Balance of Payments and Exchange Rates

The Balance of Payments Account Meaning of the balance of payments The current account Meaning of the balance of payments The current account

The Balance of Payments Account Meaning of the balance of payments The current account –trade in goods Meaning of the balance of payments The current account –trade in goods

UK balance of payments: 2001 (£ millions)

The Balance of Payments Account Meaning of the balance of payments The current account –trade in goods –trade in services Meaning of the balance of payments The current account –trade in goods –trade in services

UK balance of payments: 2001 (£ millions)

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

UK balance of payments: 2001 (£ millions)

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 Meaning of the balance of payments The current account –trade in goods –trade in services –balance of trade in goods and services –income flows

UK balance of payments: 2001 (£ millions)

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 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

UK balance of payments: 2001 (£ millions)

South Africa also has a section on the Current account for Net Gold Exports This is not included with goods It is a standalone section Do you know why? South Africa also has a section on the Current account for Net Gold Exports This is not included with goods It is a standalone section Do you know why?

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 –Net Gold Exports –balance on current 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 –Net Gold Exports –balance on current account

UK balance of payments: 2001 (£ millions) 5. Net Gold exports 0

Current account balance as % of GDP in selected countries: 1970–2003

UK Current account balance as % of GDP in selected countries: 1970–2003

USA UK Current account balance as % of GDP in selected countries: 1970–2003

USA Japan UK Current account balance as % of GDP in selected countries: 1970–2003

The Balance of Payments Account The capital account

UK balance of payments: 2001 (£ millions)

The Balance of Payments Account The capital account The financial account The capital account The financial account

The Balance of Payments Account The capital account The financial account –investment The capital account The financial account –investment

The Balance of Payments Account The capital account The financial account –investment direct The capital account The financial account –investment direct

The Balance of Payments Account The capital account The financial account –investment direct portfolio The capital account The financial account –investment direct portfolio

UK balance of payments: 2001 (£ millions)

The Balance of Payments Account The capital account The financial account –investment direct portfolio –other financial flows (mainly short term) The capital account The financial account –investment direct portfolio –other financial flows (mainly short term)

UK balance of payments: 2001 (£ millions)

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 The capital account The financial account –investment direct portfolio –other financial flows (mainly short term) –flows to and from reserves

UK balance of payments: 2001 (£ millions)

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 The capital account The financial account –investment direct portfolio –other financial flows (mainly short term) –flows to and from reserves –financial account balance

UK balance of payments: 2001 (£ millions)

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 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

UK balance of payments: 2001 (£ millions)

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 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

Exchange Rates The rate of exchange –individual rates of exchange –exchange rate index The rate of exchange –individual rates of exchange –exchange rate index

Sterling exchange rates: 1980–2003

Exchange Rates The rate of exchange –individual rates of exchange –exchange rate index The rate of exchange –individual rates of exchange –exchange rate index

The weights of the currencies of various countries in the sterling exchange rate index

Exchange Rates The rate of exchange –individual rates of exchange –exchange rate index Determination of exchange rates The rate of exchange –individual rates of exchange –exchange rate index Determination of exchange rates

Exchange Rates The rate of exchange –individual rates of exchange –exchange rate index Determination of exchange rates –the equilibrium exchange rate The rate of exchange –individual rates of exchange –exchange rate index Determination of exchange rates –the equilibrium exchange rate

$ price of £ Q of £ Determination of the rate of exchange

$ price of £ D by USA Q of £ Determination of the rate of exchange

$ price of £ QSQS S by UK Q of £ Determination of the rate of exchange D by USA QDQD ba

QSQS QDQD d $ price of £ Determination of the rate of exchange S by UK Q of £ c D by USA

Exchange Rates The rate of exchange –individual rates of exchange –exchange rate index Determination of exchange rates –the equilibrium exchange rate –appreciation and depreciation The rate of exchange –individual rates of exchange –exchange rate index Determination of exchange rates –the equilibrium exchange rate –appreciation and depreciation

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 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

Floating exchange rates: movement to a new equilibrium € / £ S1S1 D1D1 Q of £

€ / £ S1S1 D1D1 S2S2 Q of £ Floating exchange rates: movement to a new equilibrium

€ / £ S1S1 D1D1 S2S2 D2D2 Q of £ Floating exchange rates: movement to a new equilibrium

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 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

€ / £ S1S1 D1D1 S2S2 D2D2 Q of £ Floating exchange rates: movement to a new equilibrium

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 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

€ / £ S1S1 D1D1 S2S2 D2D2 Q of £ Floating exchange rates: movement to a new equilibrium

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 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

€ / £ S1S1 D1D1 S2S2 D2D2 Q of £ Floating exchange rates: movement to a new equilibrium

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 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

€ / £ S1S1 D1D1 S2S2 D2D2 Q of £ Floating exchange rates: movement to a new equilibrium

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 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

€ / £ S1S1 D1D1 S2S2 D2D2 Q of £ Floating exchange rates: movement to a new equilibrium

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 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

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 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 Exchange Rates and Balance of Payments

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 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

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 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

$ / £ $ / £ exchange rate and £ exchange rate index:

$ / £ $ / £ exchange rate and £ exchange rate index:

$ / £ Index 1990=100

$ / £ exchange rate and £ exchange rate index: $ / £ Index 1990=100

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 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

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) 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)

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 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

Fluctuations between the euro and the dollar

US interest rate

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

Fluctuations between the euro and the dollar $ / € US interest rate ECB interest rate $ / €

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 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

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 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

Debt and Developing Countries The debt problem

Debt ratios: average of all developing countries

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 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

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 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