International Monetary Economics Lecture Notes PDF

International Monetary Economics KARLO MARTIN C. CARAMUGAN Assistant Professor, CAEc International Monetary Economics International monetary economics (also referred to as international macroeconomics or international finance) is the branch of financial economics broadly concerned with...

International Monetary Economics KARLO MARTIN C. CARAMUGAN Assistant Professor, CAEc International Monetary Economics International monetary economics (also referred to as international macroeconomics or international finance) is the branch of financial economics broadly concerned with monetary and macroeconomic interrelations between two or more countries. International monetary economics examines the dynamics of the global financial system, international monetary systems, balance of payments, exchange rates, foreign direct investment, and how these topics relate to international trade. Balance-of-Payments (BoP) A country’s international transactions are recorded in the balance-of-payments accounts. Balance-of-Payment Current Record of exports and imports of goods and services and international receipts or payments of income. Account Exports of goods and services and income receipts enter with a plus Imports of goods and services and income payments enter with a BoP minus. Financial Record of transactions in financial assets between residents and nonresidents. Account Sales of assets to nonresidents represent an export of an asset and are given a positive sign in the financial account Purchases of assets from nonresidents represent an import of a financial asset and enter the financial account with a negative sign. Example Current Account Financial Account If a Filipino buys a Samsung smartphone from If a Filipino pays for the phone with Philippine South Korea for P40,000, then the Philippine currency, then this represents a sale (export) of current account goes down by P40,000. Philippine financial assets (currency) to a South Korean resident in the amount of P40,000.  This transaction represents an import of Accordingly, the South Korean financial goods worth P40,000. account records a positive entry of P40,000. If a Filipino company pays P100,000 in dividends to an American shareholder and the exchange In the example of the dividend receipt, the rate is 50 pesos per dollar (50:1), then the U.S. American resident ‘imports’ P100,000 from the current account increases by $2,000. Filipino company, so the U.S. financial account Conversely, the Philippine Current Account goes down by $2,000 (or P100,000). would decrease by P100,000.00.  This transaction represents an international income receipt of a U.S. resident in this amount. Double-entry bookkeeping Current Financial To illustrate: Account Account Suppose that a Japanese friend of yours named Each transaction enters the balance Monkey D. Luffy comes to visit you in Davao City and of payments twice. Once with a stays at the Marco Polo Hotel. positive sign and once with a negative sign. Luffy pays P5,000 for his lodging using his Japanese Credit Card. In this case, the Philippines is exporting a An implication of the double-entry service (hotel accommodation), so the Philippine bookkeeping methodology is that current account increases by P5,000. any change in the current account must be reflected in an equivalent At the same time, Marco Polo Hotel(a Filipino Hotel) change in the country’s financial purchases (imports) a financial asset worth P5,000 account. which decreases the Philippine financial account by P5,000 (disregarding the exchange rate).  Illustration of double-entry in BoP GOODS AND SERVICES PH Import SK Export Current Current Account Account Financial Financial South Korea Account Account Philippines SK Import PH Export CURRENCY  Current Account Capital Keeps record of international BoP Account transfers of financial capital. E.g. Debt forgiveness and migrants’ transfers such as goods and financial assets accompanying migrants as Financial they leave or enter the country. Account  Detailed decomposition of the CURRENT ACCOUNT Current Account Balance Merchandise Services Trade Balance Trade Balance Balance Net International Net Investment Income Balance Compensation to Income Employees Net Unilateral Transfers Detailed decomposition of the TRADE BALANCE Merchandise Services Trade Balance Trade Balance Balance Trade Balance, or Balance on Services Balance is Goods and Services, keeps The Merchandise Trade given by net exports of record of net exports (i.e., the Balance, or Balance on services, such as difference between exports Goods, is given by net transportation, travel and imports) of goods and exports of goods. expenditures, and legal services assistance. What happens There will be a negative There will be a decrease There will be a when to the MTB Δ in Trade Balance. in your Current Account, reduction in your when a country’s Hence, a country’s holding other accounts Balance-of-Payment import of GAS trade balance will be constant. exceeds its exports? negative.  Detailed decomposition of the INCOME BALANCE Net Investment Net International Income Balance Compensation to Income Employees Positive Entry INCOME RECEIPTS on PH-owned (1) earnings of PH residents employed temporarily foreign assets enters the income abroad, Income Balance is the balance with a positive sign. (2) earnings of PH residents employed by foreign net investment It includes items such as governments in the United States, and international interest and dividend (3) earnings of PH residents employed by income is given by the international organizations located in the receipts and earnings (distributed or difference between reinvested) of PH-owned firms Philippines, such as the United Nations, the income receipts on operating abroad (PH-owned firms International Rice Research Institute, Asian located abroad owning foreign Development Bank etc. Philippine-owned assets) foreign assets and income payments on INCOME PAYMENTS on foreign- Negative Entry- Payments by PH residents or institutions to: foreign-owned owned PH-assets enter the income (1) Foreign students studying in the PH (mostly at the balance with a negative sign. Philippine assets. Examples of such income payments graduate level); (2) Foreign professionals temporarily residing in the PH; are interest paid on PH government and bonds, interest paid on PH (3) Foreign temporary workers in the PH. corporate bonds, and dividends paid on PH stocks  Net Unilateral Transfers WB Definition: Secondary income refers to transfers recorded in the balance of payments whenever an Keeps record of the difference between economy provides or receives goods, services, gifts (e.g. payments that do not income, or financial items without a quid pro quo. correspond to purchases of any good, service, or asset) received from the rest Is it possible to have a negative entry for net of the world and gifts made by the PH to unilateral transfers? foreign countries. YES. This happens when a country made more It is often used to describe payments gifts to other nations than it received. made by a government to their citizens, or from one country to another country On the contrary, a positive entry in NUT implies in the form of foreign aid. that a country receives more gifts than it gives. Detailed decomposition of the FINANCIAL ACCOUNT Financial Account Balance PH securities held by foreign residents; Increase (Δ) in Foreign- PH currency held by foreign residents, owned assets in the PH PH borrowing from foreign banks, and Foreign direct investment in the PH. Increase (Δ) in PH-owned Foreign securities; assets abroad. PH bank lending to foreigners, and PH direct investment abroad. International transaction generating two offsetting entries in the financial account International transactions that involve the exchange of financial assets generate two entries in the financial account and no entry in the current account. Suppose: Positive entry- the sale, Negative entry- the or export, of dollars to purchase, or import, of A PH resident purchases shares* from Ford US. equity shares from US. in US using US dollars. The financial account receives both a positive entry and a negative entry. *Note that the problem as given does NOT refer to Shares are units of equity ownership DIVIDEND or residual income received as a shareholder interest in a corporation that exist as a in a company. Because if it is an income receipt or financial asset providing for an equal payment (like dividend from share) then the account distribution in any residual profits, if any are falls under the Current Account. declared, in the form of dividends. International transaction generating two offsetting entries in the current account Suppose: The PH donates vaccines, PPE and other medicines worth P100 million to an African country afflicted by COVID-19. This gift gives rise to a positive entry of P100 million in the merchandise trade balance (the export of the donated goods), and a negative entry in the same amount in net unilateral transfers.  CURRENT ACCOUNT BALANCE + A. Trade Balance + Merchandise Trade Balance Services Balance Summary + B. Income Balance + Net Investment Income Net International Compensation to Employees + C. Net Unilateral Transfers FINANCIAL ACCOUNT BALANCE + D. Increase (Δ) in Foreign-owned assets in the PH E. Increase (Δ) in PH-owned assets abroad.  The terms current account deficit and trade Current Account deficit are often used interchangeably, but they have substantially different meanings. Deficit versus A current account deficit occurs when a country spends more on imports than it receives on exports. Trade Deficit A trade deficit happens when a country's imports exceed its exports.  The term net international investment position (NIIP) is used to refer to a country’s net foreign wealth (i.e. Value of foreign assets owned by the Net International Investment country’s residents less the value of the country’s assets owned by foreign residents). Position (NIIP) and the Current Account When the net international investment position is negative, it is referred to as the country’s external debt. Current Account Balance is economically important One reason why the concept of current account balance is economically important is that it reflects a country’s net borrowing needs. NIIP is a stock variable while CAB is a flow Suppose PH ran a current account deficit variable. (meaning imports is greater than exports of goods/services). The level of water in the tank (a stock) is the net international investment position of the country. The current account is the flow of water that To pay for this deficit, PH must have either might enter or leave the tank through pipes. reduced part of its international asset position (by exporting currency) or increased its international liability position or both. In this way, the current account is related to changes in a country’s net international investment position (NIIP).  When the flow of water that enters the tank through pipes (exports; interest and dividend received from investments in foreign countries) is larger than the flow of water that leaves the tank (imports; interest and dividend paid on foreign investments in the country), the current account is positive, and the stock of water in the tank, the NIIP, rises overtime. By contrast, when the flow of water that leaves the tank is larger than the flow of water that enters the tank, the current account is negative, and the level of water in the tank, the NIIP, falls over time. What does this mean? This means that changes in the NIIP is primarily determined by the CAB. Net International Investment Position 1. A net international investment position (NIIP) measures the gap between a nation’s stock of foreign assets and a foreigner's stock of that nation's assets. E.g. Philippine holding of US Dollars minus US holding of Philippine Peso. 2. It can be viewed as a nation’s balance sheet with the rest of the world at a specific point in time. 3. NIIP is an important barometer of a nation’s financial condition and creditworthiness. 4. A nation with a positive NIIP is a creditor nation, while a nation with a negative NIIP is a debtor nation.