International EconomicsInternational EconomicsMordecai E. KreininMordecai E. Kreinin

Copyright ©2002 South-Western/Thomson Learning.All rights reserved.

Copyright ©2002 South-Western/Thomson Learning.All rights reserved.

Part IIInternational Financial Relations

Part IIInternational Financial Relations

C13-2

CHAPTER 13CHAPTER 13

Domestic Policies to Adjust the Balance of

Payments

Domestic Policies to Adjust the Balance of

Payments

C13-3

OVERVIEWOVERVIEW

“Automatic” Processes

Summary of the “Automatic” Balance-of-Payments Adjustment

Government Policy

Foreign Repercussions

The Balance of Payments in the Context of General Policy Objectives

Some Unanswered Questions

“Automatic” Processes

Summary of the “Automatic” Balance-of-Payments Adjustment

Government Policy

Foreign Repercussions

The Balance of Payments in the Context of General Policy Objectives

Some Unanswered Questions

C13-4

Important ConceptsImportant Concepts Marginal propensity to

consume

Marginal propensity to save

Marginal propensity to import

Multiplier

Foreign trade multiplier

Specie-flow mechanism

Velocity (V)

Demand elasticity

Automatic adjustment mechanism

Monetary policy

Fiscal policy

IMF conditionality

Expenditures-changing policies

Portfolio capital

Portfolio approach

Locomotive country

Foreign repercussions

Consistent situation

Inconsistent situation

Degree of impact

Time lags

Incompatible trinity

C13-5

“Automatic” Processes“Automatic” Processes The Monetary Mechanism Imbalance and Money Supply Add Direct Effect on Private Expenditures

Income changes Price changes MPC, MPS, MPM The multiplier X and GDP

Additional Insights: The specie-flow mechanism The equation of exchange Keynesian Position

The Monetary Mechanism Imbalance and Money Supply Add Direct Effect on Private Expenditures

Income changes Price changes MPC, MPS, MPM The multiplier X and GDP

Additional Insights: The specie-flow mechanism The equation of exchange Keynesian Position

C13-6

Additional Insights:The Foreign Trade MultiplierAdditional Insights:The Foreign Trade Multiplier

Marginal propensity to consume

Marginal propensity to save

Marginal propensity to import

Income and Price Mechanisms

Trade and the national economy

Marginal propensity to consume

Marginal propensity to save

Marginal propensity to import

Income and Price Mechanisms

Trade and the national economy

C13-7

Summary of the “Automatic” Balance-of-Payments AdjustmentSummary of the “Automatic” Balance-of-Payments Adjustment

Automatic adjustment mechanism under fixed exchange rates, a function of aggregate expenditures, money supply—operating in same direction, affecting economy through income and price mechanism

Automatic adjustment mechanism under fixed exchange rates, a function of aggregate expenditures, money supply—operating in same direction, affecting economy through income and price mechanism

The Four Linkages Involved in Automatic Adjustment Mechanism Under Fixed

Exchange Rates

The Four Linkages Involved in Automatic Adjustment Mechanism Under Fixed

Exchange Rates

C11-8

C13-9

Summary of the “Automatic” Balance-of-Payments AdjustmentSummary of the “Automatic” Balance-of-Payments Adjustment

Deficit vs. surplus in balance of payments

Marginal propensity to import

Improved competitive position and price elasticity

Money supply mechanism, sterilization

Surplus, deficit contain seeds of reversal

Under fixed exchange rate, income and price influence balance of payments in corrective direction

Under floating exchange rate, above applies to current account

Deficit vs. surplus in balance of payments

Marginal propensity to import

Improved competitive position and price elasticity

Money supply mechanism, sterilization

Surplus, deficit contain seeds of reversal

Under fixed exchange rate, income and price influence balance of payments in corrective direction

Under floating exchange rate, above applies to current account

Automatic Processes that Reverse External Imbalance under a Stable Exchange Rate

Automatic Processes that Reverse External Imbalance under a Stable Exchange Rate

FIGURE 13.1FIGURE 13.1

C11-10

C13-11

Government PolicyGovernment Policy

Domestic Policy Measures and the Current Account Expenditure-changing policies

Effect on Direct Investment Capital Effect on Other Capital Movements

Portfolio capital Portfolio approach Monetary and fiscal policies Monetary contraction

Domestic Policy Measures and the Current Account Expenditure-changing policies

Effect on Direct Investment Capital Effect on Other Capital Movements

Portfolio capital Portfolio approach Monetary and fiscal policies Monetary contraction

C13-12

Foreign RepercussionsForeign Repercussions

Leading industrial nation has additional responsibility for fate of other countries

To calculate foreign trade multiplier effect of any policy, foreign repercussions must complete circuit and affect policy-originating country

No country completely free to pursue independent domestic policies

Coordinated reduction of interest rates

Giving up fixed exchange rates or independent monetary policy

Leading industrial nation has additional responsibility for fate of other countries

To calculate foreign trade multiplier effect of any policy, foreign repercussions must complete circuit and affect policy-originating country

No country completely free to pursue independent domestic policies

Coordinated reduction of interest rates

Giving up fixed exchange rates or independent monetary policy

Foreign repercussions can be shown schematically for a two-country world, where country A experiences an autonomous increase in its exports to country B:

Foreign repercussions can be shown schematically for a two-country world, where country A experiences an autonomous increase in its exports to country B:

C11-13

Country A Country B

C13-14

The Balance of Payments in the Context of General Policy ObjectivesThe Balance of Payments in the Context of General Policy Objectives

Consistent situations

Inconsistent situations

Internal balance, external balance

Relationship of balance of payments to other economic goals

Consistent situations

Inconsistent situations

Internal balance, external balance

Relationship of balance of payments to other economic goals

C13-15

Some Unanswered QuestionsSome Unanswered Questions

Degree of Impact

Economic estimation

Time Lags

Degree of Impact

Economic estimation

Time Lags

C13-16

SummarySummary Domestic policies to restore balance of payments

under fixed exchange regime Application to current account under flexible rate

regime Multiplier effect Deficits, surpluses Automatic mechanisms provide partial remedies Fiscal and monetary measures, expansionary

policies Consistent and inconsistent situations

A Hypothetical Import FunctionBased on Table A13-1.1

A Hypothetical Import FunctionBased on Table A13-1.1

FIGURE A13-1.1FIGURE A13-1.1

C1-17

A Hypothetical Export FunctionA Hypothetical Export Function

FIGURE A13-1.2FIGURE A13-1.2

C1-18

Derivation of Total Injection

andTotal

Leakage Functions

Derivation of Total Injection

andTotal

Leakage Functions

FIGURE A13-1.3FIGURE A13-1.3

C1-19

Equilibrium Output (YE)Occurs Where (S + M) = (I + X);

Capital-Exporting Country (such as Japan)

Equilibrium Output (YE)Occurs Where (S + M) = (I + X);

Capital-Exporting Country (such as Japan)

FIGURE A13-1.4FIGURE A13-1.4

C1-20

A Capital-Importing Country(such as The United States):

I >S and M > X; (I – S) = (M – X)

A Capital-Importing Country(such as The United States):

I >S and M > X; (I – S) = (M – X)

FIGURE A13-1.5FIGURE A13-1.5

C1-21

Effect on GDP of an Increase in (I + X)Effect on GDP of an Increase in (I + X)

FIGURE A13-1.6FIGURE A13-1.6

C1-22