible Trinity
The basic conclusion of the Mundell-Fleming model gives an important corollary - the impossible trinity. The impossible trinity means that it is impossible for an economy to achieve complete capital flow, fixed exchange rate and independent monetary policy at the same time, that is, it is impossible for these three policy objectives to appear in three in one at the same time, and only two of them can appear at a time. The Impossible Trinity Also known as the International Financial Trilemma
It should be noted that the above theory has another premise, that is, small economies under open conditions . If it is a super-large economy, which can affect the operation of the global economy, then the principle of the impossible trinity fails. The reason is simple, this mega-economy has enough power to influence global capital markets, so it affects world interest rates, not the other way around. Therefore, although its monetary policy brings about changes in interest rates, the world interest rates also change accordingly, so net capital inflows are not affected.