Llad Phillips 1 Introduction to Economics Microeconomics The World Economy.

Llad PhillipsLlad Phillips 11

Introduction to Economics

MicroeconomicsMicroeconomics

The World EconomyThe World Economy


Outline: Lecture Sixteen

The US in the World EconomyThe US in the World Economy Balance of Payments AccountingBalance of Payments Accounting Puchasing Power ParityPuchasing Power Parity Central Bank Reserves & Foreign Exchange Central Bank Reserves & Foreign Exchange

InterventionIntervention


Exports of Goods and Services as Fraction of GDP, 1929-1995 .

0

0.02

0.04

0.06

0.08

0.1

0.12

19291933193719411945194919531957196119651969197319771981198519891993Year

Fraction

Exports as % of GNP

Linear (Exports as % ofGNP)


Growth in World TradeGrowth in World Trade

Source: Source: Economic Report of the President, 1997 Economic Report of the President, 1997

http://www.gpo.ucop.edu/catalog/erp97.htmlhttp://www.gpo.ucop.edu/catalog/erp97.html


Measuring the Balance of Trade

Merchandise Balance of Trade: goodsMerchandise Balance of Trade: goods Balance of Trade ( Net Exports) : add Balance of Trade ( Net Exports) : add

servicesservices Balance on Current Account: Balance on Current Account:

– first: add net transfer paymentsfirst: add net transfer payments– second: add income from US assets abroadsecond: add income from US assets abroad


Balance of Payments Merchandise Trade BalanceMerchandise Trade Balance

– Exports of GoodsExports of Goods capital goods, except automotive: 41%capital goods, except automotive: 41% industrial supplies and materials: 24%industrial supplies and materials: 24% consumer goods, except automotive: 11%consumer goods, except automotive: 11% automotive vehicles, engines & parts: 11%automotive vehicles, engines & parts: 11% foods, feeds, beverages: 9%foods, feeds, beverages: 9%


Balance of Payments (Cont.)

– Imports of GoodsImports of Goods capital goods, except automotive: 29%capital goods, except automotive: 29% industrial supplies and materials: 25%industrial supplies and materials: 25% consumer goods, except automotive: 21%consumer goods, except automotive: 21% automotive vehicles, engines & parts: 16%automotive vehicles, engines & parts: 16% foods, feeds, beverages: 4%foods, feeds, beverages: 4%


Source: CIASource: CIA


Balance on Goods: Merchandise Trade Balance, US 1996 .

0

100000

200000

300000

400000

500000

600000

700000

800000

900000

Exports Imports

Millions $

Source: US Dept. of Commerce, Survey of Current Business


Balance on Merchandise, US , 1946-1996, Millions $ .

-200000

-100000

0

100000

200000

300000

400000

500000

600000

700000

800000

900000

46 49 52 55 58 61 64 67 70 73 76 79 82 85 88 91 94

Year

Millions $

Exports, $MImportsMerchandise Net

Source: Economic Report of the President, 1997


Balance of Payments Merchandise Trade BalanceMerchandise Trade Balance Balance of Trade: Net Exports(component Balance of Trade: Net Exports(component

of GNP)of GNP)– Exports of Goods and ServicesExports of Goods and Services

other private services: 31%other private services: 31% travel: 30%travel: 30% royalties and license fees: 13%royalties and license fees: 13%

– Imports of Goods and ServicesImports of Goods and Services travel: 31%travel: 31% other private services: 27%other private services: 27% other transportation: 18%other transportation: 18%


Balance of Trade: Goods and Services, US, 1996 .

0

100000

200000

300000

400000

500000

600000

700000

800000

900000

1000000

Exports Imports

Millions $

Services

Goods


Balance of Trade: Goods and Services, US, Millions $ .

