Download The exchange rate

1
PART XI: MACROECONOMICS
OF OPEN ECONOMIES
Open Economy Macroeconomics:
Basic Concepts
Chapter 29
2
What did we learn so far?
• Macroeconomics is the study of the economy as a
whole, in order to explain economic events that
affect many households, firms and markets at the
same time
• Part XIII dealt with the Gross Domestic Product
used to measure national production and the Price
Indexes used to measure inflation
• Part IX looked at the production, saving-investment
and employment in the long run
• Part X introduced money and established the link
between money and inflation in the long run
• Until now we assumed a closed economy without
economic relations with the outside world
3
What we learn in Part XI?
• We relax the assumption of the closed economy and
move onto the macroeconomics of the open
economy
• Chapter 29 introduces the basic concepts of openeconomy macroeconomics
• Such as the Balance of Payments, Net Foreign
Investment, nominal and real exchange rates
• Chapter 30 looks at the macroeconomic theory of
the open economy in the long run
• By showing the link between the loanable funds
market and the FX market in an open economy
• And clears the way for the analysis of short run
fluctuations in the economy
4
Open economy
• A closed economy has no interaction with other
economies in the world
• There are no exports, no imports, no tourists, no
capital flows, etc.
• An open economy interacts freely with other
economies around the world
• It buys and sells goods and services in the world
product markets
• It buys and sells capital assets in the world
financial market
• Open economy refers both to merchandise and
service flows and to financial transactions among
countries
5
Turkey as an open economy
• There is no case of an absolutely closed economy in
the world in the sense that all economies undertake
some foreign trade, tourism, etc.
• The share of exports of goods and services in
GDP is a reasonable measure of openness from the
perspective of foreign trade
• Free movement of capital flows (also called
convertibility) also imply an open economy
• Turkey was a relatively closed economy before
1980 and opened up since then
• TL was made convertible in 1989
• Customs Union with the EU since 1996 resulted in
increased international trade
6
Turkey opens to the world 1979-99
1979
1989
1999
92.774
2.261
4.798
5.069
6.271
107.012
11.780
22.472
15.792
21.511
183.755
29.326
53.249
40.692
54.613
34,7
35,3
5,2
6,8
78,9
13,5
21,0
20,1
90,0
8,5
29,0
29,7
( Million $)
GDP
Exports
FX Revenues
Imports
FX Spending
(%)
Industrial Exports/Total Export
Workers Rem/FX Revenues
FX Revenues / GDP
FX Spending / GDP
7
Turkey opens to the world 1975-2002
40
35
%
30
25
20
15
10
5
0
1975
1978
1981
1984
1987
FX Revenues/GNP
1990
1993
1996
1999
FX Spending/GNP
2002
8
The Balance of Payments
• All transactions of the economy with the outside
world is recorded in the Balance of Payments (BoP)
• In Turkey, the Central Bank calculates and publishes
the Balance of Payments on a monthly basis
• BoP is made of four parts
– Current Account
– Capital Account
– Net Errors and Omissions
– Reserve Changes
• The BoP is always in balance and can have no
deficit or surplus
• Deficits or surpluses exist in its different parts but
their sum is always zero
9
Exports, imports and net exports
