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Lecture 3/22

by: Maritt Nowak

Lecture 3/22 IR 292

Maritt Nowak
GPA 3.47

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About this Document

FDI, exchange rates, etc.
Fundamental International Economics
James Baldwin
Class Notes
Economics, Macroeconomics, International Economics, international relations
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This 3 page Class Notes was uploaded by Maritt Nowak on Tuesday March 22, 2016. The Class Notes belongs to IR 292 at Boston University taught by James Baldwin in Spring 2016. Since its upload, it has received 19 views. For similar materials see Fundamental International Economics in INTERNATIONAL RELATIONS at Boston University.


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Date Created: 03/22/16
IR 292 March 22, 2016 Types of Financial Flows • subcomponents of private assets: foreign direct investment (FDI), foreign securities, loans  to foreign firms and banks • FDI: tangible items; real estate, factories, warehouses, transportation facilities, and other  physical (real) assets • securities and loans can be considered foreign portfolio investment — paper assets such as  stocks and bonds • both FDI and foreign portfolio investment—claim in a foreign economy’s future output; FDI  have longer time horizons Role of Expectations in Financial Flows • Shifts in expectations can lead to sudden stoppages of financial inflows • the result is a destabilizing of outflows of financial capital • this occurrence has been labeled as a sudden stop • sudden stops have been involved in the most financial crises in last 30 years Limits on Financial Flows • until recently, most nations limited the movement of financial flows related financial account  transactions across their borders • the European Union liberalized financial flows between member countries only in 1993 • the movement towards open markets over the 1980s and 1990s resulted in the lifting of  controls on financial flows • developing countries, in particular, have liberalized financial account transactions in order to  get access to financial capital for development • although financial flows can be volatile, economists agrees the free flows are best for  economic efficiency The National Income and Product Accounts • National income and product accounts (NIPA): internal, domestic accounting systems the  countries use to keep track of total production and total income • two fundamental concepts of the system: • gross domestic product (GDP): the value of all final goods and services produced within a  country’s borders during a period of time (usually a year) • gross national product (GNP): the value of all final goods and services produced by the  labor, capital, and other resources of a country within the country as well as abroad • • GNP = GDP + foreign investment income received ­ investment income paid to foreigners +  net unilateral transfers International Debt • debt is defined as money owed to nonresidents which must be paid in a foreign country • current account deficits must be financed through inflows of financial capital (loans) • loans from abroad add to a country’s stock of external debt and generate debt service  obligations • all countries, rich and poor, have external debt • in many low and middle income countries, external debt leads to financial problems • unsuitable debt occurs for numerous reasons: • sudden drop in commodity prices • natural disasters • corruption • foreign lending behavior The International Investment Position • when a country runs a current account deficit, it borrows from abroad and increases its  indebtedness • if a country runs a current account surplus, it lends to foreigners and reduces its overall  indebtedness • international investment position = domestically owned foreign assets ­ foreign owned  domestic assets • costs and benefits of capital inflows • enables countries to invest more • makes it possible for governments to spend more (save less) • capital inflows take the form of direct investment, may bring new technologies (technology  transfer) • new management techniques Chapter 10: Exchange Rates and Exchange Rate Systems THE SECRET: an exchange rate is the price of money (determined by supply and demand) Exchange Rates and Currency Trading • Exchange rate: The price of a currency stated in terms of a second currency • exchange rates are reported in every newspaper with a business section and on numerous  web sites • appreciation of a currency: the currency’s becoming more valuable (or able to buy more units  of another currency) • depreciation of a currency: the currency’s becoming less valuable in relation to another  currency • the three most frequently traded currencies are: • EU euro • Japanese yen • British pound Reasons for Holding Foreign Currencies 1. Trade and investment: traders (importers and exporters) and investors routinely transact in foreign currencies 2. interest rate arbitrage: taking advantage of interest rate differentials between countries;  arbitrageurs borrow money where interest rates are low and sell it where interest rates are  high 3. speculation: buying and selling of currency in anticipation of changes in the currency’s  exchange rate; speculators sell overvalued currencies and buy undervalued currencies Institutions 1 retail customers: firms and individuals 4. commerical banks: inventories of foreign currencies 5. foreign exchange brokers: middleman between buyers and sellers 6. central banks: banks for banks Exchange Rate Risk • exchange rate risks stem from the fact that currencies are constantly changing in value • expected future payments in a foreign currency will likely be a different domestic currency  amount from when the contract was signed • firms that do business in more than one country are thus subject to exchange rate risk • forward exchange rate: the price of currency that will be delivered in the future; allows an  exporter or importer to sign a currency contract that guarantees a set price for the foreign  currency in either 30, 90, 180 days into the future • forward market: a market in which the buying and selling of currencies for future delivery  takes place; important mechanism for exporters, importers, financial investors, and  speculators • spot market: buying and selling of foreign currencies in the present


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