Workshop 12

Balance of Payments and Exchange rates

1. The following are the various elements of the UK balance of payments account: (a) (b) (c) (d) (e) (f) (g) (h) (i) ($) (%) (l) (m) (n) Imports of goods () Exports of goods ( ) Imports of services () Exports of services ( ) !ther income and current outflows () !ther income and current inflows ( ) Transfers of capital from the UK (") Transfers of capital to the UK ( ) #irect and portfolio UK investment overseas () #irect and portfolio investment in UK ( ) !ther (mainly short&term) financial outflows () !ther (mainly short&term) financial inflows ( ) 'dding to reserves () #rawing on reserves ( )

Into which of the above categories would you put the following( (i) (ii) (iii) (iv) (v) (vi) (vii) (viii) (ix) (x) )ideo recorders imported from *apan+++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++ Insurance cover purchased at ,loyds in ,ondon by overseas residents+++++++++++++++++++++++++++++++ UK gives aid to finance capital pro$ect in a developing country++++++++++++++++++++++++++++++++++++++++++ *apanese car company purchases factory in UK++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++ UK residents ta%ing holidays in -lorida+++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++ Interest earned by UK residents on assets abroad++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++ .unning down the stoc% of foreign exchange in the /an% of England++++++++++++++++++++++++++++++++ 0ew deposits made in ban%s in the UK by overseas residents+++++++++++++++++++++++++++++++++++++++++++++ 1cotch whis%y sold in -rance+++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++ UK insurance company sets up branch in 2anada+++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++

Workshop 12

Balance of Payments and Exchange Rates

2.

The following shows how the UK3s balance of payments account is set out+
CREDITS DEBITS

(4) Exports of goods

(5) Imports of goods 1 2 = Balance on trade in goods (6) Exports of services (7) Imports of services 3 4 = Balance on trade in services (1 2) + (3 4) = Balance on trade in goods and services (8) Incomes and current transfers from abroad (9) Incomes and current transfers going abroad 5 6 = Other income flows (1 2) + (3 4) + (5 6) = Current account balance (:) Transfers of capital to UK from abroad (;) Transfers of capital abroad from UK ! Capital account balance (<) 0et investment in the UK from abroad (4=) UK net investment abroad (44) 1hort&term financial inflows to UK (45) 1hort&term financial outflows from UK either (46) #rawing on reserves or (47) 'dding to reserves (" 1#) + (11 12) + (either 13 or 14) = Financial account balance $%rrent acco%nt &alance + $a'ital acco%nt &alance + (inancial acco%nt &alance = Overall &alance of 'a)ments Overall &alance of 'a)ments 'l%s net errors and omissions = #

The following are the items in the UK3s 5=== balance of payments (> billions) Exports of services++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++9:+5 Exports of goods+++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++4;:+4 UK net investment abroad (direct and portfolio)++++++++++++++++++++++++++++58=+9 .eserves (adding to ? "ve)++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++"6+< 1hort&term financial inflows to UK+++++++++++++++++++++++++++++++++++++++++++++++++5;4+; 1hort&term financial outflows from UK++++++++++++++++++++++++++++++++++++++++++5:=+< 2apital transfers to UK from abroad+++++++++++++++++++++++++++++++++++++++++++++++++++5+; 2apital transfers abroad from the UK+++++++++++++++++++++++++++++++++++++++++++++++++=+; 0et incomes and current transfers from@to abroad++++++++++++++++++++++++++++ 4+: Imports of goods+++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++548+< Imports of services++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++89+6 0et investment in the UK from abroad (direct and portfolio)+++++++++59=+; Using the table aboveA wor% out the figures for the UK for the following: (a) The balance on trade in goods and services+++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++ (b) The current account balance++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++ (c) The capital account balance+++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++ (d) The financial account balance+++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++ (e) 0et errors and omissions++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++

Workshop 12

Balance of Payments and Exchange Rates

3.