• Exports (X) are domestically produced goods and
services that are sold abroad
• DİE publishes monthly figures for goods exports
(Free On Board – FOB)
• Imports (M) are goods and services produced
abroad that are sold domestically
• DİE publishes monthly figures for goods imports
(Cost Insurance Freight – CIF)
• Net Exports (NX) = Trade Balance is the value of a
nation’s exports minum the value of its imports
• Attention: for non-economists exports and imports
refer only to merchandise trade and does not include
trade in services
10
Current account
• Current account of the BoP includes all types of
FX revenues and expenditures of the economy
• Current account is a more comprehensive measure
of the economic relations with the outside world
compared with Net Exports or Trade Balance
• Whenever an economy earns FX from abroad either
from the sale of a good or service or as payment for
a factor of production, the revenue is registered in
the relevant item in the Current Account
• Whenever an economy spends FX abroad to buy a
good or service or for a factor of production, the
payments is registered in the Current Account
• Current account may be in balance, deficit or surplus
11
Current account: details
• Visibles (merchandise)
– Exports of goods + “shuttle trade”
– Import of goods + non-financial gold
– Goods under repair and process
• Services
– Tourism + transport
– Construction + financial services
– Trade and other services
• Investment income
– FDI + portfolio + other investment income
• Current transfers
– Workers’ remittances +official transfers
12
BoP: current account (old)
A. CARİ İŞLEM LER DENGESİ
İHRACAT FOB
İHRACAT
BAVUL TİCARETİ
TRANSIT TICARET
İTHALAT FOB
İTHALAT CIF
ALTIN İTHALATI
TRANSİT TİCARET
NAVLUN VE SİGORTA
DIŞ TİCARET DENGESİ
DİĞER M AL VE HİZM ET GELİRLERİ
TURİZM
FAİZ
DİĞER
DİĞER M AL VE HİZM ET GİDERLERİ
TURİZM
FAİZ
DİĞER
TOPLAM M AL VE HİZM ET DENGESİ
KARŞILIKSIZ TRANSFERLER (ÖZEL) : NET
İŞÇİ GELİRLERİ
DİĞER
KARŞILIKSIZ TRANSFERLER (RESM İ): NET
İŞÇİ GELİRLERİ
DİĞER
A. CURRENT ACCOUNT
M ERCHANDISE EXPORTS FOB
EXPORTS FOB IN TRADE RETURNS
SHUTTLE TRADE
TRANSIT TRADE
M ERCHANDISE IM PORTS FOB
IM PORTS CIF IN TRADE RETURNS
IM PORTS OF NONM ONETARY GOLD
TRANSIT TRADE
FREIGHT AND INSURANCE ON IM PORTS
TRADE BALANCE
OTHER GOODS AND SERVICES INCOM E
TRAVEL
INTEREST
OTHER
OTHER GOODS AND SERVICES EXPENDITURE
TRAVEL
INTEREST
OTHER
TOTAL: GOODS, SERVICES AND INCOM E
PRIVATE UNREQUITED TRANSFERS :NET
WORKERS' REM ITTANCES
OTHER
OFFICIAL UNREQUITED TRANSFERS : NET
WORKERS' REM ITTANCES
OTHER
13
BoP: current account (new)
I - CARİ İŞLEMLER HESABI
Hizmet ve Yatırım Geliri Dengesi(A+B+C)
Mal ve Hizmet Dengesi (A+B)
A. DIŞ T İCARET DENGESİ
1 .
G e n e l M a l T ic a r e ti
1.1.
1.1.1.
1.1.2.
1.1.3.
1.2.
1.2.1.
1.2.2.
1.2.3.
İş le m
3 .
T a m ir G ö r e n
4 .
P a r a s a l O lm a y a n
B .
G ö re n
H İZ M E T L E R
C U R R E N T
M a lla r
M a lla r
A lt ın
(n e t)
D E N G E S İ
A C C O U N T
Goods, Services and Income (A+B+C)
Goods and Services (A+B)
A .
1 .
İhracat f.o.b.
İhracat f.o.b.
Bavul T icareti
Uyarlama: Diğer Mallar
İthalat f.o.b.
İthalat c.i.f.
Uyarlama: Navlun ve Sigorta
Uyarlama: Diğer Mallar
2 .
I -
1 .1 .
G O O D S
G e n e r a l M e r c h a n d is e
Exports f.o.b.
1 .1 .1 .
E x p o r ts
f.o .b .
1.1.2.
Shuttle trade
1 .1 .3 .
A d ju s tm e n t: C la s s ific a tio n
1 .2 .
