Instructors Manual - By John Mathis For International Monetary and F...

Instructor’s Manual By John Mathis For International Monetary and Financial Economics 1st Edition By Joseph P. Daniels David D. Van Hoose 1 / 4

1 © 2014 Pearson Education, Inc Chapter 1 Keeping Up with a Changing World—Trade Flows, Capital Flows, and the Balance of Payments Chapter Outline International Economic Integration: The Importance of Global Trade and Financial Markets The Balance of Payments Examples of International Transactions and How they Affect the Balance of Payments The Capital Account and the International Flow of Assets Relating the Current Account Balance and Capital Flows Chapter Summary Questions and Problems Online Application Selected References and Further Reading Teaching Tips Part 1, Chapter 1: Issues to discuss or research on the web: 1.The World has changed structurally as there has been an increase in global transactions. This globalization of economic activity involves the expansion of international trade between nations, but the growth in international financial flows has been much more significant. Thus there has been an increasing “interconnectedness” between countries. The U.S. economy is affected increasingly by what happens in other countries, and the United States has a greater impact on other countries. In terms of international trade (real side—goods and services transactions—think of the global supply chains that bring fresh food, clothing, and retail products into the megacities of the World. Look at the number of students from other countries in your classes. In terms of the financial side, the liberalization of many major global financial markets, the rise in the number of affluent wealth holders seeking diversification and higher returns, and the growing size and number of global economies has had an even larger impact on the explosion in the average daily value of financial flows. This expansion has been helped by advances in technology and computers, telecommunications, and transportation. Globalization has helped facilitate corporate access to markets, labor sources (outsourcing), resources, and knowledge worldwide so these companies can remain competitive globally.

2.The measurement of this increasing globalization and market interconnectedness is accomplished using the balance of payments of a country relative to all other countries. The balance of payments (normally measured in U.S. dollars) captures the sources and uses of the funds of a nation in terms of both a current account balance and a financial account balance, which normally 2 / 4

• ❖ Daniels/Van Hoose, International Monetary and Financial Economics

© 2014 Pearson Education, Inc are determined by market forces. The current account measures the real sector of an economy in terms of exports, less imports of both goods and services. The financial sector is reflected in the financial account, which captures the inflow of funds less the outflow of funds measured in terms of different time periods: long-term or net foreign direct investment and short-term or net portfolio investment. International financial flows far exceed trade flows which add to the international volatility and uncertainty on both the financial (financial markets) and real side (real GDP growth/unemployment) of an economy. There is a third account in the balance of payments which is the official settlements account reflecting government transactions including currency intervention. The overall balance of payments position expresses if the sum of debits and credits from each of the three accounts is positive or negative, and in balance when equal to zero or equilibrium, representing the most efficient allocation of resources. Work students through the details of balance of payments transactions.

3.From an analytical standpoint, how do we link the balance of payments to the domestic economy?The current account balance is determined by the difference between the value of domestic expenditures and production, as this equals how much is imported and exported. Domestic investment may be financed by domestic savings or net financial inflows from overseas, which equal the financial account. So, the current account and financial account are expected to be equal. Sizeable current account deficits result from large financial inflows that finance the gap between domestic saving and investment and help to finance job-creating private investment expenditures. Therefore, that the United States is a net debtor nation or that the net international investment position is negative may not be good or bad. Financial inflows can add to a nation’s capital stock and increase the purchasing power of those that are hired to work.Suggested Answers to End of Chapter Questions 1.a. A local college student travels abroad for the holidays and spends $1,000 on food and lodging.Goods Services Income Unilateral Transfers Current Account Debit –$1,000 –$1,000 Credit b.A local auto dealership imports a $20,000 automobile.Goods Services Income Unilateral Transfers Current Account Debit –$20,000 –$20,000 Credit 3 / 4

Chapter 1/Keeping up with a Changing World ❖ 3 © 2014 Pearson Education, Inc

• The home government gives a drought-stricken nation $1 million as a humanitarian gesture.

Goods Services Income Unilateral Transfers Current Account Debit –$1,000,000 –$1,000,000 Credit

• You receive a $100 interest payment on a foreign government bond you own.

Goods Services Income Unilateral Transfers Current Account Debit Credit $100 $100

• A $21,000 deficit
• A deficit of $1,020,900.
• A surplus of $1,020,900.
• The balance on merchandise trade is 719 – 1,145 = –426. The balance on goods, services, and income

is –426 + 279 – 210 + 284 – 269 = –342. (Note: See Table 1-5 for the recording of income payments and receipts.) The current account balance is –342 –49 = –391.

• The current account balance plus the capital account balance plus the statistical discrepancy totals

zero. Hence, the capital account balance is a surplus of 380 (–391 + 11 = –380).

• Ignoring a statistical discrepancy, a balance-of-payments equilibrium is when the sum of the debits

and credits in the current account and the private capital account total zero such that the official settlements balance is zero. Because we do not know the official settlements balance, we cannot say if this situation is a balance-of-payments deficit, surplus, or equilibrium.

• The sum of lines (12) and (22) are negative, indicating a balance of payments deficit.
• Positive aspects of being a net debtor include the possibility of financing domestic investment that is

not possible through domestic savings, thereby allowing for domestic capital stock growth which may allow job, productivity, and income growth. Negative aspects include the fact that foreign savings may be used to finance domestic consumption rather than domestic savings, which will compromise the growth suggested above.Positive aspects of being a net creditor include the ownership of foreign assets which can represent income flows to the crediting country. Further, the net creditor position also implies a net exporting position. A negative aspect of being a net creditor includes the fact that foreign investment may substitute for domestic investment.

• A nation may desire to receive both portfolio and direct investment due to the type of investment each

represents. Portfolio investment is a financial investment while direct investment is dominated by the

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