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Slides developed by Jeff Madura, with additions and enhancements by Tim Richardson
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Chapter 2

Balance of Payments page 39

✦ The Current Account
✦ The Capital Account

Exchange Rate
IMF and the World Bank

Slides developed by Jeff Madura, with additions and enhancements by Tim Richardson
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✦“A measurement of all

transactions between
domestic and foreign
residents over a period of
time” Madura page 39

Slides developed by Jeff Madura, with additions and enhancements by Tim Richardson
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Balance of Payments
Measure of all transactions between
domestic and foreign residents
◆ Current account
– balance of goods and services
✦ net trade + interest and dividend payments
– unilateral transfers exports

imports

Slides developed by Jeff Madura, with additions and enhancements by Tim Richardson
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✦ BOP accounts provide a system for documenting

economic transactions during a given period
between 2 countries

✦A BOP statement documents a country’s past

economic transactions with other countries
• - like a “national” chequing account balance book

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✦2 basic concepts

✦ 1. The statement is made up of balances,

which show either surplus or deficit

✦ 2. The total statement must be a balance

Slides developed by Jeff Madura, with additions and enhancements by Tim Richardson
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Statements are in 4 major Sections

◆ 1. The Current Account
- imports and exports of goods and services
◆ 2. The Capital Account
- investments and loans
◆ 3. Errors and Omissions
◆ 4. The Official Reserve Account
- changes in response to the surpluses or deficits in the Current
and Capital Account

page 85 & 86 in text

Slides developed by Jeff Madura, with additions and enhancements by Tim Richardson
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◆ Explanation of Balances
5 categories

1. Balance of Trade
- imports and exports of JUST goods
2. Balance of Goods and Services
3. Current Account
- goods & services + short term capital transfers
4. Basic Balance
- goods & services + long term capital transfers
5. The Official Settlements Account
- changes in response to the surpluses or deficits in the
Current and Capital Account

Slides developed by Jeff Madura, with additions and enhancements by Tim Richardson
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Careful analysis of a Country’s BOP

statements should be made before considering
doing business in the country.

This information can help you evaluate risk.

Slides developed by Jeff Madura, with additions and enhancements by Tim Richardson
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Balance of Payments
Trends in Trade
◆ NAFTA:
– free trade block of US, Canada and Mexico
◆ European trade
– Single European Act
✦ increased intra-european trade
– eastern european trade changes
✦ importing larger amounts of goods and services
◆ Trade agreements around the world
Slides developed by Jeff Madura, with additions and enhancements by Tim Richardson
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Balance of Payments
Trends in Trade
◆ GATT trade agreement
– 117 countries agreed to lower tariffs
– trade barriers slowly eliminated until year 2000
◆ European capital flow
– much capital shifting to eastern Europe
– German reunification
✦ redirection of funds increased US interest rates

Slides developed by Jeff Madura, with additions and enhancements by Tim Richardson
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Factors affecting Current

Account
◆ 1. Inflation
– higher rates relative to other countries affects
trade
✦ increased imports and decreased exports
◆ 2. National income
– increases (decreases) relative to other countries
✦ current account decreases (increases)
✦ greater wealth implies greater need for foreign goods

Slides developed by Jeff Madura, with additions and enhancements by Tim Richardson
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Factors affecting Current

Account
◆ 3. Government restrictions
– tariff (tax on imported goods)
✦ increases prices & lowers demand on imported
goods
✦ increases current account of the country

✦ US tariffs on apparel and farm products

✦ tariffs imposed in different countries on a case of

imported beer:
– US: $0.1235, Europe: $2.93, China: $14.64

Slides developed by Jeff Madura, with additions and enhancements by Tim Richardson
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Factors affecting Current

Account
◆ 4. Exchange rates
– a currency valued in terms of another currency
– increase in exchange rate suggests decrease in
current account
✦ exported goods would cost more, thus decreasing
demand for the good
✦ assumes price-elastic goods (sensitive to price

changes)