Imports f.o.b.
1 .2 .1 .
Im p o r ts
c .i.f.
1.2.2.
Adjustment: Coverage
1 .2 .3 .
A d ju s tm e n t: C la s s ific a tio n
2 .
G o o d s
3 .
R e p a ir s
4 .
N o n
B .
fo r P r o c e s s in g
o n
G o o d s
M o n e ta r y
G o ld
(n e t)
S E R V IC E S
1 .
T a ş ım a c ılık
1 .
T r a n s p o r ta tio n
2 .
T u r iz m
2 .
T ra v e l
3 .
İn ş a a t H iz m e t le r i
3 .
C o n s tr u c tio n
4 .
F in a n s a l H iz m e tle r
4 .
F in a n c ia l S e r v ic e s
5 .
D iğ e r T ic a r i H iz m e tle r
5 .
O th e r B u s in e s s
6 .
R e s m i H iz m e tle r
6 .
G o v e r n m e n t S e r v ic e s
7 .
D iğ e r H iz m e tle r
7 .
O th e r S e r v ic e s
C .
Y A T IR IM
G E L İR İ D E N G E S İ
1 .
D o ğ ru d a n
2 .
P o r tfö y
3 .
D iğ e r Y a tır ım la r
D .
Y a t ır ım la r
Y a t ır ım la r ı
C A R İ T R A N S F E R L E R
C .
S e r v ic e s
S e r v ic e s
IN C O M E
1 .
D ir e c t In v e s tm e n t
2 .
P o r tfo lio
3 .
O th e r In v e s tm e n t
D .
C U R R E N T
In v e s tm e n t
T R A N S F E R S
14
Current account balance
• The balance of the current account summarises the
revenue-spending relations with the world
• Deficit in the current account means that FX
spending (imports) is higher than FX revenues
(exports)
• Surplus in the current account means that FX
revenue (exports) is higher than FX spending
(imports)
• We treat Net Exports, Trade Balance and Current
Account Balance as meaning the same thing
• Attention: deficit in merchandise trade does not
always and automatically imply a deficit in the
current account (see examples in table)
15
Examples from the world
(Bill.US$) Trade Balance Invisibles Current Account Bal.
US
-454
20
-434
EU - 11
-10
-15
-25
Germany
52
-76
-24
Brazil
-1
-25
-26
Russia
61
-15
46
Turkey
-27
17
-10
Spain
-40
22
-18
All figures for 2000
16
What affects net exports?
• Many factors influence the level of exports and
imports and thus the net exports in an economy
• The tastes of consumers for domestic and foreign
goods
• The prices of goods at home and abroad
• The exchange rate at which people can use
domestic currency to buy foreign currencies
• The costs of international transport for goods
• The policies of the government towards
international trade
• The level of economic activity as summarised by the
growth rate of GDP both at home and abroad
Net Foreign Investment – NFI
17
• Net foreign investment is the sum of foreign assets
purchased by domestic residents and domestic assets
purchased by foreigners
• Three types of assets are distinguished
• Foreign Direct Investment – FDI – refers to
investment in factories, offices, companies, etc.
