MGEC61 – International Economics: Finance
Introduction
International finance is a study of problems and policies of an open economy.
International finance studies the issues like unemployment, savings, trade imbalances, money and price levels (include exchange rates).
Organization of the course
1) Introduction – chapter 13
2) Interest rate parity (how exchange rate is determined by the flows of capital) and exchange rate overshooting – chapters 14 & 15
3) Purchasing power parity and the exchange rate in the long run (how exchange rate is determined by the flows of goods and the determinants of exchange rate in the long run) – chapter 16
4) The DD-AA model (the model that explains how exchange rate and output are determined in
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MGEC61 – Chapter 13
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Example: Suppose the country runs a CA surplus, CA > 0:
Exports of goods and services > Imports of goods and services.
Export revenues earned > Import payments made.
The Balance of Payments Accounts (BOP Accounts)
The balance of payments (BOP) accounts record a country’s international transactions with the rest of the world in a given time period.
The BOP accounts record a country’s payments to and its receipts from foreigners. The BOP accounts also show the sources of demand and supply of a country’s currency in the foreign exchange market.
The BOP accounting uses the system of double-entry bookkeeping: every international transaction automatically enters the BOP accounts twice, once as a credit and once as a debit. It is because if we buy something from a foreigner, we must pay him/her in some way, and the foreigner must then spend or store our payment, and vice versa.
Credit entry: any transaction resulting in a receipt from foreigners.
Examples include exports of goods, services, or assets.
Debit entry: any transaction resulting in a payment to foreigners
Examples include imports of goods, services, or assets.
MGEC61 – Chapter 13
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3
Components of BOP Accounts
BOP accounts
Current Account
(CA)
Financial Account
Capital Account
(KA)
Non-Reserve portion of KA,
1. (TCO B) Identify four categories of measures that might constitute a Balanced Scorecard of performance measures and provide an example of each. Also explain how a Balanced Scorecard could assist your organization. This answer must be in your own words—significant cut and paste from the text or other sources is not acceptable. (Points : 30)
Exchange rate is the price of a nation’s currency in terms of another currency. Basically, it is the price of some foreign currency in terms of a home currency. Economist define the long-run as the period in which prices are flexible, and the short-run as the period in which prices are sticky. Therefore, the forces behind the exchange rate movements should be examined both in the long run and short run. Following a standard text-book description, I start with the long-run period.
Thus the rationale behind changing the nominal exchange rate under a fixed or pegged exchange rate system is easy to follow provided that the set rate is found to be far away from the optimal or equilibrium rate. However, why does the central bank need to manage exchange rates which are determined by market forces in case of independent floating? This remains a contentious issue. Essentially, the central bank is believed to determine the appropriate level (or path) of the nominal exchange rate and then intervene in foreign exchange markets to bring the actual exchange rate close to the appropriate level. In practical sense, the appropriate level of the exchange rate may represent the rate which, when translated into a real exchange rate, is consistent with the long-run equilibrium real exchange rate. Many economists of neoclassical persuasion believe that the market determined exchange rates broadly represent the long-run equilibrium exchange rates and there is no need for managing exchange rates or intervention in foreign exchange markets.
Consequences regarding the international businesses and the flow of trade and investment among the three countries are given below as benefits and drawbacks of holding fixed exchange rate system-
DISSERTATION TOPIC: THE RELATIONSHIP BETWEEN EXCHANGE RATE VOLATILITY AND TRADE (US TRADE IN GOODS, TRADE IN SERVICES AND TRADE IN GOODS AND SERVICES (1970-2014)
Secondly, interest rates rise, can make the interest income increased, holding the currency to attract investors to buy the currency, therefore, support for the currency is good; if interest rates fall, holding the currency income will reduce, its appeal is diminished. Therefore, it can be said that "interest rates, currency is strong; interest rates fall, weak currency".
