1. International Economics
国际经济学
Lectured by Yuanfen Tu
School of International Trade and Economics

2. International Economics By Robert J. Carbaugh 13th Edition
Chapter 4:
Mechanisms of International Adjustment

3. Adjustment Mechanisms
Works for the return to equilibrium after the initial equilibrium has been disrupted
Current-account adjustment
Automatic adjustment
Discretionary government policies
Automatic adjustment of the current-account
Under a fixed exchange-rate system
Adjustment variables: prices and income 3

4. Schools of thought on adjustment
Balance of payments adjustments
Classical approach (1800s - early 1900s)
Centered on gold standard
Emphasized role of prices and interest rates
Keynesian approach (1930s onward)
Emphasized income changes affecting adjustment
Monetarist approach (1960s-, Chicago school)
Focus on role of money in changes and adjustment

5. Price adjustment
Balance of payments adjustments
The original theory of current-account adjustment is credited to David Hume.
Arose from concern with the prevailing mercantilist view
A nations’ current account tends to move toward equilibrium automatically.
Price levels is the main factors.

6. Price Adjustments Gold standard, late 1800s to early 1900s
Conditions for each member nation
Money supply = gold or paper money backed by gold
Official price of gold – defined in terms of national currency
Buy and sell gold at that price
Free import and export of gold
Money supply - directly tied to current account 6

7. Price Adjustments Quantity theory of money
Essence of the classical price-adjustment mechanism
Equation of exchange: MV=PQ
M – money supply
V – velocity of money
P - average price at which each of the final goods is sold
Q – physical volume of all final goods produced 7

8. Price Adjustments MV=PQ identity
Total monetary expenditures on final goods = monetary value of the final goods sold
Amount spent on final goods = amount received from selling them 8

9. Price Adjustments Classical economists Assumptions
Q is fixed at the full employment level in the long term
V was constant
A change in M must induce a direct and proportionate change in P 9

10. Balance-of-Payments Adjustment
Balance of payments adjustments
Deficit nations
Would be losing gold, therefore shrinking their money supply and causing prices to fall
Lower prices would make their exports more competitive and lessen demand for imports, restoring equilibrium
Surplus nations
Would be gaining gold, increasing money supply and price level
Higher prices would cut exports and encourage imports until the surplus was eliminated

11. Balance-of-Payments Adjustment
Balance of payments adjustments

12. Price Adjustments Criticisms against the price-adjustment mechanism
Classical linkage between changes in a nation’s gold supply and changes in its money supply no longer holds
Full employment – doesn’t always exist
Prices and wages are inflexible in a downward direction
Stability and predictability of V - questioned 12

13. Financial Flows and Interest-Rate Differentials
Factors affecting a nation’s capital and financial account
Interest-rate fluctuations in domestic and foreign markets
Investment profitability
National tax policies
Political stability 13

14. Interest rate adjustment
Balance of payments adjustments
In the classical approach, another channel through which a BOP disequilibrium is corrected is through adjustments in the short-term interest rates.
This factor, was not the central focus of the classical approach to BOP adjustment because financial markets were not advanced during this time.

15. Interest rate adjustment
Balance of payments adjustments
Inflows of gold expand the money supply, causing short-term interest rates to fall; outflows cause rates to rise
Investors in surplus nations would send gold abroad in search of higher rates; deficit nations would receive gold from abroad for investment, restoring equilibrium

16. Financial Flows and Interest-Rate Differentials
Most important factor that causes financial assets to move across national borders
Hypothetical capital and financial account schedules for the United States
Assumes that interest-rate differentials are the basic determinant of financial flows
Discouraging financial flows
Interest equalization tax
Foreign-credit-restraint program

17. Capital and financial account schedule for the U.S.
FIGURE 4.1
Capital and financial account schedule for the U.S.
Interest-rate differentials between the United States and the rest of the world induce movements along the U.S. capital and financial account schedule. Relatively high (low) U.S. interest rates trigger net financial inflows (outflows) and an upward (downward) movement along the capital and financial account schedule. The schedule shifts upward/downward in response to changes in noninterest rate determinants such as investment profitability, tax policies, and political stability. 17

18. Income Adjustments Income adjustment mechanism
John Maynard Keynes, 1930s
Focus on automatic changes in income to bring about adjustment in a nation’s current account
Under fixed exchange rates
Influence of income changes in nations with current-account surpluses and deficits would help restore equilibrium automatically 18

19. Income Adjustments Income adjustment mechanism
Under fixed exchange rates
Persistent current-account surplus
Rising income - Increasing imports
Current-account deficit
Fall in income - Declining imports
Effects of income changes on import levels will reverse the disequilibrium in the current account 19

20. Income determination in a closed economy
Balance of payments adjustments
In the Keynesian Model：
national income: Y=C+S
total expenditure: Y=C+I
Y=C+S=C+I
The basic equilibrium condition can thus be stated as
S=I or S-I =0

22. Income determination in a closed economy
Balance of payments adjustments

23. Income determination in a closed economy
Balance of payments adjustments
Examples: Given C= Y and autonomous investment I=100,determine the equilibrium level of national income.
Y=C+S S=Y-C I=S
Y Y=100 Y=1000

