chapter5-Adjustment-of-BOP.ppt

1、 Adjustment of BOPChapter 5Outline of this chapterq Reasons for disequilibrium of BOPq Adjustment mechanisms of various factors q Theories of adjustment of BOPDisequilibrium of BOPReasons for Disequilibrium of BOPp Secular Disequilibrium（持久性不平衡持久性不平衡)Cyclical Disequilibrium Structural Disequilibrium

2、 Income Disequilibriump Temporary Disequilibrium（临时性不平衡）（临时性不平衡）Seasonal/Accidental Disequilibrium Speculative Disequilibrium Monetary DisequilibriumAdjustment mechanisms ofvarious factorsIf part of the balance of payments is in deficit or surplus for a period of time,mechanisms are needed to restor

3、e equilibriumAdjustment mechanisms can be:Automatic-economic processesDiscretionary-government policiesKey variablesq Adjustment variables A.Prices B.Interest rates C.Income D.Money E.Exchange rateFixed exchange rateA.Price adjustmentqPrice adjustment depends on the reaction of prices in the market

4、to adjust to a BOP imbalance,rather than the forex rateqRequirements for price adjustment to work under a fixed exchange rate(gold standard:1816-1914):1.no restraint on buying and selling gold 2.money supply is allowed to change in response to changes in gold holdings 3.prices and wages need to be f

5、lexible upward and downwardPrice adjustment-backgroundqUnder the gold standard,each nations currency was backed by gold and had a fixed price in terms of goldqImports and exports were paid for in gold or bank note qA nations money supply(total amount of gold and gold-backed currency)was directly tie

6、d to balance of payments-whether gold was flowing in or out overallqBalance of payments surplus would expand money supply;deficit would shrink money supplyqBy the classical quantity theory of money,increases in the money supply led directly to an increase in overall prices(and a shrinking money supp

7、ly caused overall prices to fall)Humes Price Specie Flow MechanismDeficits on the Balance of Payments Loss of foreign reserves Reduction in money supply Decrease in prices Improved competitiveness of domestic products Exports increase,imports decrease BP deficit eliminated This is an automatic adjus

8、tment mechanism under fixed exchange rates.Price Adjustment of the BOPqDeficit nationsWould be losing gold,therefore shrinking their money supply and causing prices to fallLower prices would make their exports more competitive and lessen demand for imports,restoring equilibriumqSurplus nationsWould

9、be gaining gold,increasing money supply and price levelHigher prices would cut exports and encourage imports until the surplus was eliminated国际收国际收支赤字支赤字黄金黄金 外流外流货币供货币供给下降给下降价格价格 下降下降出口增加出口增加进口减少进口减少国际收国际收支盈余支盈余货币供货币供给上升给上升黄金黄金 内流内流价格价格 上升上升出口减少出口减少进口增加进口增加Automatic mechanisms under gold standardqGo

10、ld flows are not directly linked to domestic money supplyqNations are often not at full employmentIf economy is not at capacity,less likely that prices will rise as money supply doesqPrices and wages are often not able to fall in the short runFalling money supply will cut output and employment rathe

11、r than pricesProblems with price adjustment theoryq Inflows of gold expand the money supply,causing short-term interest rates to fall;outflows cause rates to riseq Investors in surplus nations would send gold abroad in search of higher rates;deficit nations would receive gold from abroad for investm

12、ent,restoring equilibriumB.Interest rate adjustmentInterest rate adjustment MechanismDeficits on the Balance of Payments money supply declines interest rate increases return on short-term financial assets increases capital inflows BOP deficit eliminated This adjustment mechanism concentrates on both

13、 short-term capital flows and trade,while excludes the effects brought by long-term capital flows on the BOP.qSurplus nations will experience rising national income,leading to an increased demand for imports-partially offsetting the surplusqDeficit nations will experience falling income,leading to a

14、 drop in demand for imports-partially offsetting the deficitqForeign repercussions effect(回波效应)-one countrys deficit is anothers surplus,so that while income is declining in one country,its exports will increase to the country with rising incomeC.Income AdjustmentIncome Adjustment MechanismDeficits

15、on the Balance of Payments payment to overseas increases domestic income declines domestic AD declines imports decline BOP deficit eliminated This adjustment mechanism excludes the effects brought by capital flows on the BOP.pBOP disequilibrium represents an imbalance between the supply and demand f

16、or moneypDemand for money is:pDirectly related to income and pricespInversely related to interest ratespSupply of money has two components:pDomestic component-credit created by national governmentpInternational component-foreign exchange reservesD.Monetary adjustment backgroundMonetary AdjustmentpPa

17、yments deficits are the result of an excess supply of money at homeExcess supply of money encourages imports,which results in foreign exchange reserves flowing overseas and reducing the money supplypExcess demand for money leads to a payments surplusExcess demand is reflected in higher interest rate