-200000

-150000

-100000

-50000

0

50000

100000

46 49 52 55 58 61 64 67 70 73 76 79 82 85 88 91 94

Year

Millions $

Merchandise Net

Services Net

Balance of Trade


Balance of Payments Merchandise Trade Balance: GoodsMerchandise Trade Balance: Goods Balance of Trade: Goods & ServicesBalance of Trade: Goods & Services Balance on Current AccountBalance on Current Account

– Exports of goods & services Exports of goods & services plus net transfer plus net transfer payments plus US income on assets abroadpayments plus US income on assets abroad

– Imports of goods & services Imports of goods & services plus net transfer plus net transfer payments plus foreign income on assets in US payments plus foreign income on assets in US

transferstransfers– US Government grantsUS Government grants

– US Government pensions & otherUS Government pensions & other

– private remittancesprivate remittances


Balance on Current Account, US, 1996, (Except Asset Income) .

0

100000

200000

300000

400000

500000

600000

700000

800000

900000

1000000

Exports Imports

Millions of $

transfers, net

Services

Goods


US Balance of Trade and Net Transfers .

-160000

-140000

-120000

-100000

-80000

-60000

-40000

-20000

0

20000

46 49 52 55 58 61 64 67 70 73 76 79 82 85 88 91 94

Year

Millions $ Balance of Trade

transfers, net


Balance of Payments Merchandise Trade Balance: GoodsMerchandise Trade Balance: Goods Balance of Trade: Goods & ServicesBalance of Trade: Goods & Services Balance on Current AccountBalance on Current Account

– Exports of goods & services plus net transfer Exports of goods & services plus net transfer payments plus US income on assets abroadpayments plus US income on assets abroad

US income on assets abroadUS income on assets abroad– direct investment receiptsdirect investment receipts

– other private receiptsother private receipts

– US government receiptsUS government receipts

– Imports of goods & services plus net transfer Imports of goods & services plus net transfer payments plus foreign income on assets in US payments plus foreign income on assets in US

transferstransfers payments to foreign assets in the USpayments to foreign assets in the US


US Balance on Current Account, 1996, Millions $ .

0

200000

400000

600000

800000

1000000

1200000

1400000

Exports Imports

Millions $

Investment income

transfers, net

Services

Goods


Receipts and Payments on Assets .

-50000

0

50000

100000

150000

200000

250000

46 49 52 55 58 61 64 67 70 73 76 79 82 85 88 91 94

Year

Millions $

Receipts, US Assets Abroad

Payments on Foreign Assets in US

Money income, net


US Balance on Current Account: Merchandise & Trade .

-200000

-150000

-100000

-50000

0

50000

46 49 52 55 58 61 64 67 70 73 76 79 82 85 88 91 94

Year

Millions $

Merchandise Net

Balance of Trade

Balance on Current Account

Debtor Debtor NationNation

Creditor NationCreditor Nation


How Do We Pay Balance on Current Account?

We Sell Bonds to Foreign InvestorsWe Sell Bonds to Foreign Investors Capital Account, 1996Capital Account, 1996

– Foreign Assets in the US, net change (Capital Foreign Assets in the US, net change (Capital Inflow)Inflow)

foreign official assets in the US, net: $ 122354 Mforeign official assets in the US, net: $ 122354 M other foreign assets in the US, net: $ 425201 Mother foreign assets in the US, net: $ 425201 M

– US Assets Abroad, net change (Capital Outflow)US Assets Abroad, net change (Capital Outflow) US official reserves, net $ -6668 MUS official reserves, net $ -6668 M other US Government Assets, net $ -690 Mother US Government Assets, net $ -690 M US private assets, net: $ 358422 MUS private assets, net: $ 358422 M


Capital Inflow: receipts from sale of US bonds & assets Relation Between Capital Account and Current Account

+ Stock ofUS AssetsAbroad

InterestRate

Interest Receiptson US Assets

Stock of Foreign Assetsin US

Interest Rate

Interest PaymentsInterest Paymentson Foreign Assetson Foreign Assets

Components of Current Account

Capital Outflow: payments for foreign bonds & assets

Stock of USAssets Abroad

capital account componentcapital account component


US Balance of Payments, 1996 .