• Portfolio investment involves the stock market and
long term (several years) bonds
• Borrowing includes all types of loan transactions of
the financial and non-financial sectors with nonresidents
• Long term and short term (less than one year) loans
are treated seperately
18
Capital account
• In the BoP, FX flows that are not FX revenues or FX
spending are recorded in the Capital Account
• Basically it records financial transactions with the
world
• Its main part are
– Foreign Direct Investment – FDI
– Portfolio investment
– Long term capital movements
– Short term capital movements
• Net Errors and Omissions capture residual FX
movements
• The change in Central Bank FX reserves are also
recorded in the BoP
19
BoP: capital account (old)
B. SERMAYE HAREKET LERİ (REZERV HARİÇ)
B. CAPIT AL MOVEMENT S, EXC. RESERVES
DOĞRUDAN YAT IRIMLAR (NET )
DIRECT INVEST MENT (NET )
PORT FÖY YAT IRIMLARI (NET )
PORT FOLIO INVEST MENT (NET )
UZUN VADELİ SERMAYE HAREKET LERİ
LONG-T ERM CAPIT AL MOVEMENT S
KULLANIMLAR
DRAWINGS
ÖDEMELER
REPAYMENT S
MEVDUAT (KMDT H-NET )
DEPOSIT WIT H CBRT (NET )
KISA VADELİ SERMAYE HAREKET LERİ
VARLIKLAR (NET )
SHORT -T ERM CAPIT AL MOVEMENT S
ASSET S (NET )
VERİLEN KREDİLER
LOANS EXT ENDED
BANKALAR DÖVİZ MEVCUT LARI
DMB's FX.HOLDINGS
DİĞER VARLIKLAR
OT HER ASSET S
YÜKÜMLÜLÜKLER (NET )
LIABILIT IES (NET )
SAĞLANAN KREDİLER
LOANS RECEIVED
MEVDUAT LAR
DEPOSIT S
C. NET HAT A VE NOKSAN
GENEL DENGE
D. REZERV HAREKET LERİ
C. NET ERRORS AND OMISSIONS
T OT AL: OVERALL BALANCE
D. T OT AL CHANGE IN RESERVES
ULUS. PARA FONU NEZD. VARLIKLAR
RESERVES POSIT ION IN T HE FUND
ULUSLARARASI PARA FONU KREDİLERİ
USE OF FUND CREDIT S
RESMİ REZERVLER
OFFICIAL RESERVES
20
BoP: capital account (new)
B.
SERMAYE HESABI
B.
CAPITAL ACCOUNT
C.
FİNANS HESABI
C.
F IN A N C IA L A C C O U N T
8.
Y u rtd ış ı n d a D o ğ ru d a n Y a t ı r ı m
8.
D ire c t In v e s tm e n t A b ro a d
9.
Y u rtiç in d e D o ğ ru d a n Y a t ı r ı m
9.
D ire c t In v e s tm e n t in T u rk e y
10.
P o rtfö y H e s a b ı -V a rl ı k la r
10.
P o rtfo lio In v e s tm e n t- A s s e ts
11.
P o rtfö y H e s a b ı -Y ü k ü m lü lü k le r
11.
P o rtfo lio In v e s tm e n t- L ia b ilitie s
1 1 .1 .
H is s e S e n e tle ri
1 1 .1 .
E q u ity S e c u ritie s
1 1 .2 .
B o rç S e n e tle ri
1 1 .2 .
D e b t S e c u ritie s
12.
D i ğ e r Y a t ı r ı m la r-V a rl ı k la r
12.
O th e r In v e s tm e n t- A s s e ts
1 2 .1 .
M e rk e z B a n k a s ı
1 2 .1 .
M o n e ta ry A u th o ritie s
1 2 .2 .
Genel H ükum et
1 2 .2 .
G e n e ra l G o v e rn m e n t
1 2 .3 .
B a n k a la r
1 2 .3 .
B anks
1 2 .4 .
D i ğ e r S e k tö rle r
1 2 .4 .
O th e r s e c to rs
13.
D i ğ e r Y a t ı r ı m la r-Y ü k ü m lü lü k le r
13.
O th e r In v e s tm e n t- L ia b ilitie s
1 3 .1 .
M e rk e z B a n k a s ı
1 3 .1 .
M o n e ta ry A u th o ritie s
1 3 .2 .
Genel H ükum et
1 3 .2 .
G e n e ra l G o v e rn m e n t
1 3 .3 .
B a n k a la r
1 3 .3 .
B anks
1 3 .4 .
D i ğ e r S e k tö rle r
1 3 .4 .
O th e r s e c to rs
C a ri,S e rm a y e v e F in a n s a l H e s a p la r
D.
