lecture-3-theory-of-balance-of-payments-国际金融课件.ppt

1、2023-1-31Chinese Finance Research Institute1ContentsqElasticity ApproachqAbsorption ApproachqMonetary ApproachqAn overall CommentsqAssignments2023-1-31Chinese Finance Research Institute2 The Elasticity Approach,pioneered by Marshall(1923)and Lerner(1944)and later extended by Robinson(1937)and Machlu

2、p(1939),focuses on the effect of exchange rate changes upon a countrys current account balance.I.How Does the Exchange Rate Matter?Changes of the exchange rate will have an impact upon a countrys export supplies and demands,basically through changes of relative prices between domestic products and f

3、oreign products,and between tradable(exports and import substitutes)and non-tradable goods.This is the so-called expenditure-switching effect.qElasticity Approach2023-1-31Chinese Finance Research Institute3 Let Pd stand for the price of domestic products,Pf price of foreign goods,and S the exchange

4、rate,expressed as the home currency price per unit of foreign currency.We will turn to the determination of exchange rate later.Thus we may obtain the relative price of a foreign goods dominated in home countrys currency.Let RP denote the relative price.RP=SPf/PdqElasticity Approach2023-1-31Chinese

5、Finance Research Institute4 e.g.1-2-1 Suppose Chinese jeans costing RMB2000,and U.S.sweaters costing$250.Again suppose the exchange rate is$1=RMB8.27.The following table presents an imagined situation of changes of the exchange rate and relative prices(A case from Krugman et al(2012).Exchange rate8.

6、308.358.408.45Sweater/Pairs of jeans1.03751.0441.051.056 Conclusion:All else equal,a depreciation lowers the relative price of a countrys exports and raises the relative price of its imports.Conversely,an appreciation of a countrys currency raises the relative price of its exports and lowers the rel

7、ative price of its imports.qElasticity Approach2023-1-31Chinese Finance Research Institute5II.AssumptionspIncome and prices(both Pf and Pd)are constant,both home and foreign consumers preferences are also constantpComplete immobility of capitalpIgnoring dynamic effect of the depreciation and using c

8、omparative static equilibrium approachpInfinite elasticity of supply of imports and exportsqElasticity Approach2023-1-31Chinese Finance Research Institute6III.DerivationsIII.1 Definitions Define S,the exchange rate X,export volume M,import volume B,current account balance denominated in home currenc

9、y.Since there is no capital mobility at all,B also means a countrys overall status of balance of payments.B=PdX-SPfMqElasticity Approach2023-1-31Chinese Finance Research Institute7 Let also X and M stand for the exchange rate elasticity for export and import demands respectively.Recall the definitio

10、n of elasticity we have learned in microeconomic theory,we will easily write,Note,why do we use a negative sign before the exchange rate elasticity for imports?SXXSSSXXXSMMSSSMMMqElasticity Approach2023-1-31Chinese Finance Research Institute8III.2 A Brief Derivation Suppose that home countrys curren

11、cy depreciate,say,the exchange rate rises from S to S+S.The depreciation will lead to the changes in exports and imports by X and M respectively(volume effect).Be aware that X0 and M0,a depreciation will lead to the improvement of a countrys balance of payments if,and only if,MfdXffdfMSPXPSMPSMMSMSP

12、XPSMPB1101MfdXMSPXPqElasticity Approach2023-1-31Chinese Finance Research Institute10 Again,suppose the initial balance of payments is in equilibrium,which means that,B=PdX-SPfM=0.Substitute this equation into the condition we have already obtained,X+M1 This inequality is the famous Marshall-Lerner C

13、ondition,which tells us the condition under which a depreciation or devaluation of a countrys currency may improve the countrys balance of payments.A some interesting example of China is illustrated in Table 1-2-1.qElasticity Approach2023-1-31Chinese Finance Research Institute11Table 1-2-1 RMB rate