0

200000

400000

600000

800000

1000000

1200000

1400000

1600000

1800000

Exports Imports

Millions $

capital account

Investment income

transfers, net

Services

Goods


US: Capital Inflow and Capital Outflow, 1960-1996 .

0

100000

200000

300000

400000

500000

600000

60 62 64 66 68 70 72 74 76 78 80 82 84 86 88 90 92 94 96Year

Millions $

Capital Inflow

Capital Outflow

DebtorDebtorNationNation

Creditor Creditor NationNation


Puchasing Power Parity Exchange Rate Ought to Reflect Puchasing Exchange Rate Ought to Reflect Puchasing

PowerPower– a bundle of goods that costs $1000 dollars in a bundle of goods that costs $1000 dollars in

the US should be purchasable for $1000 dollars the US should be purchasable for $1000 dollars in Japanin Japan

food, clothing, shelter, etc.food, clothing, shelter, etc.

Exchange Rate:119.6 yen to the dollarExchange Rate:119.6 yen to the dollar– $1000 =119,600 yen$1000 =119,600 yen– so 119,600 yen should buy in Japan what so 119,600 yen should buy in Japan what

$1000 buys in US$1000 buys in US Price of the dollar is 119.6 yenPrice of the dollar is 119.6 yen


Price of $Price of $

Quantity of $Quantity of $

Market for Foreign Exchange in JapanMarket for Foreign Exchange in Japan

Demand for $Demand for $

Supply of $Supply of $

119.6 yen119.6 yen


Purchasing Power Parity real exchange rate equals nominal exchange rate real exchange rate equals nominal exchange rate

divided by relative prices for a bundle of goodsdivided by relative prices for a bundle of goods– real x-ch rate = 119.6 yen per $ ÷(CPIreal x-ch rate = 119.6 yen per $ ÷(CPIJapanJapan/CPI/CPIUSUS))

For Example, if there is inflation in Mexico, then For Example, if there is inflation in Mexico, then the number of pesos to buy a $ should increasethe number of pesos to buy a $ should increase– real x-ch rate = 9.925 pesos per $ ÷(CPIreal x-ch rate = 9.925 pesos per $ ÷(CPIMexMex/CPI/CPIUSUS))


Source:Source:YardeniYardeni


Exchange Rate for Mexico: New Pesos per US $ .

0.01

0.1

1

10

80 81 82 83 84 85 86 87 88 89 90 91 92 93 94 95 96

Year

Exchange Rate

Source: International Monetary Fund, Source: International Monetary Fund, International Financial Statistics Yearbook, 1996International Financial Statistics Yearbook, 1996


Source: OECDSource: OECD


Link Between Government Deficits and Trade Deficits


US Govt. runs a deficitUS Govt. runs a deficit– citizens don’t want higher taxescitizens don’t want higher taxes

US Treasury finances deficit by selling treasuriesUS Treasury finances deficit by selling treasuries– US citizens & institutions buy in primary marketUS citizens & institutions buy in primary market– foreign citizens & institutions buy in primary marketforeign citizens & institutions buy in primary market

Why do foreigners invest in US?Why do foreigners invest in US?– politically stable countrypolitically stable country– may be attracted by:may be attracted by:

low US inflation ratelow US inflation rate high US interest ratehigh US interest rate


US GovtUS GovtDeficitDeficit

TreasuryTreasuryIssues BondsIssues Bonds

ForeignersForeignersBuy BondsBuy Bonds

Foreign ConcernForeign Concernwith US Inflationwith US Inflation

Foreign Concern Foreign Concern with US Interestwith US Interest

RatesRates

FederalFederalReserveReserve

Central Bank Responsibilities: Domestic and ForeignCentral Bank Responsibilities: Domestic and Foreign


Capital FlightCapital Flight1. foreigners sell their US securities1. foreigners sell their US securities2. foreigners exchange their US $ proceeds for Yen2. foreigners exchange their US $ proceeds for Yen3. Supply of dollars shifts and price of the dollar falls3. Supply of dollars shifts and price of the dollar falls