24. Income determination in a closed economy
Balance of payments adjustments
Multiplier process(乘数过程):
△Y=k △ I
where k represents multiplier
△I= △S=s △Y
where s represents the marginal propensity to save
△Y=(1/s) △I

25. Income determination in a closed economy
Balance of payments adjustments
Examples:
Given C= Y and autonomous investment increases from I=100 to I=200,determine the new equilibrium level of national income.
△Y=(1/s) △I=(1/0.2)*100=500
Y= =1500

26. Income determination in a open economy
Balance of payments adjustments
The condition for equilibrium income:
S+M=I+X S-I=X-M
△M=m △Y
where m represents the marginal propensity to import

27. Income determination in a open economy
Balance of payments adjustments
Foreign-trade multiplier(对外贸易乘数）
△S+ △M= △I + △X
△S=s △Y
△M=m△Y
(s+m) △Y= △I + △X

29. Income Adjustments The foreign repercussion effect
Income adjustment mechanism
Include the impact that changes in domestic expenditures and income levels have on foreign economies
Both the rise in income of the surplus nation and the fall in income of the deficit nation are dampened 29

30. Income Adjustments Importance of the foreign repercussion effect
Depends on the economic size of a country
A small nation that increases its imports from a large nation
Little impact on the large nation’s income level
Major trading nations
Significant foreign repercussion effect 30

31. Disadvantages of Automatic Adjustment Mechanisms
An efficient adjustment mechanism
Requires central bankers to forgo their use of monetary policy
To promote the goal of full employment without inflation
Each nation must be willing to accept inflation or recession
When current-account adjustment requires it 31

32. Monetary Adjustments Monetary approach to balance of payments
Balance of payments - affected by discrepancies between
The amount of money people desire to hold
The amount supplied by the central bank
Excess demand for money - fulfilled by inflows of money from another country
Excess supply of money - eliminated by outflows of money to another country 32

33. Payments Imbalances Under Fixed Exchange Rates
Balance of payments adjustments
Demand for money is: Md=PL (Y, i)
Directly related to income and prices
Inversely related to interest rates
Supply of money has two components:
Domestic component - credit created by national government (D)
International component - foreign exchange reserves (F)
Ms=m (D+F) m: money multiplier
When m=1, Ms=D+F

34. Payments Imbalances Under Fixed Exchange Rates
Balance of payments adjustments
When in a equilibrium Md=Ms=D+F
F=Md-D
Payments deficits are the result of an excess supply of money at home
Excess supply of money encourages imports, which results in foreign exchange reserves flowing overseas and reducing the money supply

35. Payments Imbalances Under Fixed Exchange Rates
Balance of payments adjustments
Change
Impact
Increase in money supply
Deficit
Decrease in money supply
Surplus
Increase in money demand
Decrease in money demand

36. Payments Imbalances Under Fixed Exchange Rates
Balance of payments adjustments
Note: the BOP surplus or deficit is temporary and self-correcting automatically in the long-run.
That is after the excess demand for money or the excess supply of money is eliminated through an inflow of funds or out flow of funds, the BOP surplus or deficit is corrected.

37. Payments Imbalances Under Fixed Exchange Rates
Balance of payments adjustments
Supply increases (decreases) Bop deficit (surplus) international reserve outflow (inflow) money market equilibrium
Bop equilibrium

38. Payments Imbalances Under Fixed Exchange Rates
Balance of payments adjustments
(1)国际收支是一种货币现象;(2)国际收支逆差，实际上就是一国国内的名义货币供应量(D)超过了名义货币需求量。由于货币供应不影响实物产量，在价格不变的情况下，多余的货币就要寻找出路。对个人和企业来讲，就会增加货币支出，以重新调整它们的实际货币余额;对整个国家来讲，实际货币余额的调整便表现为货币外流，即国际收支逆差。

39. Payments Imbalances Under Fixed Exchange Rates
Balance of payments adjustments
反之，当一国国内的名义货币供应量小于名义货币需求时，在价格不变的情况下，货币供应的缺口就要寻找来源。对个人和企业来讲，就要减少货币支出，以使实际货币余额维持在所希望的水平;对整个国家来说，减少支出维持实际货币余额的过程，便表现为货币内流，国际收支盈余;

40. Payments Imbalances Under Fixed Exchange Rates
Balance of payments adjustments
(3)国际收支问题，实际上反映的是实际货币余额(货币存量)对名义货币供应量的调整过程。当国内名义货币供应量与实际经济变量(国民收入、产量等)所决定的实际货币余额需求相一致时，国际收支便处于平衡。

41. Balance of payments adjustments
Policy Implications
Theory focuses on domestic monetary policy as key to balance of payments
Policies that increase the supply of money relative to the demand will lead to:
A payments deficit
An outflow of foreign-exchange reserves
A reduction in the domestic money supply
Policies that increase the demand for money relative to the supply will trigger:
A payments surplus
An inflow of foreign-exchange reserves
An increase in the domestic money supply

42. Policy Implications Nonmonetary policies: Implications for growth
Balance of payments adjustments
Policy Implications
Continued
Nonmonetary policies:
Unnecessary: Disequilibria are self-correcting
In the short run, such policies may speed up adjustment process
Implications for growth
If domestic component of the money supply is not raised commensurate with demand:
Excess demand will induce an inflow of funds from abroad and a payments surplus