The following diagram shows a demand curve and supply curve of sterling against the euro+

1.80 1.70 1.60 1.50 1.40 1.30

Q of sterling

(a) Bho is demanding sterling in the diagram and for what purpose( +++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++ (b) Bho is supplying sterling in the diagram and for what purpose( +++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++ (c) Car% the eDuilibrium exchange rate+ (d) 0ow illustrate the effect of an increased demand for sterling and a decreased supply+ (e) Eas the exchange rate appreciated or depreciated(***********************+''reciated , -e'reciated 4. 'ssume that there is a free&floating exchange rate+ Bill the following cause the exchange rate to appreciate or depreciate( In each case you should consider whether there is a shift in the demand or supply curves of sterling (or both) and which way the curve(s) shift(s)+ (a) Imports increase+ #emand curve shift left , right , no shift 1upply curve shift left , right , no shift Exchange rate a''reciates , de'reciates #emand curve shift left , right , no shift 1upply curve shift left , right , no shift Exchange rate a''reciates , de'reciates

(b) UK interest rates rise relative to those abroad+

(c) The UK experiences a lower rate of inflation than other countries (assuming no change in interest rates)+ #emand curve shift left , right , no shift 1upply curve shift left , right , no shift Exchange rate a''reciates , de'reciates (d) 1peculators believe that the rate of exchange will fall+ #emand curve shift left , right , no shift 1upply curve shift left , right , no shift Exchange rate a''reciates , de'reciates

Workshop 12

Balance of Payments and Exchange Rates

5.

'ssume that the government wishes to pursue a deflationary policy+ (a) Bhat will happen to the exchange rate if it uses deflationary monetary policy( +''reciate , -e'reciate (b) Bhat effect will this exchange rate movement have on aggregate demand( .ncrease it , -ecrease it (c) Bhat will happen to the exchange rate if it uses deflationary fiscal policy( +''reciate , -e'reciate (d) Bhat effect will this exchange rate movement have on aggregate demand( .ncrease it , -ecrease it

6.

The use of interest rates as the main instrument for stabilising the exchange rate can often led to conflicts with internal policy ob$ectives+ In which of the following cases is there a clear conflict between internal and external policy ob$ectivesA if interest rate changes are the only policy instrument available to the government or central ban% for achieving both sets of ob$ectives( (a) The government (or central ban%) wants to prevent an appreciation of the exchange rate and to reduce demand&deficient unemployment+ /es,0o (b) The government (or central ban%) wants to help domestic exporters and to reduce the rate of inflation+ /es,0o (c) The government (or central ban%) wants to reduce the price of imports and to curb the rate of growth in the money supply+ /es,0o (d) The government (or central ban%) wants to prevent a depreciation of the exchange rate and to stimulate investment+ /es,0o (e) The government (or central ban%) wants to halt a rise in the exchange rate and to reduce the rate of growth of the money supply+ /es,0o (f) The government (or central ban%) wants to reverse a recent fall in the exchange rate and to reduce its unpopularity with home owners+ /es,0o

7.

Bhich of the following are li%ely to contribute to the volatility of exchange rates between the ma$or currencies( (a) (b) (c) (d) (e) (f) (g) ' growth in the siFe of short&term capital flows relative to current account flows+ /es,0o The abolition of exchange controls+ /es,0o ' harmonisation of international macroeconomic policies+ /es,0o The adoption of money supply targets by individual countries+ /es,0o The adoption of exchange rate targets by individual countries+ /es,0o The adoption of inflation targets by individual countries+ /es,0o ' growing belief that speculation against exchange rate movements is li%ely to be stabilising+ /es,0o (h) ' growing belief that speculation against exchange rate movements is li%ely to be destabilising+ /es,0o (i) ' growing ease of international transfers of funds+ /es,0o ($) 2ountries3 business cycles become more synchronised with each other+ /es,0o