HE2006/206 Internationalmonetar monetaryeconomics LecturesandTutorials1to6

AssocProf fJoseph hD.ALBA Office:HSS0479Tel:67906234 Email:ajoalba@ntu.edu.sg ajoalba@ntu edu sg OfficeHours:Weds.,10am11:30am.Pleaseemailme toletmeknowyouarecoming.Youmayalsoemailme foranappointmentifyoucannotmakeitWednesday morning. Youmayalsoconsultmeafterclass, class 5:30pmoutside LT19A Pleasecontinuouslycheckthecoursewebsiteat EdveNTUreforannouncements.

1 of49

HE2006/206InternationalMonetary Economics
Youcanfindthelecturenotesandassignedquestionsin Ed NTU L EdveNTUre. Lecturenoteswill illb beavailable il bl the h day d b before f thelecture. TextisbyKrugman,Obstfeld andMelitz for9th edition, InternationalEdition.(Oldereditionsmaybeusedbut pleasecheckthecorrectquestionnumberstobediscussed duringtutorials)

2 of49

CourseMarksforfirsthalfofthe semester
Forpart1 1,quiz1willaccountfor10%ofyour mark.Quizoneistentativelyscheduledduring Tutorial6

3 of49

CourseMarksforfirsthalfofthe semester
Classparticipationinthefirstsixweekswillbe10% ofy yourcoursemark.
Participationduringlectures/tutorialswillbewith clickers
Please l inform f mein i person if fyouforget f orhave h problems/issueswithyourclickersduringthebreak orright after alectureortutorialeitherinoroutsidethelecturehall. InformationgivenafterIleavethevicinityofLT19Awillnotbe entertained. Pleasetrytheassignedproblemsets.Youmayworkingroups orconsultyourseatmatesfortheanswers. answers Youwillbeasked questionsbeforeIdiscussthesuggestedanswerstothe questions.

Youmaybeexcusedifyouhaveamedicalcertificate (MC)officiallysubmittedtotheschool.
4 of49

Feedbackandclickers
PleasegivemefeedbackrightawaysoIcan makethenecessaryadjustmentsduringthe lectures/tutorials. Togetorexchangeyourclickers,pleasegoto BlockN2.1,Basement1 (http://clickers.ntu.edu.sg/) Pleasehelpmechecktoensureyourclickers work. Tosetyourclickers,pleasepressCh__Ch
5 of49

Whatisyouryearofstudy?Iamin
1. Year2 1 2. Year3 3. Year4

0%
1

0%
2

0%
3

MakeupclassforChineseNY,25Jan, Wed. d What h isyourpreferred f dtime?

1. 1730to2030hrs; 1 2. 1830to2130hrs

0%
1

0%
2

Lecture1: Chapter h 13

NationalIncome Accountingand d theBalance ofPayments

Chapter14 Thebasicsof exchangerates Exchangeratesand thepricesofgoods
Copyright 2012 Pearson Addison-Wesley. All rights reserved.

Preview
Review:Nationalincomeaccounts
measuresofnationalincome( (earnedby ythenationsfactorsof production,e.g.,labor,capital,land) measuresofvalueofproduction(GNPorGDP),representedasY GNI=GNP depreciation+unilateraltransfers Inmacro,weusethecircularflowdiagramtoillustratetheassumption thatproduction=income=Y measuresofvalueofexpenditure(C, (C I, I G, G EX IM)

Nationalsaving,investment,andthecurrentaccount Balance B l of fpaymentsaccounts Review:ExchangeRateandPrices

GNP=ExpenditureonaCountrys Goods d and dServices

Thenationalincomeidentityforanopen economyis Y =C+I+G+EX IM =C+I+G+CA
Expenditure by domestic individuals and institutions Net expenditure by foreign individuals and institutions

1310

Expenditure p andProductioninanOpen p Economy y

CA = EX IM = Y (C + I + G )
Whenproduction>domesticexpenditure,exports>imports:current account>0andtradebalance>0
whenacountryexportsmorethanitimports, imports itearnsmoreincomefrom exportsthanitspendsonimports netforeignwealthisincreasing

Whenproduction<domesticexpenditure,exports<imports:current account<0andtradebalance<0
whenacountryexportslessthanitimports,itearnslessincomefromexports thanitspendsonimports netforeignwealthisdecreasing

1311

SavingandtheCurrentAccount
Nationalsaving g(S)=nationalincome(Y)thatisnotspent p on consumption(C)orgovernmentpurchases(G). S=Y C G S=(Y C T) +(T G) S=Sp +Sg

1312

HowIstheCurrentAccountRelatedtoNationalSaving? g

CA =Y (C +I +G) =(Y C G) I =S I
currentaccount =nationalsaving investment currentaccount= netforeigninvestment

Aco country ntr thatimportsmorethanitexports e ports haslownationalsavingrelativetoinvestment.