14、and trade balanceSource:SAFE;NBSC;in 100 millions of RMB2023-1-31Chinese Finance Research Institute12IV.Empirical Evidences IV.1 Evidences from ChinaqElasticity Approach2023-1-31Chinese Finance Research Institute13qElasticity ApproachIV.2 Evidences from Industrialized Economies2023-1-31Chinese Finan

15、ce Research Institute14V.CommentspIgnorance of income effect When income effect is taken into account,the following condition should hold(Refer to“Absorption Approach”),X+M 1+m This is the so-called Harberger Condition.pUnrealistic assumption of complete capitalpIgnorance of dynamic effects of a dep

16、reciation Refer to Figure 1-2-1.qElasticity Approach2023-1-31Chinese Finance Research Institute15tCAFigure 1-2-1 The J-curve Effect2023-1-31Chinese Finance Research Institute16pAssumption of infinite elasticity of supply A more general condition,called Bickerdike-Robinson-Metzler Condition can be es

17、tablished.For more detailed statements and derivations,see Gandolfo(2002),chapter 7.Where,eX and eM stand for the supply elasticity of home countrys exports and imports respectively.pComplete pass-through and pricing currency choice011MMXXMXMXMXMXeeeeeeqElasticity Approach2023-1-31Chinese Finance Re

18、search Institute17Table 1-2-2 Incomplete pass-throughSource:Hausmann et al.(2002)2023-1-31Chinese Finance Research Institute18I.Analytical FrameworkI.1 Framework The Absorption approach,put forward by Alexander(1952),focuses on the hypothesis that current account imbalances can be viewed as the diff

19、erence between home output and spending.We begin with the national income identity in an open economy,Y=C+I+G+(X-M)B=(X-M)=Y-A Where,A=C+I+G stands for a countrys absorption.qAbsorption Approach2023-1-31Chinese Finance Research Institute19 Absorption is also classified into induced absorption and au

20、tomatic absorption defined respectively as follows,A=aY+D Where,a is the marginal propensity to absorption,whereas D denotes the automatic part of absorption.Thus,B=(1-a)Y-D Hence,B=(1-a)Y-D *qAbsorption Approach2023-1-31Chinese Finance Research Institute20I.2 Basic Questions Since equation*is a sta

21、tistical identity.“The question we now have to ask is to what extent devaluation can affect B,that is,the difference between income and absorption.”pHow does devaluation affect income(Y)?This could be represented by YpHow does a change in income(Y)affect absorption(A)?This is what a in the equation*

22、actually meanspHow does devaluation directly(that is,not via income)affect absorption(A)?Simply this is what D stands forqAbsorption Approach2023-1-31Chinese Finance Research Institute21II.Effects of Devaluation on Income&AbsorptionEffects upon&via income(1-a)Y)Direct effects on absorption(D)Idle-Re

23、sources EffectTerms-of-Trade EffectCash Balance EffectIncome Redistribution Effect Money Illusion Effect Three other direct absorption effectsSource:Machlup(1955),p260.qAbsorption Approach2023-1-31Chinese Finance Research Institute22III.Effects of A DevaluationIII.1 Idle-Resources Effect If there ar

24、e idle resources in the devaluating country or the economy is at less than full employment,then a devaluation will lead to a much larger amount of increase in output through export increases and import reductions(the Marshall-Lerner condition should hold).If marginal absorption propensity is less th

25、an 1,then the increase in income will improve a countrys balance of payments by the amount of(1-a)Y.qAbsorption Approach2023-1-31Chinese Finance Research Institute23III.2 Terms-of-Trade Effect The Terms of trade refers to the ratio of export price to import price.An increase in the ratio representin

26、g the amelioration of the terms,often means the terms is changing to home countrys favor and a decline in the ratio,the deterioration of the terms,often means that the change is detrimental to home countrys trade.Too often,a depreciation or devaluation of home currency leads to the deterioration of

