1. Jaromír Šindel ECES External Imbalance during Transformation Process – current account sustainability The Puzzles of Central and Eastern Europe Transformation and Integration ECES, Prague

2. Openness of Transition Economies High Openness of C&EE Countries (exports and imports of goods and services as a % of GDP) The Puzzles of Central and Eastern Europe Transformation and Integration ECES, Prague

3. Diagram of Internal & External Imbalances Current Account Domestic Demand or Absorption (C + G + I) Financial Account Intl. Reserves Foreign Indebtedness The Puzzles of Central and Eastern Europe Transformation and Integration ECES, Prague Balance of Payments

4. Current Accout Trade - goods and services Yields – employees, dividends, reinvested earnings Current Transfers – intergovernment transfers and others Capital Account Refugee transfers, patents, licences, trademarks, copyrights, … Fiancial Account (distinguish capital – debt and assets) Direct Investment – equity, reinvested earnings, others Portfolio Investment Others Investment The Puzzles of Central and Eastern Europe Transformation and Integration ECES, Prague

5. Current Account – Trade Balance Effect of Exchange Rate Automatically Equalizing Mechanisms Fixed ER –Price Mechanism –Income Approach (Engine Theorem) –Monetary Approach Elasticity Approach – floating ER Intertemporal Approach The Puzzles of Central and Eastern Europe Transformation and Integration ECES, Prague

6. Price Mechanism Balance of Payments Country ACountry B Equilibrium B. of Payments def i cit surplus Gold - exportGold - import Deflation Inflation Import - Drop Export - Rise Import - Rise Export - Drop The Puzzles of Central and Eastern Europe Transformation and Integration ECES, Prague

7. Income Approach (Engine Theorem) Balance of Payments Country ACountry B deficit Aggr. expenditures - drop Decrease of Real Income Import - Drop surplus Aggr. expenditures - rise Increase of Real Income Import - Rise Equilibrium B. of Payments Engine Theorem – International Business Cycle The Puzzles of Central and Eastern Europe Transformation and Integration ECES, Prague

8. Monetary Approach Balance of Payments - Equilibrium Increase of Domestic Prices Increase of Imports Increase of Real Income Increase of Imports and Drop in Exports Increase of Imports Balance of Payment - Surplus Domestic Currency - Appreciation Pressure Central Bank Intervention against Appreciation – sell of domestic currency Increase of Domestic Montery Supply The Puzzles of Central and Eastern Europe Transformation and Integration ECES, Prague

9. Elasticity Approach Marshall-Lerner Condition - devaluation has positive impact on the trade balance development only if the sum of demand elasticity to export and import is higher than 1 Price effect -impact of devaluation on import (domestic) and (export) prices -Question – contracts? – shortterm effect Volume effect - Changes in prices affect the demanded volume and sales J-curve - Trade Balance 0 - + t Firstly the Price effect is stronger, then the Volume effect. The Puzzles of Central and Eastern Europe Transformation and Integration ECES, Prague

10. … and Transition Countries? … fixed exchange rate … international reserves The level of International Reserves is impacted by the balance of payment´s development - current account development - financial account development (next lecture) … it finances the current account deficits The Puzzles of Central and Eastern Europe Transformation and Integration ECES, Prague

11. … and Transition Countries? Savings x investment CAB = S – I Transition countries have still higher investment than savings. The Puzzles of Central and Eastern Europe Transformation and Integration ECES, Prague

12. … CAB in Transition Source: Eurostat. CAB as % of GDP The Puzzles of Central and Eastern Europe Transformation and Integration ECES, Prague

13. … CAB in Transition Source: Eurostat. CAB as % of GDP The Puzzles of Central and Eastern Europe Transformation and Integration ECES, Prague

14. … CA deficit … WHY? Exchange rate Income effect – present or expected future income Labour cost vs. Productivity Trade balance vs. Income balance The Puzzles of Central and Eastern Europe Transformation and Integration ECES, Prague

15. … CA deficit … WHY? The Exchange Rate … devaluation – J-curve effect? … price effect was stronger than volume effect … Exports increased price competitiveness was reduced by high transaction cost (new contracts, know-how, intracompany trade, eastern trademark – low quality goods, …) Imports more expensive imports reduced the income effect … The Puzzles of Central and Eastern Europe Transformation and Integration ECES, Prague

16. CA deficit and The Exchange Rate The Puzzles of Central and Eastern Europe Transformation and Integration ECES, Prague Development of the Czech Crown Source: Holub, T.: Foreign Exchange Interventions Under Inflation Targeting: The Czech Experience. ČNB (2004).

17. … CA deficit … WHY? In Transition NX NS NX trans Y The role of income marginal propensity to import = (IMP/Y) * income elasticity of import - How big part of additional unit of income is spent on additional unit of import The Puzzles of Central and Eastern Europe Transformation and Integration ECES, Prague

18. … CA deficit … WHY? Labour Costs vs. Productivity Source: Eurostat. The Puzzles of Central and Eastern Europe Transformation and Integration ECES, Prague

19. … CA deficit … WHY? Source: Eurostat. Labour Costs vs. Productivity The Puzzles of Central and Eastern Europe Transformation and Integration ECES, Prague

20. Lessons for future. The Puzzles of Central and Eastern Europe Transformation and Integration ECES, Prague Design economic policy according to external balance for Cuba and China. Goals, solutions, reasons, very different situations (Cuba – closed, poor, China – cheap exporter, poor).