1313

HowIstheCurrentAccountRelatedtoNationalSaving? ( t) (cont.)

CA =S Ior I =S CA
Countriescanfinanceinvestmenteitherbysavingorby acquiringforeignfundsequaltothecurrentaccountdeficit. deficit
acurrentaccountdeficitimpliesafinancialassetinflowornegative netforeign g investment.

WhenS>I,thenCA>0sothatnetforeigninvestmentand p outflowsforthedomesticeconomy yare financialcapital positive.

1314

HowIstheCurrentAccountRelatedtoNationalSaving? ( t) (cont.)

CA =Sp +Sg I =Sp governmentdeficit I Governmentdeficitisnegativegovernment saving

equaltoG T

Ahigh g g governmentdeficitcausesa negativecurrentaccountbalancewhenother factorsremainconstant.

1315

Fig.132:U.S.CurrentAccountandNetForeignWealth, 1976 2009 19762009

Source: U.S. Department of Commerce, Bureau of Economic Analysis.

1316

50000

100000

150000

200000

250000

SingaporeCAandnetforeignasset

50000 1976 1 1977 1 1978 1 1979 1 1980 1 1981 1 1982 1 1983 1 1984 1 1985 1 1986 1 1987 1 1988 1 1989 1 1990 1 1991 1 1992 1 1993 1 1994 1 1995 1 1996 1 1997 1 1998 1 1999 1 2000 2 2001 2 2002 2 2003 2 2004 2 2005 2 2006 2 2007 2 2008 2 2009 2 2010 2

SGPNetforeignassets(currentmillionsUS$)

SGPCurrentaccountbalance(currentmillionsUS$)

BalanceofPaymentsAccounts
Acountrys y balanceofp payments y accountsaccounts forits paymentstoanditsreceiptsfromforeigners. Anytransactionresultinginareceiptfromforeignersis enteredascredit(+) Anytransactionresultingtopaymenttoforeignersis enteredasdebit() Aninternationaltransactioninvolvestwoparties,andeach transactionenterstheacco accounts ntstwice: t ice onceasacredit(+)and onceasadebit().

1318

BalanceofPayments y Accounts(cont.) ( )

The eba balance a ceo ofpay payments e tsaccou accounts tsa are esepa separated ated into3broadaccounts:
currentaccount:accountsforflowsofgoodsand services(importsandexports). financialaccount:accountsforflowsoffinancial assets(financialcapital). capitalaccount:flowsofspecialcategoriesofassets ( (capital): l) typically ll nonmarket, k nonproduced, d d or intangibleassetslikedebtforgiveness,copyrightsand trademarks.
1319

Example p ofBalanceofPayments y Accounting g

USresidentimportsafaxmachinefromOlivetti. OlivettidepositsUSresidentscheckinaU.S.bank.

F machine Fax hi (current t account, t U.S. U S good d import i t) $80 Bank deposit (financial account, U.S. asset sale) +$80
1320

Example p ofBalanceofPayments y Accounting g(cont.)

USresidentbuyslunchinFranceandpaysbycreditcard. FrenchrestaurantreceivespaymentfromUSresidents creditcardcompany. M l purchase Meal h (current t account, t U.S. U S service i import i t) $30 Sale of credit card claim (financial account, U.S. asset sale) +$30
1321

Example p ofBalanceofPayments y Accounting g(cont.) ( )

USresidentbuysashareofBP. U S bank. bank BPdepositsthemoneyinaU.S.