27、the terms and the decline of home countrys real income simply because“more units of exports have to be given to obtain a unit of imports”.qAbsorption Approach2023-1-31Chinese Finance Research Institute24III.3 Cash-Balance EffectqAbsorption Approach2023-1-31Chinese Finance Research Institute25III.4 I

28、ncome-Redistribution Effect Price increases caused by a depreciation are detrimental to fixed income earners and favorable to interest earners.However,the net effect is ambiguous.III.5 Money Illusion Effect Irving Fisher(1928)was the first to put forward the concept.III.6 Laursen-Metzler Effect See

29、Pilbeam(2006,pp.65)for detailed discussions on the effect.qAbsorption Approach2023-1-31Chinese Finance Research Institute26IV.Simple Comments pAn ad hoc specification of causality between income&absorption,and trade balancepThe role of relative price changes,namely substitution effect,in the balance

30、 adjustments is neglectedpIn case of full employment,a depreciation or a devaluation may not lead to increases in incomepIgnorance of capital mobility tooqAbsorption Approach2023-1-31Chinese Finance Research Institute27qAbsorption ApproachV.Elasticity and Absorption Approach:A Synthesis pCompeting o

31、r complementary?pRevisit of the Harberger Condition DepreciationIncrease in X0Decrease in M0Increase in BChanges in YChanges in B2023-1-31Chinese Finance Research Institute28VI.Effects of Depreciation on the PricepEffects on aggregate demand A depreciation will lead to an increases in net exports an

32、d consequently an expansion of AD,if there are resources not fully employed in the economy.The increase in AD will lead to the rise of equilibrium output and the general price level.pEffects on aggregate supply A depreciation will lead to an increase in import prices and hence to the rise of product

33、ion costs.Therefore,AS curve will shift to the left.qAbsorption Approach2023-1-31Chinese Finance Research Institute29Figure 1-2-2 Depreciation&inflationE3E2E1P3P2P1PADADASASY1Y3Y2Y2023-1-31Chinese Finance Research Institute30 The approach(MABP),was pioneered by Whitman et al(1975)etc.,and was popula

34、r in the decade.The approach has its origin from David Humes Price-Species-Flow mechanism and focuses on the role of stock equilibrium in money market.The approach differs from the above two approaches in that it,ptakes international capital mobility into account and focuses on the overall balance r

35、ather than trade balance.pholds that changes in monetary market lead to the corresponding changes of international reserves.qMonetary Approach2023-1-31Chinese Finance Research Institute31I.A Simple ModelI.1 Stable Monetary Demand By the quantity theory of money,money demand is a function of national

36、 income.Md=kPY Where,Md denotes real demand for money,and P for price.Y stands for national income.The money demand function forms the basis of the aggregate demand schedule which is illustrated in the Figure 1-2-3.qMonetary Approach2023-1-31Chinese Finance Research Institute32Figure 1-2-3 Aggregate

37、 demand schedulePYAD1AD2P2Y2P1Y12023-1-31Chinese Finance Research Institute33I.2 Vertical Aggregate Supply Schedule “The simple monetary model assumes that the labor market is sufficiently flexible that the economy is continuously at a full employment level of output(Pilbeam,2006).”See also Figure 1

38、-2-4.I.3 Purchasing Power Parity(PPP)For the time being,we simply state that the exchange rate adjusts so quickly that the following equation hold continuously.We will turn to the theory again later.See Figure 1-2-5.P=SP*qMonetary Approach2023-1-31Chinese Finance Research Institute34Figure 1-2-4 Agg

39、regate supply scheduleYPAS1AS2Y1Y22023-1-31Chinese Finance Research Institute35Figure 1-2-5 PPP schedulePOvervaluationUndervaluationS2023-1-31Chinese Finance Research Institute36qMonetary ApproachI.4 Money SupplyMs=D+R Where Ms is the home money base,D is home bond holdings of the monetary authoriti