N E T H ATA V E N OK S AN
C u rre n t, C a p ita l a n d F in a n c ia l A c c o u n t
D.
N E T E R R O R S A N D O M M IS S IO N S
GEN EL D EN GE
E.
R E Z E R V V A R L IK L A R
(*)
GLOB AL B ALAN C E
E.
R E S E R V E AS S E TS
14.
R e z e rv V a rl ı k la r
14.
R e s e rv e A s s e ts
15.
U lu s la ra ra s ı P a ra F o n u K re d ile ri
15.
U s e o f F u n d C re d its a n d L o a n s
16.
Ö d e m e le r D e n g e s i F in a n s m a n ı
16.
E x c e p tio n a l F in a n c in g
21
Turkey: Summary BoP (1994-2002)
(BILLION US DOLLARS)
MERCHANDISE EXPORT S FOB
MERCHANDISE IMPORT S FOB
T RADE BALANCE
INVISIBLE AND T RANSFER INCOME
INVISIBLE AND T RANSFER SPENDING
INVISIBLE AND T RANSFER BALANCE
A. CURRENT ACCOUNT BALANCE
T OT AL FX INCOME
T OT AL FX SPENDING
B. CAPIT AL,EXCLUDING RESERVES
DIRECT INVEST MENT (NET )
PORT FOLIO INVEST MENT (NET )
T OT AL BORROWING (NET )
C. NET ERRORS AND OMISSIONS
T OT AL FX SUPPLY (NET ) (A+B+C)
F. T OT AL CHANGE IN RESERVES (+ decrease)
Total
1994-2002
272,9
-376,4
-103,5
205,3
-114,2
91,1
-12,4
478,2
-490,6
14,3
6,5
-3,9
11,6
0,4
2,3
-2,3
As % of
GNP
17,1
-23,6
-6,5
12,9
-7,2
5,7
-0,8
30,0
-30,8
0,9
0,4
-0,2
0,7
0,0
0,1
-0,1
22
Saving-investment in open economy
• Remember the national income identity
Y = C + I + G + NX
• National saving can now be written as
Y – C – G = I + NX
S = I + NX = I + NFI
Saving = Domestic Invesment
+ Net Foreign Investment
• This is a very important result
• Positive NFI means a surplus in the current account
and implies saving is higher than investment
• Negative NFI means a deficit in the current account
and implies investment is higher than saving
23
Domestic and foreign saving
• We can restate the relation between saving and
investment for the open economy
• Open economy permits domestic investment to be
different (higher or lower) from national savings
• Total savings are now equal to
ST = SD + SF
Total Saving = Domestic Saving + Foreign Saving
• Investment will now be equal to total saving
ST = SD + SF = I
• As SF = - NFI = - NX, a deficit in the current
account increases foreign savings and therefore
investment
24
Exchange rates
• International transactions can only happen if prices
in one currency can be transformed into prices in
another currency
• This vital transformation is undertaken by the
exchange rates
• Once we know the exchange rate between any two
currencies, we can immediatly compare local prices
in one country with the prices in the other country
• We can distinguish three different exchange rates
– Nominal exchange rates
– Real exchange rates
– Purchasing Power Parity (PPP) exchange rates
25
Nominal exchange rate
• The nominal exchange rate is the rate we see
everyday in the markets
• Nominal exchange rate is the rate at which a person
can buy or sell the currency of one country with the
currency of another country
• The nominal exchange rate between two currencies
can be expressed in two ways
– In units of foreign currency per one TL
– In units of TL per one unit of the foreign currency
• The first is used by most countries
• Due to high inflation, we have been using the
second method for the nominal exchange rate in
Turkey
26
The exchange rate for TL
• Currently, one US Dollar is exchanged for one
million six hundred thousand TL
– Either 1 US$ = 1.600.000 TL
– Or 1 TL = 1 / 1.600.000 US$
• The first expression gives us the US$/TL nominal
exchange rate for the Americans
• The second expression gives us the TL/US$ nominal
exchange rate for the Turks
• All major currencies are quoted domestically in the
second way
• For the TL, we could use 1 million TL as the unit of
account and express the exchange rate as
1 million TL = 0.625 US$
27
Changes in the exchange rate
• If TL buys more foreign currency, there is an
appreciation of the TL
– Exemple: when the TL/US$ exchange rate moved
from 1.75 million to 1.6 million, TL has
appreciated
• If TL buys less foreign currency, there is a
depreciation of the TL
– Exemple: when the TL/US$ exchange rate moves
from 1.6 million to 1.75 million, TL has