The aim of this report is going to analyse the importance of forecasting future exchange rates and the relationship of Purchase Power Parity. Also is going to test if this is even possible by applying simple theory of the International Finance statistics. For many economists, governments and investors is very important the forecasting of exchange rate in order to organise their next strategical movements in order to invest money in a country in order to diminish the risks and increase the returns. By saying forecast future exchange rate is when we are able to predict the change in the exchange rates between two countries. Purchase Power Parity (PPP)
In this paper, I will only focus on discussing the Purchasing Power Parity (PPP) and I will divide this paper into four sections. In section 1, I will come up with the definition of PPP and other theories behind it. For section 2, I will briefly introduce the absolute PPP and relative PPP and empirical evidence on PPP. Section 3 explains empirical test of PPP in practice and the problem of PPP. For the last section, there are conclusion and remarks.
Globalization and liberalization have been promoting the integration of the global economy over the past decades. While the most significant change under this process is the increasing number of cross-border trades over the world, and it is obvious that exchange rates, as the quintessential international financial variable, plays a vital important role in the multinational transactions. For the last 25 years, worldwide economists have been studying the relationship between macroeconomic variables and exchange rates. One of the aims of the research is to make predictions based on the models (or links) they have found. However, many of them failed to uncover the link and tend to think that exchange rates movements may follow a random walk, but some of them still found some evidence that support the existence of such a link effective in the short-term and to a greater extent in the long-term. They, therefore, constructed their exchange rate determination models and made a calendar of expected macroeconomic announcements, and it has become a regular part of many financial Medias, such as The Economists and Financial Times. One of the most frequently discussed models is the flexible-price monetary model, and which is also the main discussion topic of this essay.
5. Why do interest rates vary among countries? Why are interest rates similar for those European countries that use the euro as their currency?
The figure shows output y and exchange rate e. The line AA shows points at which the domestic rates equals the foreign rates. The line GG outlines the amount of output given a particular exchange rate. When a strong open economy effect is added to the model, a crisis occurs. For example, if foreign currency controls most debts of many firms in a country, the balance sheets will constrain their investment. This will lead to domestic demand having a direct dependence on the real exchange rate; y = D(y, i, eP*/P) + NX(eP*/P, y) . Under these circumstances, when the real exchange rates becomes unfavorable, the firms holding foreign current will not be able to invest. This will lead to triviality at the margin of the direct exchange rate effect. The corporate sector runs bankrupt but the small businesses benefit from weak currency. The effects can be so significant
The link between trade performances and exchange rate movements has been the matter of many practical studies. The literature review explains that the set of results, often in similar countries, might stem from practical proof being removed from diverse time periods and not the same methodologies. First, it clarifies whether exchange rate instability impedes trade flows. Second, it shows if the exchange rate depreciation develops the trade balance (J-curve effect).
2. The relative purchasing power parity condition holds that prices in different countries will different by roughly the same amount over time. This condition is based on the idea that differences in prices from one country to another reflect differences in underlying cost factors, access to inputs, taxation and other country-specific variables. Specially excluded in this condition is the exchange rate. Over time, the condition assumes, the movements of interest rates and exchange rates will mean that there is parity in the prices of goods between the two countries. The condition assumes therefore that any differences in prices can be explained in terms of non-currency country-specific factors. In the short run, there is no such assumption. This is because there is sometimes a time lag with respect to price changes. While currency exchanges rates and interest rates can change quickly, price changes can be slower for a number of reasons. Moreover, some of the inputs costs might change but again there is a time lag for these changes. The condition of relative purchasing power parity, therefore, is said to exist mainly in the long run.
It is no surprise that there have been many literatures on the determination of exchange rates given the significant impact that movement in exchange rates have on a world’s political and economic stability as well as the welfare of individual countries. It plays an important role in international investments, company profits and a countries macroeconomic fundamental factor such as unemployment, wages and interest rates among others. This has led to the development of many models and economic theories, one of which is the monetary model. Despite this, economists still cannot agree as to which model best explains movement in exchange rates because the results obtained when testing different models often contradict one another.
Direct investment: when an invest take a place outside the country (abroad) the record of transfer of ownership it’s called a direct investment with amount of 48.3 billion in 2012.