40、es,and R is the official reserves.See Figure 1-2-6.pOpen Market Operation(OMO)pForeign Exchange Operation(FXO)The money supply equation can also be written in the first difference form,Ms=D+R2023-1-31Chinese Finance Research Institute37Figure 1-2-6 PPP scheduleMsR45D1D2Ms1Ms22023-1-31Chinese Finance

41、 Research Institute38I.5 Balance of Payments DisequilibriumBP=CA+K+R=0 Where,BP,CA,K stand for the balance of payments,current balance,and capital account balance respectively.Or,CA+K=-RpFixed exchange rate regime pFloating exchange rate regimeI.6 The Models EquilibriumqMonetary Approach2023-1-31Chi

42、nese Finance Research Institute39Figure 1-2-7 The equilibriumPPSYASADY1P1P1S1MsRD1M1R1MdMs2023-1-31Chinese Finance Research Institute40qMonetary ApproachII.Effects of Various ShocksII.1 Devaluation Effects(Figure 1-2-8)Conclusion:Devaluation can have only a transitory effect on the balance of paymen

43、ts.II.2 Effects of Money SupplypFixed exchange rate regime(Figure 1-2-9-1)Sterilized interventionSurplus countries purchase of deficit currencypFloating exchange rate regime(Figure 1-2-9-2)2023-1-31Chinese Finance Research Institute41Figure 1-2-8 Effects of a devaluationPPSYASAD1Y1P1P1S1MsRD1M1R1Md1

44、MsS2P2Md2M2R2AD2P22023-1-31Chinese Finance Research Institute42Figure 1-2-9-1 Money expansion under fixed regimePPSYASAD1Y1P1P1S1MsRD1D2R1Md1Ms1P2M1R2AD2P2Ms2M22023-1-31Chinese Finance Research Institute43PPSYASAD1Y1P1P1S1MsRD1D2R1Md1Ms1P2M1AD2P2Ms2M2Figure 1-2-9-2 Money expansion under floating reg

45、imeY2Md2S22023-1-31Chinese Finance Research Institute44II.3 Effects of IncomepFixed exchange rate(Figure 1-2-10-1)pFloating exchange rate(Figure 1-2-10-1)II.4 Effects of Price ChangespFixed exchange ratepFloating exchange rate See Chapter 5 of Pilbeam(2006)for detailed analyses.qMonetary Approach202

46、3-1-31Chinese Finance Research Institute45PPSYAS1AD1Y1P1P2S1MsRD1M1R1Md1MsP1Md2M2R2Figure 1-2-10-1 An income increase under fixed rateY2AS2AD2P22023-1-31Chinese Finance Research Institute46PPSYAS1AD1Y1P1P2S1MsRD1M1R1Md1MsP1R2Figure 1-2-10-2 An income increase under fixed rateY2AS2P2S22023-1-31Chines

47、e Finance Research Institute47qMonetary ApproachIII.ImplicationspUnder a fixed exchange rate regime,the authorities lose control over their domestic monetary policy at the price of fixing the exchange ratepFrom the viewpoint of the balance of payments it is irrelevant whether the change in the money

48、 supply results from an OMO or a FXOpBe aware that“there is a split in the monetarist camp over the desirability of fixed as opposed to floating exchange rates”2023-1-31Chinese Finance Research Institute48qMonetary ApproachIV.CriticismspCausation relationshippAssumptionsThey are open to question by

49、empirical evidences,esp.the assumption of a stable money demand function is highly questionableThey are not applicable in the short runpNegligence of the composition of deficit or surplus 2023-1-31Chinese Finance Research Institute49 Any approach we have covered up till now focuses on a single facto

50、r that may possibly affect a countrys balance of payments.In other words,the approaches we have discussed above explained the contributors to surplus or deficits of balance of payments from a certain angel.However,they do not and cannot offer us a comprehensive illustration of the problem.For simpli