Yen price of US $Yen price of US $

quantity of $quantity of $

demand for $demand for $ supply of $supply of $

4. Federal Reserve may use its Yen Reserves to buy $, stabilize4. Federal Reserve may use its Yen Reserves to buy $, stabilizex-ch ratex-ch rate


Mexico in 1995 Salinas Government runs a deficitSalinas Government runs a deficit

– spending domestically to “buy” the electionspending domestically to “buy” the election burst of inflationburst of inflation capital flight from pesocapital flight from peso

– Mexicans sell pesos and demand $Mexicans sell pesos and demand $– demand for $ increases, peso price of $ risesdemand for $ increases, peso price of $ rises

forces devaluationforces devaluation


Demand for $Demand for $

Quantity of $Quantity of $

Peso PricePeso Priceof the $of the $

Supply of SSupply of S

Flight of Pesos from MexicoFlight of Pesos from Mexico


Source:Source:YardeniYardeni


Exchange Rate for Mexico: New Pesos per US $ .

0.01

0.1

1

10

80 81 82 83 84 85 86 87 88 89 90 91 92 93 94 95 96

Year

Exchange Rate

Source: International Monetary Fund, Source: International Monetary Fund, International Financial Statistics Yearbook, 1996International Financial Statistics Yearbook, 1996


Thailand in 1997 Production downProduction down

– Toyota shuts down 2 large factories in BangkokToyota shuts down 2 large factories in Bangkok Banks hold bad loansBanks hold bad loans

– speculation in golf courses, condos, high risesspeculation in golf courses, condos, high rises West worries: potential Intl. financial crisisWest worries: potential Intl. financial crisis International Monetary Fund: bailout loansInternational Monetary Fund: bailout loans

– Indonesia: $10 BIndonesia: $10 B US Treasury pledges $3BUS Treasury pledges $3B

– Thailand: $22 BThailand: $22 B– Philippines: $1BPhilippines: $1B– South Korea: $40B South Korea: $40B

source:source:Business WeekBusiness Week11-17-9711-17-97


Changing Scenario in AsiaChanging Scenario in Asia

Source: Source: Economic Report of the President ,Economic Report of the President ,19971997

Four Tigers: Hong Kong, Taiwan,Four Tigers: Hong Kong, Taiwan,Singapore, South KoreaSingapore, South Korea

Thailand and Neighbors: China,Thailand and Neighbors: China,Malaysia, IndonesiaMalaysia, Indonesia


Thailand Exchange Rate: Bahts Per Dollar, 1981-1997 .

0

5

10

15

20

25

30

35

40

1981.011981.111982.091983.071984.051985.031986.011986.111987.091988.071989.051990.031991.011991.111992.091993.071994.051995.031996.011996.111997.09Date

Rate

source: Federal Reserve Bank of St. Louissource: Federal Reserve Bank of St. Louis


source: CIAsource: CIA


Source: http://interactive.wsj.comSource: http://interactive.wsj.com


Source: YardeniSource: Yardeni

‘‘94 Exports:94 Exports:Manufactures: 73%Manufactures: 73%Partners: US 21%Partners: US 21%

Japan 17%Japan 17%


Source: YardeniSource: Yardeni


Summary-Vocabulary-Concepts merchandise trade balancemerchandise trade balance balance of tradebalance of trade balance on current accountbalance on current account creditor nationcreditor nation debtor nationdebtor nation income on US assets income on US assets

abroadabroad payments on foreign assets payments on foreign assets

in USin US capital accountcapital account capital inflowcapital inflow

capital outflowcapital outflow balance of paymentsbalance of payments purchasing power purchasing power

parityparity real exchange ratereal exchange rate Mexican PesoMexican Peso Japanese YenJapanese Yen Thailand BahtThailand Baht capital flightcapital flight devaluationdevaluation

Llad Phillips 1 Introduction to Economics Microeconomics The World Economy.

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