Stock purchase (financial account, U.S. asset purchase) $90 Bank deposit (financial account, U.S. asset sale) +$90
1322

Example p ofBalanceofPayments y Accounting g(cont.) ( )

U.S.banksforgivea$50Mdebtowedbythegovernmentof Argentinathroughdebtrestructuring. U.S.bankswhoholdthedebttherebyreducethedebtby creditingArgentina Argentina's sbankaccounts. accounts

Debt forgiveness (capital account, U.S. transfer payment) $50 M Reduction in banks claims (financial account, U.S. asset sale) +$50 M
1323

HowDotheBalanceofPayments y AccountsBalance?
Duetothedoubleentry yofeachtransaction, ,thebalanceof paymentsaccountswillbalancebythefollowingequation: currentaccount+ financialaccount+ capitalaccount=0

1324

BalanceofPaymentsAccounts
The3broadaccountsaremorefinely ydivided: Currentaccount:importsandexports 1. merchandise(g (goodslikeDVDs) ) 2. services(paymentsforlegalservices,shippingservices, touristmeals,etc.) 3. incomereceipts(interestanddividendpayments, earningsoffirmsandworkersoperatinginforeign countries)

1325

BalanceofPayments y Accounts(cont.) ( )
Currentaccount:netunilateraltransfers f gifts(transfers)acrosscountriesthatdonotpurchasea goodorservicenorserveasincomeforgoodsand services i produced d d Capitalaccount:recordsspecialtransfersofassets,butthisis aminoraccountfortheU.S.

1326

BalanceofPayments y Accounts(cont.) ( )
Financialaccount:thedifferencebetweensalesofdomestic assetstoforeignersandpurchasesofforeignassetsby domesticcitizens. Financial Fi i linflow i fl
Foreignersloantodomesticcitizensbybuyingdomesticassets. Domesticassetssoldtoforeignersareacredit(+)becausethedomestic economyacquires i moneyduring d i the h transaction. i

Financialoutflow
Domesticcitizensloantoforeignersbybuyingforeignassets. Foreignassetspurchasedbydomesticcitizensareadebit()becausethe domesticeconomygivesupmoneyduringthetransaction.

1327

BalanceofPayments y Accounts(cont.) ( )
Financialaccount hasatleast3subcategories: g 1. Official(international)reserveassets 2. Allotherassets 3. Statisticaldiscrepancy

1328

BalanceofPayments y Accounts(cont.) ( )
Statisticaldiscrepancy p y
Datafromatransactionmaycomefromdifferentsourcesthatdifferin coverage,accuracy,andtiming. Thebalanceofpaymentsaccountsthereforeseldombalancein practice. Thestatisticaldiscrepancyistheaccountaddedtoorsubtractedfrom thefinancialaccounttomakeitbalancewiththecurrentaccountand capitalaccount.

1329

BalanceofPayments y Accounts(cont.) ( )
Official(international)reserveassets:foreignassetsheldby centralbankstocushionagainstfinancialinstability.
Assetsincludegovernmentbonds,currency,gold,andaccountsatthe InternationalMonetaryFund. Officialreserveassetsownedby(soldto)foreigncentralbanksarea credit(+)becausethedomesticcentralbankcanspendmoremoney g instability. y tocushionagainst Officialreserveassetsownedby(purchasedby)thedomesticcentral bankareadebit()becausethedomesticcentralbankcanspendless moneytocushionagainstinstability. instability

1330

BalanceofPayments y Accounts(cont.) ( )

Thenegative g valueoftheofficialreserveassetsis calledtheofficialsettlementsbalance orbalance ofpayments.

Itisthesumofthecurrentaccount,thecapitalaccount, thenonreserveportionofthefinancialaccount,andthe statisticaldiscrepancy. p y Anegativeofficialsettlementsbalancemayindicate thatacountry
i isdepleting d l i i itsofficial ffi i li international i lreserveassets,or maybeincurringlargedebtstoforeigncentralbankssothat thedomesticcentralbankcanspendalottoprotectagainst fi financial i li instability. bili
1331

Summary
1.Nationalsavingminusdomesticinvestmentequalsthecurrent account(exportsminusimports). 2. 3. Thecurrentaccountequalsthecountrysnetforeigninvestment(net outflowsoffinancialassets). assets) Thebalanceofpaymentsaccountsrecordsflowsofgoods&services andflowsoffinancialassetsacrosscountries.
Ithas3parts:currentaccount,capitalaccount,andfinancialaccount, whichbalanceeachother. Transactionsofgoodsandservicesappearinthecurrentaccount; transactionsoffinancialassetsappearinthefinancialaccount.

