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ECONOMICS 3150M

ECONOMICS 3150M. Winter 2014 Professor Lazar Office: N205J, Schulich flazar@yorku.ca 736-5068. Lecture 3: January 13 Ch. 14. Balance of Payments. Finance Account : transactions involving financial assets Direct investment Portfolio investments Other: loans, deposits

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ECONOMICS 3150M

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  1. ECONOMICS 3150M Winter 2014 Professor Lazar Office: N205J, Schulich flazar@yorku.ca 736-5068

  2. Lecture 3: January 13Ch. 14

  3. Balance of Payments • Finance Account: transactions involving financial assets • Direct investment • Portfolio investments • Other: loans, deposits • Capital inflow – credit in capital account [CNOOC acquires Nexen] • Capital outflow – debit in capital account [TD acquires US bank] • Official reserve transactions by central banks: official settlement balance • Unilateral transfers: repatriation of income; foreign aid • Sum of all accounts in each country = 0 (equilibrium in foreign exchange markets) • Debits  supply of Canadian $ • Credits  demand for Canadian $

  4. Canada’s Finance Account (C$ M)

  5. Bank of Canada, International Reserves • As of December 15, 2013, the Bank of Canada held a total of $72 billion in international reserves, consisting of the following:   • U.S. dollars: $39.7 billion: • Other foreign currencies: $18.9 billion; • Gold: $120 million; • Special drawing rights with the IMF: $8.7 billion; and • Reserves with the IMF: $4.6 billion • The Bank’s holdings of international reserves increased $18.5 billion between September 8, 2009 and December 15, 2012

  6. Top 25 Countries with Foreign Exchange Reserves, December 31, 2011(US$ B)

  7. National Income Accounts • Y – (C + I +G) = CU • Y < (C + I + G)  CU < 0 • Domestic demand > domestic production (case of US) • CU =  net foreign wealth = - FA (Finance account balance) • CU < 0,  US borrows from foreigners  FA > 0 • Net foreign debt  • CU > 0,  China lends (invests) to (in) foreigners  FA < 0 • Net foreign debt 

  8. Canada’s International Investment Position (C$ M)

  9. Globalization • Expanded economic interaction among countries • Anything that makes it easier to buy/sell goods across borders • Anything that makes it easier for an investor to invest in securities originating in another country • Anything that makes it easier for a worker in one country to travel and seek employment in another

  10. Globalization • Recycling from countries with current account surpluses to countries with current account deficits • Current account balance + capital account balance - change in official holdings of reserves = 0 • Countries with current account deficits (surpluses) must either generate capital account surpluses (deficits) or central banks must be selling (buying) foreign reserves or both

  11. Globalization • Recycling can take place smoothly as long as foreign investors have confidence in country with current account deficit • If confidence shaken, foreign investors will expect significant risk premium – loss of confidence will result in capital outflows, depreciation of currency and higher interest rates • Slippery slope: capital outflows worsen confidence, higher interest rates and possible liquidity squeeze reduce economic growth and reduce asset values – threaten viability of banking sector and major companies • IMF intervention may be necessary to restore confidence (IMF mandates economic policies of government in exchange for assistance) • IMF, World Bank and major central banks are lenders of last resort to countries

  12. Globalization • Trade and economic interdependence spills over and affects exchange rates, interest rates, rate of domestic economic growth, financial position of governments, profitability of domestic companies • If US economy slows down, decrease in demand for Canadian products (exports of goods and services to the US), so economic slowdown spills over into Canada • World trade declined in 2008 for first time in over 50 years because of global recession resulting from spillover form U.S.

  13. Changes in Net Foreign Wealth • Consider case of US – largest debtor country in history • Net international investment position of US, 2011: -$3,731 B • US owned assets abroad: $21,636 B • Foreign owned assets in US: $25,367 B • Net international investment position, 2012: -$3,864 B • US owned assets abroad: $21,628 B • Foreign owned assets in US: $25,502 B • Changes in 2008: • Financial flows: -$439 B • Price changes : $490 B • Exchange rate changes: $5 • Other: -$189

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