Slides developed by Jeff Madura, with additions and enhancements by Tim Richardson
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History
Currency value used to be based on stock of gold
the government held in central bank.
This was the Fixed Exchange Rate System
Problems developed when money was printed,
and not backed by gold
In 1976 the world changed to a
Floating Exchange Rate System

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Floating Exchange Rate System

◆ this system determines the value of a currency according to the
demand for it, and the supply on the international 4X markets
✦ clean float - no government intervention
✦ dirty float - government intervention

◆ current system is managed rates, not exactly free floating

◆ small economies tie their rate to major trading partners
◆ ie. Hong Kong dollar used to be “pegged” at
6 HK$ to 1 US$

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181 countries
- promotes int’l monetary cooperation

MAIN PURPOSES
◆ facilitate the expansion and balanced growth of int’l trade
◆ promote currency exchange stability
◆ establishment of multilateral system of payments
◆ help countries with temporary balance of payments
difficulties

http://www.imf.org/external/np/exr/facts/glance.htm
Slides developed by Jeff Madura, with additions and enhancements by Tim Richardson
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181 countries
- promotes int’l monetary cooperation

MAIN ACTIVITY
◆ Lends money to members who have trouble meeting
financial obligations - BUT, only on the condition
that they undertake economic reforms to eliminate
these difficulties for their own good.

http://www.imf.org/external/np/exr/facts/glance.htm
Slides developed by Jeff Madura, with additions and enhancements by Tim Richardson
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181 countries
- promotes int’l monetary cooperation

Key Duties
◆ CFF - Compensatory Financing Facility
◆ purpose is to reduce the impact of export
instability on country economies

Slides developed by Jeff Madura, with additions and enhancements by Tim Richardson
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Areas of Activity
◆ Surveillance
✦ It appraises its members exchange rate policies

✦ Analyses their general economic situation

◆ Financial assistance to IMF member countries

◆ Technical assistance
✦ re: fiscal and monetary policy

http://www.imf.org/external/np/exr/facts/glance.htm
Slides developed by Jeff Madura, with additions and enhancements by Tim Richardson
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ORIGINS:
Official name: International Bank for Reconstruction and
Development

Founded to help reconstruct European Countries after WW II

http://www.worldbank.org

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Activities:
Today it is involved in development aid for poor countries
Lends money for long-term development projects.
Works with the IMF to resolve debt problems in the Developing
World
Has made mistakes in giving money to corrupt regimes.
Made environmental mistakes ie. Gave money for a highway
through Brazilian jungle.

Slides developed by Jeff Madura, with additions and enhancements by Tim Richardson
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Activities:
In situations where war has ended, the World
Bank acts to facilitate the transition to
sustainable peace after hostilities cease and to
support economic and social development.

Slides developed by Jeff Madura, with additions and enhancements by Tim Richardson
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World Investment Flows

- Portfolio Investment
✦ stocks, bonds, securities, T-bills
- Direct Investment
✦ mfg.plants, warehouses, processing
operations, representative offices

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Why FDI Exits

◆ Land, Resources and some types of business

cannot be relocated
◆ If a company wants access, they have to go there
✦ eg. Mining operations, forest harvesting
◆ If your customer moves overseas, you may follow
to continue to be able to supply
✦ eg. Autoparts companies

Slides developed by Jeff Madura, with additions and enhancements by Tim Richardson
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Why FDI Exits
◆ Some companies set up operations overseas
because manufacturing locally is cheaper than
exporting and paying the shipping costs
◆ Companies also setup mfg. Overseas in low-wage
areas to make products that are then sent back to
customers in the Home Country, or to a 3rd
market
✦ eg. Japanese companies mfg. Electronic goods in
Malaysia, and export to the USA

Slides developed by Jeff Madura, with additions and enhancements by Tim Richardson
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Concerns of the Host Country

◆ Jobs for citizens
◆ Additional taxes
◆ Technology
◆ Attraction to other types of companies
◆ loss of economic control
◆ vulnerability to employment crisis if co.
leaves

Slides developed by Jeff Madura, with additions and enhancements by Tim Richardson