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  3. Lecture International finance: An analytical approach (3/e): Chapter 3 - Imad A. Moosa

Lecture International finance: An analytical approach (3/e): Chapter 3 - Imad A. Moosa

Chapter 3 - The balance of payments and the effective exchange rate. The objectives of this chapter are: The objectives of this chapter are: To define the balance of payments, to examine the australian balance of payments statistics, to illustrate the relation between the balance of payments and the foreign exchange market,... Chapter 3 The Balance of Payments and the Effective Exchange Rate Objectives • To study the structure of the balance of payments • To illustrate how the BOP is related to

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  1. Chapter 3 The Balance of Payments and the Effective Exchange Rate
  2. Objectives • To study the structure of the balance of payments • To illustrate how the BOP is related to the FX market • To introduce the concept of the effective exchange rate Copyright 2010 McGraw-Hill Australia Pty Ltd PPTs t/a International Finance: An Analytical Approach 3e by Imad A. Moosa Slides prepared by Afaf Moosa 3-2
  3. Definition • The balance of payments (BOP) is a systematic record of all economic transactions between the residents of the reporting country and the rest of the world over a specified period of time. Copyright 2010 McGraw-Hill Australia Pty Ltd PPTs t/a International Finance: An Analytical Approach 3e by Imad A. Moosa Slides prepared by Afaf Moosa 3-3
  4. Important elements in the definition • Rest of the world • Economic transactions • Resident • Flows versus stocks Copyright 2010 McGraw-Hill Australia Pty Ltd PPTs t/a International Finance: An Analytical Approach 3e by Imad A. Moosa Slides prepared by Afaf Moosa 3-4
  5. Important elements in the definition (cont.) • The BOP records changes in assets and liabilities • Figures may or may not be seasonably adjusted Copyright 2010 McGraw-Hill Australia Pty Ltd PPTs t/a International Finance: An Analytical Approach 3e by Imad A. Moosa Slides prepared by Afaf Moosa 3-5
  6. Structure of the BOP • The BOP consists of the current account and the financial account Copyright 2010 McGraw-Hill Australia Pty Ltd PPTs t/a International Finance: An Analytical Approach 3e by Imad A. Moosa Slides prepared by Afaf Moosa 3-6
  7. Components of the current account • Merchandise account (trade balance) • Net services • Current transfers Copyright 2010 McGraw-Hill Australia Pty Ltd PPTs t/a International Finance: An Analytical Approach 3e by Imad A. Moosa Slides prepared by Afaf Moosa 3-7
  8. The financial account • Records official and non-official net financial flows • A balancing item is added to account for errors and omissions Copyright 2010 McGraw-Hill Australia Pty Ltd PPTs t/a International Finance: An Analytical Approach 3e by Imad A. Moosa Slides prepared by Afaf Moosa 3-8
  9. The Australian BOP: Current account (AUD Million) Copyright 2010 McGraw-Hill Australia Pty Ltd PPTs t/a International Finance: An Analytical Approach 3e by Imad A. Moosa Slides prepared by Afaf Moosa 3-9
  10. The Australian BOP: Financial account (AUD Million) Copyright 2010 McGraw-Hill Australia Pty Ltd PPTs t/a International Finance: An Analytical Approach 3e by Imad A. Moosa Slides prepared by Afaf Moosa 3-10
  11. The Australian BOP: Balancing item (AUD Million) Copyright 2010 McGraw-Hill Australia Pty Ltd PPTs t/a International Finance: An Analytical Approach 3e by Imad A. Moosa Slides prepared by Afaf Moosa 3-11
  12. The BOP and FX market • The BOP is related to the FX market because transactions involving trade and capital flows give rise to the demand for and supply of currencies • The demand for foreign currency is the supply of domestic currency, and vice versa Copyright 2010 McGraw-Hill Australia Pty Ltd PPTs t/a International Finance: An Analytical Approach 3e by Imad A. Moosa Slides prepared by Afaf Moosa 3-12
  13. Derivation of the demand and supply curves • The demand for foreign exchange is equivalent to import expenditure • The demand curve is derived from the supply and demand for imports (cont.) Copyright 2010 McGraw-Hill Australia Pty Ltd PPTs t/a International Finance: An Analytical Approach 3e by Imad A. Moosa Slides prepared by Afaf Moosa 3-13
  14. Derivation of the demand and supply curves (cont.) • The supply of foreign exchange is equivalent to export revenue. • The supply curve is derived from the supply of and demand for exports. Copyright 2010 McGraw-Hill Australia Pty Ltd PPTs t/a International Finance: An Analytical Approach 3e by Imad A. Moosa Slides prepared by Afaf Moosa 3-14
  15. The demand side equations The following equations are used to derive the demand curve: * Df P Qm m Qm a bPm Pm SPm* Copyright 2010 McGraw-Hill Australia Pty Ltd PPTs t/a International Finance: An Analytical Approach 3e by Imad A. Moosa Slides prepared by Afaf Moosa 3-15
  16. The supply side equations The following equations are used to derive the supply curve: Sf Px* Qx Qx c dPx * Px Px S Copyright 2010 McGraw-Hill Australia Pty Ltd PPTs t/a International Finance: An Analytical Approach 3e by Imad A. Moosa Slides prepared by Afaf Moosa 3-16
  17. The demand for and supply of foreign exchange curves Copyright 2010 McGraw-Hill Australia Pty Ltd PPTs t/a International Finance: An Analytical Approach 3e by Imad A. Moosa Slides prepared by Afaf Moosa 3-17
  18. Factors affecting the current account • Economic growth: A country with a higher growth rate than its trading partners will experience deterioration in the current account. (cont.) Copyright 2010 McGraw-Hill Australia Pty Ltd PPTs t/a International Finance: An Analytical Approach 3e by Imad A. Moosa Slides prepared by Afaf Moosa 3-18
  19. Factors affecting the current account (cont.) • The exchange rate: The effect of the exchange rate depends on the elasticities of demand for exports and imports. * * * B Px Qx PmQm Q m em Pm Q x  e x Px* (cont.) Copyright 2010 McGraw-Hill Australia Pty Ltd PPTs t/a International Finance: An Analytical Approach 3e by Imad A. Moosa Slides prepared by Afaf Moosa 3-19
  20. Factors affecting the current account (cont.) • Inflation: A country that has a higher inflation rate than its trading partners will experience deterioration in the current account. (cont.) Copyright 2010 McGraw-Hill Australia Pty Ltd PPTs t/a International Finance: An Analytical Approach 3e by Imad A. Moosa Slides prepared by Afaf Moosa 3-20
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