Chapter 17 Summary

LO 17.1 The Relationship Between International Economics and Trade Finance

• International economics includes the study of international trade and the study of international finance.
• International trade uses microeconomic analysis to understand why nations trade and the impacts of trade on consumers, businesses, nations, and the world.
• International finance uses macroeconomic models to understand the domestic economy and the financial implications of its linkages with other national economies.

LO 17.2 Major Macroeconomic Indicators in Trade

• In trade finance, macroeconomic models highlight the relationships among economic variables such as GDP, unemployment, inflation, trade balances, exchange rates, and interest rates.
• Economists generally express the size of a nation’s economy as its GDP, which measures the value of the output of all goods and services produced within the country in a year.
• Balance of trade reflects impacts of international trade on an economy’s GDP. High exports indicate a growth in nation’s GDP whereas high imports are an indication of decreased GDP.
• The unemployment rate helps inform financial forecasters about the expected cost of labor and the ability of employers to hire people if a firm plans to increase the production of goods or services.
• Inflation is the rate of change of prices in the entire economy. This information informs policy makers how to adjust the money supply to meet particular targets.
• Financial forecasters pay close attention to current and expected interest rates, as they have a fundamental impact on the cost of raising money and determining the required rate of return for investment.

LO 17.3 Balance of Payment and its Components

• The balance of payments provides enough information about a country’s international activities that further helps international traders to compare different national economies and select their trading partners.
• If the value of total exports from a country exceeds total imports, we say a country has a trade surplus. However, if total imports exceed total exports, then the country has a trade deficit. Of course, if exports equal imports, then the country has balanced trade.
• The balance of payments can be expressed as: [latex]\text{BOP} =[/latex]
  [latex]\text{Current Account} + \text{Financial Account} + \text{Capital Account} + \text{Balancing Item}[/latex]
• The current account records the flow of income from one country to another.
• The financial account records the flow of assets from one country to another.
• The capital account is typically much smaller than the other two and includes miscellaneous transfers that do not affect national income.
• The balancing item is simply an amount that accounts for any statistical errors and ensures that the total balance of payments is zero.

LO 17.4 Calculation of Current Account, Financial Account, and Capital Account

• Calculating the Current Account
  • The current account represents the sum of the balance of trade (net earnings on exports minus payments for imports), factor income (earnings on foreign investments minus payments made to foreign investors), and cash transfers.
  • The current account is calculated by adding up the 4 components of the current account: goods, services, income, and cash transfers.
  • When the sum of these four components is positive, the current account has a surplus.
• Calculating the Financial Account
  • The financial account (also known as the capital account under some balance of payments systems) measures the net change in ownership of national assets.
  • When the financial account has a positive balance, we say that there is a financial account surplus.
  • Likewise, we say that there is a financial account deficit when the financial account has a negative balance.
  • The financial account has four components: foreign direct investment, portfolio investment, other investment, and reserve account flows.
  • To calculate the total surplus or deficit in the financial account, sum the net change in FDI, portfolio investment, other investment, and the reserve account.
• Calculating the Capital Account
  • The capital account acts as a miscellaneous account, measuring non-produced and non-financial assets, as well as capital transfers.
  • Like the financial account, a deficit in the capital account means that money is flowing out of a country and the country is accumulating foreign assets.
  • Likewise, a surplus in the capital account means that money is flowing into a country and the country is selling (or otherwise disposing of) non-produced, non-financial assets.
  • The balance of the capital account is calculated as the sum of the surpluses or deficits of net non-produced, non-financial assets, and net capital transfers.

LO 17.5 Reasons for a Zero Balance of Payment

• Equilibrium in the market for a country’s currency implies that the balance of payments is equal to zero.
• The reasons for a zero balance can be attributed as capital flows and equilibrium.
• Trade within a country differs in one important way from trade between countries: unless the two nations share a common currency, any trade requires that countries to go through the foreign exchange market to trade currency, in addition to trading goods and services.
• When a country’s balance of payments is equal to zero, there is equilibrium in the market for that country’s currency.

LO 17.6 International Investment Position

• A country’s IIP measures the total value of foreign assets held by domestic residents minus the total value of domestic assets held by foreigners.
• It roughly corresponds to the sum of a country’s trade deficits and surpluses over its entire history.
• If the value of a country’s trade deficits over time exceeds the value of its trade surpluses, then its IIP will reflect a larger value of foreign ownership of domestic assets than domestic ownership of foreign assets and we would say the country is a net debtor. In contrast, if a country has greater trade surpluses than deficits over time, it will be a net creditor.

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