1332

Summary(cont.)
4.Officialinternationalreserveassetsareacomponentofthefinancial account,whichrecordsofficialassetsheldbycentralbanks. 5.Theofficialsettlementsbalanceisthenegativevalueofofficial internationalreserveassets,anditshowsacentralbank banks sholdingsof foreignassetsrelativetoforeigncentralbanksholdingsofdomestic assets.

1333

Ch t 14 Chapter

ExchangeRatesand the t eForeign o eg ExchangeMarket: pp AnAssetApproach

Copyright 2012 Pearson Addison-Wesley. All rights reserved.

Review
Thebasicsofexchangerates Exchangeratesandthepricesofgoods

1435

DefinitionsofExchangeRates
Exchange g ratesareq quotedasforeign g currency yp perunitof domesticcurrencyordomesticcurrencyperunitofforeign currency.
Howmuch hcanb beexchanged h d f foronedollar? d ll ?89.40/$ /$ Howmuchcanbeexchangedforoneyen?$0.011185/

E Exchange h rates t allow ll usto t denominate d i t th thecost torprice i of fa goodorserviceinacommoncurrency.

HowmuchdoesaNissancost?2,500,000 , , Or,2,500,000x$0.011185/=$27,962.50

1436

Table141:ExchangeRateQuotations

1437

DepreciationandAppreciation
Depreciation ep ec at o is sadecrease dec easeint the evalue a ueo ofa currencyrelativetoanothercurrency.
Adepreciatedcurrencyislessvaluable (less expensive)andthereforecanbeexchangedfor(can buy)asmalleramountofforeigncurrency. $1/ $1.20/ meansthatthedollarhasdepreciated relativetotheeuro.Itnowtakes$1.20tobuyone euro,sothatthedollarislessvaluable. Theeurohasappreciatedrelativetothedollar: itisnowmorevaluable.
1438

DepreciationandAppreciation(cont.)
Appreciation pp isanincreaseinthevalueofa currencyrelativetoanothercurrency.
Anappreciatedcurrencyismorevaluable (more expensive) i )and dth therefore f canbe b exchanged h dfor f (can ( buy)alargeramountofforeigncurrency. $1/ $0.90/ $0 90/ meansthatthedollarhasappreciated relativetotheeuro.Itnowtakes only$0.90tobuyoneeuro,sothatthedollarismore valuable. Theeurohasdepreciatedrelativetothedollar: itisnowlessvaluable.
1439

DepreciationandAppreciation(cont.)
Adepreciated p currency yislessvaluable, ,andthereforeitcan buyfewerforeignproducedgoodsthataredenominatedin foreigncurrency.
ANissancosts2,500,000=$25,000 $ at$0.010/ $ / becomesmoreexpensive$27,962.50at$0.011185/

Adepreciated d i t dcurrencymeansthat th timports i t aremore expensiveanddomesticallyproducedgoodsandexportsare lessexpensive. Adepreciatedcurrencylowersthepriceofexportsrelativeto thepriceofimports.

1440

DepreciationandAppreciation(cont.)
Anappreciated pp currency yismorevaluable, ,andthereforeit canbuymoreforeignproducedgoodsthataredenominated inforeigncurrency.
ANissancosts2,500,000 2 500 000=$27,962.50 $27 962 50at$0 $0.011185/ 011185/ becomeslessexpensive$25,000at$0.010/

Anappreciatedcurrencymeansthatimportsareless expensiveanddomesticallyproducedgoodsandexportsare moreexpensive. Anappreciatedcurrencyraisesthepriceofexportsrelativeto thepriceofimports.

1441

Table142:$/ExchangeRatesandtheRelativePriceofAmerican DesignerJeansandBritishSweaters

(50 * $1 $1.25/) 25/) /$45 = 1.39 1 39 (50 * $1.5/) /$45 = 1.67 (50 * $1.75/) /$45 = 1.94

1442

Summary
1. Anexchange g rateisthep priceofonecountrys y currency yin termsofanothercountryscurrency.
Itenablesustotranslatedifferentcountriespricesintocomparable terms.

1443

Summary(cont.)
2. Depreciationofacurrencymeansthatitbecomesless valuableandgoodsdenominatedinitarelessexpensive: exportsarecheaperandimportsmoreexpensive. Appreciationofacurrencymeansthatitbecomesmore valuableandgoodsdenominatedinitaremoreexpensive: exportsaremoreexpensiveandimportscheaper.

3 3.

1444

End
Chapter14willbecontinuednextweek Thankyouforyourattention

1345