18、s and less spending on imports,encouraging a flow of foreign exchange into the countryMonetary Adjustment Mechanismnis as the same as that of the Humes Price Specie Flow MechanismnThat is:disequilibria on the BOP foreign exchange reserve(a part of Ms)domestic Money supply relative price of domestic

19、products imports and exports BOP restores equilibriumMonetary adjustment implicationsp Theory focuses on domestic monetary policy as key to balance of paymentsp Other policies designed to affect the balance of payments-tariffs,quotas,devaluation of the currency-are ineffective in the long run accord

20、ing to the theoryAutomatic mechanisms under fixed exchange rate systemp Interest rate effectsp Income effectsp Relative price effects赤字赤字外汇储备减少外汇储备减少货币供给货币供给减少减少利率提高利率提高资金流资金流入增加入增加利率效应：利率效应：改善资本与金融账户收入效应：收入效应：改善经常账户收支相对价格效相对价格效应：应：改善经常账户收支减少国减少国内支出内支出收入减收入减少、进少、进口减少口减少物价物价下降下降出口增出口增加、进加、进口减少口减少资金流资

21、金流出增加出增加利率降低利率降低货币供给增加货币供给增加外汇储备增加外汇储备增加盈余盈余增加国增加国内支出内支出收入增收入增加、进加、进口增加口增加物价物价上升上升出口减出口减少、进少、进口增加口增加p Require governments not to intervenep Automatic systems seem desirable when they are believed to lead to full employment;when nations face unemployment and shrinking output,automatic mechanisms seem

22、 inadequateSummary：Disadvantages of automatic mechanismsE.Exchange rate adjustmentnEffect of exchange rate on trade price effectnEffect of BOP on exchange rateUnder floating exchange rate regime赤字赤字外汇需求大外汇需求大于外汇供给于外汇供给本币本币贬值贬值本国商品相本国商品相对价格下降对价格下降出口增加出口增加进口减少进口减少盈余盈余外汇需求小外汇需求小于外汇供给于外汇供给本币本币升值升值本国商品相本

23、国商品相对价格上升对价格上升出口减少出口减少进口增加进口增加Automatic mechanisms under floating exchange rate systemDiscretionary adjustment qWhy governments make policies for the equilibrium of the BOP?power structure national interestqHow do governments intervene in the adjustment of the BOP?monetary policy fiscal policy forex

24、 policydevaluation/revaluationforex controlintervention in the forex market foreign trade policy international co-operation Theories of the adjustment of BOPWhen can devaluation correct a payments deficit?pThree main theoriesElasticity approachnEmphasizes price effects;devaluation works best when de

25、mand is elasticAbsorption approachnFocus on income effects;domestic spending must fall,tooMonetary approachnFocus on change in purchasing power of money and effect on domestic spendingI.Elasticity Approach to the Balance of Trade（弹性分析法）（弹性分析法）Marshall-Lerner Condition（马歇尔（马歇尔-勒纳条件）勒纳条件）nMarshall-Ler

26、ner condition:nWhen(Sm,Sx),Devaluation will improve the trade balance if domestic demand elasticity for imports（本国对外国进口需求价格弹性）plus foreign demand elasticity for exports（外国对本国出口需求价格弹性）is greater than 1Devaluation will worsen the trade balance if the sum of the two elasticities is less than 1If the su

27、m is equal to 1,devaluation will have no effectThe exact condition for stability is called the Marshall-Lerner conditionnIt is:Overall Effect of Depreciation on Trade BalancenDevaluation results in expenditure switching.Foreigners buy more of our exports and less of their own and other countries pro

28、duction,whilst domestic producers buy fewer imports and more domestically produced goods.nThe extent to which exchange rates affect exports and imports will depend upon the elasticity of demand for the products and the nature of the contracts that have been agreed.nAfter a depreciation of$demand for

29、 American exports will grow faster if the demand for USA goods overseas is elastic.nThe Marshall-Lerner condition says that a real depreciation of home currency will improve the trade balance only if:|Dx+Dm|1.J-CurvewIt is more likely that the drop in the value of the home currency will improve the

30、trade balance,especially in the long run.wthe short-run and long-run reaction to a depreciation leads to a movement of the current account balance over time in the shape of a j-curve0+-18 monthsMonths since devaluationNet change in trade balanceThe J-Curve Effect（J曲线效应）曲线效应）nAssume that the Marshall

31、-Lerner condition holds,after a depreciation of home currency it may not be possible to switch away from imports.Thus we end up spending more when the exchange rate falls in value causing the balance of trade to worsen in the short run.Over time however the deficit improves.This process is known as

32、the J curve effect.Reasons for the J-CurvenImport and export volumes are slow to adjust after exchange rate changesnMost import and export orders are placed months in advance,hence the primary effect of a depreciation is to raise the value of the pre-contracted level of importsPrice Adjustments Shor

33、t vs.Long Runnshort-run elasticity of demand and supply tend to be smaller than long-run elasticity becausenconsumersneed to alter consumption plans,find substitutes to higher priced goodsneed to honor contractsif expect further depreciation,may even increase imports when a small depreciation occurs