depreciated
• An appreciation is also called revaluation
• A depreciation is also called devaluation
28
Real exchange rate
• The real exchange rate is the rate at which a person
can trade the goods and services of one country for
the goods and services of the other country
• The real exchange rate compares the prices of
domestic goods with the prices of foreign goods
• For exemple, if a BigMac costs $ 2.50 in the US and
TL 2.5 million in Turkey, the real exchange rate is 1
$ = 1 million TL even if the nominal exchange rate
is different (The Economist BigMac Index)
• Purchasing Power Parity exchange rate is
calculated by the World Bank on the basis of the
prices of a basket of goods and services
29
Calculating the real exchange rate
• The real exchange rate depends on the nominal
exchange rate and the prices of goods in the two
countries measured in local currencies
Real exchange rate =
Nominal exchange rate x Domestic price
Foreign price
• When a country’s real exchange rate is low, its
goods are cheap relative to foreign goods and its
exports will increase while imports decrease
• The opposite if the real exchange rate is high
• Accordingly we talk about an undervaluation or
overvaluation of the currency
30
Purchasing-power parity theory
• The purchasing-power parity theory is the simplest
and most widely accepted theory explaining the
variation of exchange rates over time
• According to this theory, in the long run a unit of
any given currency should be able to buy the same
quantity of goods in all countries
• The law of one price says that a good must sell for
the same price in all locations
• Otherwise there exists unexploited profit opportunities of buying cheaply and selling expensively
• Exchange rates will therefore change in such a way
that prices become equal everywhere
31
Inflation and the exchange rate
• The purchasing-power parity theory tells us that the
nominal exchange rate between the currencies of
two countries must reflect the difference price levels
in those countries
• Countries with relatively high inflation should have
nominally depreciating currencies and countries
with relatively low inflation should have nominally
appreciating currencies
• This theoretical view is confirmed by the real world
• Almost all of the movements in nominal exchange
rates in the long run can be explained by inflation
differentials among countries
32
Limitations of the theory
• First and foremost, the theory holds in the long run,
meaning over a period of several years
• Many goods in the economy, mainly in the service
industries are not easily traded or shipped from one
country to another and large price differences may
persist
• These are called non-tradables
• Even among traded goods (called tradables) perfect
substitutes are rare
• Capital movements in and out of the country can
have a very strong effect on the real exchange rate in
the short run even if their effect in the long run is
much smaller
33
Conclusion
• An open economy corresponds to free flows of
goods and services as well as financial transactions
with the outside world
• Balance of Payment records the transactions of the
economy with the world
• Net exports are the value of domestic goods and
services sold abroad minus the value of foreign
goods and services sold domestically
• Net foreign investment is the acquisition of foreign
assets by residents minus the acquisition of domestic
assets by foreigners
• Net foreign investment is always equal to net
exports in the economy
34
Conclusion
• The nominal exchange rate is the relative price of
the currencies of two countries
• Exchange rate should be expressed in terms of the
local currency
• The real exchange rate is the relative price of the
goods and services of two countries
• According to the theory of purchasing-power parity,
a unit of currency should buy the same quantity of
goods in all countries
• The nominal exchange rate between the currencies
of two countries should reflect the price levels of the
countries