Module Capital Flows and the Balance of Payments KRUGMAN'S MACROECONOMICS for AP* 41 Margaret Ray and David Anderson

What you will learn in this Module : The meaning of the balance of payments accounts The determinants of international capital flows

Balance of Payments Accounts Balance of Payments Accounts Current Account Net Exports Trade Balance Factor Income Transfers Financial Account Current/Financial Relationship If a the current account is in deficit the financial account must be in surplus and vice versa

Modeling the Financial Account Modeling the Financial Account Savings will flow toward higher returns r% Q LF USA S LF USA D LF Japan r% Q LF Japan S LF Japan D LF China S LF 1 USA S LF 1 Japan Debit to the US Financial Account or Capital Outflow Credit to the Japanese Financial Account or Capital Inflow 5% 3% 5% 7%

Underlying Determinants of International Capital Flows Underlying Determinants of International Capital Flows Differences in economic growth rates A country with a rapidly growing economy, tends to offer more investment opportunities than a country with a slowly growing economy. So, because demand is higher they will offer higher interest rates Differences in savings rates This may be the result of differences in private savings rate or the result of government budget deficits

Two-way Capital Flows Two-way Capital Flows Capital moves in both directions Differences in individual investor's incentives (higher interest rates vs. higher stock returns) Financial specialization (firms may sell shares of stock to foreign investors and at the same time invest in foreign companies) Countries can be both creditors and debtors simultaneously