34、nproducersrecognition lag-decision-making lagproduction/inventory lag-delivery lagQuantity Adjustments Short vs.Long RunThe ML condition is met in the long run but not in the short run.Quantity adjustments take time.nIf we devalue or depreciate the domestic currency,the domestic price of imports ris

35、es immediately,the price of exports will rise with a lag as our products attract a higher demand because they are cheaper in terms of the foreign currency.The physical quantity of exports will not increase immediately because it will take time add to plant capacity to satisfy increased demand.nWe ca

36、nnot cut back on all imported goods immediatelywe need time to find domestic substitutes or inferior but cheaper foreign substitutes.In the short run the elasticity of quantity movements is small(inelastic).Thus the price of the import good rising dominates causing the TB to become a larger deficit

37、or a smaller surplus.nEventually quantities adjust and the TB will become less of a deficit or a bigger surplus.J-Curve for EXR DepreciationTimeeTimeCAB(+)(-)Exchange Rate PathCAB PathEXRDepreciationCAB0e0.Absorption approach（吸收分析法）（吸收分析法）What is absorption?A nations total expenditures on final good

38、s and servicesTheoretical framework for the Absorption Approach to the Balance of TradeTotal output is equal to total expenditure that is:Y=C+I+G+(X-M)Here,Y is total output,C is consumption;I,investment;X exports;G government spending and M,imports.let TB=X-M,A=C+I+G,we define A,domestic absorption

39、,which also represents total domestic spending,thus we haveY=C+I+G+(X-M)(国内吸收国内吸收)A TB A TB(国际收支差额国际收支差额)In brief,there are two basic equations:Y=A+TB TB=Y-AExplanation about the BOPnRepresentative:Sidnen AlexandernBalance of trade is the difference between total domestic output and domestic absorpt

40、ionSurplus on TB is a result of total output exceeds total domestic absorption.i.e.,YA.In such case,this country will export the rest of its output.When YA,TB0,there will be a deficit on the balance of trade.Effects of a Devaluation on the BOPEmphasizes impact of devaluation on spending behavior of

41、domestic economy Devaluation increases TB only if Y increases relative to A(absorption).UnemploymentY can increases as X increases and M decreases with a devaluation.A devaluation will shift resources into export production and encourage spending on import substitutesFull employmentY cannot increase

42、.An increase in TB is to have domestic absorption A fall.Devaluation may lead to inflation.（why?）.Monetary Approach（货币分析法）（货币分析法）The Monetary Approach to the Balance of Payments(MABP)The Balance of Payments=Change in foreign reserves(FR)at the central bankBOP surplus increase in FR BOP deficit decre

43、ase in FR According to the MABP,BOP is a monetary phenomenon,related to money supply and money demand.Excess demand for money BOP surplusExcess supply of money BOP deficit Presumptions of MABP MABP developed in 1970s,which was established on the basis of monetarilism.Three basic presumptions:a.outpu

44、t is at a full employment,real demand for money is the function of income and interest rate.b.in a long run,money demand is stable,money supply has no effects on real output.c.prices of manufacturing factors are external,i.e.they are determined by international market forces.Basic ModelMoney supply

45、of MABP Suppose that supply of money equals base money,that is:M=m(R+D)here,M is monetary base;D is domestic credit and R,foreign reserves;m is the multiplier.To simplify matters,we let m=1.Thus,M=R+D Increase in D(D):central bank lending to the private sector or commercial banks,and central bank pu

46、rchase of government securitiesIncrease in R(R):central bank purchase of FX(a surplus on BOP)Basic Model(contd)Money demand of MABP Demand for money L=kPY Here,L is the demand for money;P is the domestic price level,Y is real income;k,a constant fraction.It is clear that money demand positively depe

47、nds on the price level(P)and income(Y).Basic Model(contd)Law of one price（一价定律）（一价定律）in an open economy According to PPP,the exchange rate should be equal to the ratio of the domestic and foreign price levels,i.e.E=P/Pf By rearranging,we have P=E Pf Note:In a small open economy,the domestic price le

48、vel is determined by the foreign price level and the exchange rateBasic Model(contd)Suppose that money supply equals money demand.Putting(2),(3)and(4)together,we haveR+D=k(E Pf)Y Rearrange equation(5)in terms of percentage changes,we are left with +Pf+Rearranging(6),we have -Pf+(7)The change in rese

49、rves minus the percentage change in EXR is approximately equal to the foreign inflation rate,plus the percentage growth of real income,minus the change in domestic credit.Under a fixed EXRnUnder a fixed exchange rate,E is fixed and R is variable.0 Interpret the above as Pf+rearrange(6)as:Pf+-(7)n It

50、 is obvious that there is a positive relationship between and ,and Pf.Whats more,is negatively related to.Policy Implicationsn R increases(BOP surplus)ifdomestic real Income increases,Ydomestic credit declines,Dv For China,to lower the BOP surplus,R will be decreased bylowering domestic real income,