Introduction to Economics
Microeconomics
The World Economy
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1
Outline: Lecture Sixteen
 The
US in the World Economy
 Balance of Payments Accounting
 Puchasing Power Parity
 Central Bank Reserves & Foreign Exchange
Intervention
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2
Exports of Goods and Services as Fraction of GDP, 1929-1995 .
0.12
Exports as % of GNP
0.1
Linear (Exports as % of
GNP)
Fraction
0.08
0.06
0.04
0.02
1993
1989
1985
1981
1977
1973
1969
1965
1961
1957
1953
1949
1945
1941
1937
1933
1929
0
Year
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3
Growth in World Trade
Source: Economic Report of the President, 1997
http://www.gpo.ucop.edu/catalog/erp97.html
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Measuring the Balance of Trade
 Merchandise
Balance of Trade: goods
 Balance of Trade ( Net Exports) : add
services
 Balance on Current Account:
– first: add net transfer payments
– second: add income from US assets abroad
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Balance of Payments
Merchandise
Trade Balance
– Exports of Goods
 capital
goods, except automotive: 41%
 industrial supplies and materials: 24%
 consumer goods, except automotive: 11%
 automotive vehicles, engines & parts: 11%
 foods, feeds, beverages: 9%
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Balance of Payments (Cont.)
– Imports of Goods
 capital
goods, except automotive: 29%
 industrial supplies and materials: 25%
 consumer goods, except automotive: 21%
 automotive vehicles, engines & parts: 16%
 foods, feeds, beverages: 4%
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Source:CIA
CIA
Source:
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Balance on Goods: Merchandise Trade Balance, US 1996 .
900000
800000
700000
Millions $
600000
500000
400000
300000
200000
100000
0
Exports
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Imports
Source: US Dept. of Commerce, Survey of Current Business
9
Balance on Merchandise, US , 1946-1996, Millions $ .
900000
800000
700000
Exports, $M
Imports
Merchandise Net
600000
Millions $
500000
400000
300000
200000
100000
94
91
88
85
82
79
76
73
70
67
64
61
58
55
52
49
-100000
46
0
-200000
Year
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Source: Economic Report of the President, 1997
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Balance of Payments
 Merchandise Trade
Balance
 Balance of Trade: Net Exports(component
of GNP)
– Exports of Goods and Services
 other
private services: 31%
 travel: 30%
 royalties and license fees: 13%
– Imports of Goods and Services
 travel:
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31%
 other private services: 27%
 other transportation: 18%
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Balance of T rade: Goods and Services, US, 1996 .
1000000
900000
Services
Goods
800000
700000
Millions $
600000
500000
400000
300000
200000
100000
0
Exports
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Imports
12
Balance of T rade: Goods and Services, US, Millions $
.
100000
50000
Millions $
-50000
-100000
94
91
88
85
82
79
76
73
70
67
64
61
58
55
52
49
46
0
Merchandise Net
Services Net
Balance of Trade
-150000
-200000
Year
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Balance of Payments
 Merchandise Trade
Balance: Goods
 Balance of Trade: Goods & Services
 Balance on Current Account
– Exports of goods & services plus net transfer
payments plus US income on assets abroad
– Imports of goods & services plus net transfer
payments plus foreign income on assets in US
 transfers
– US Government grants
– US Government pensions & other
– private remittances
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Balance on Current Account, US, 1996, (Except Asset Income) .
1000000
900000
800000
Millions of $
700000
transfers, net
Services
Goods
600000
500000
400000
300000
200000
100000
0
Exports
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Imports
15
US Balance of T rade and Net Transfers .
20000
94
91
88
85
82
79
76
73
70
67
64
61
58
55
52
49
46
0
-20000
Millions $
-40000
-60000
-80000
-100000
Balance of Trade
transfers, net
-120000
-140000
-160000
Year
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Balance of Payments
 Merchandise Trade
Balance: Goods
 Balance of Trade: Goods & Services
 Balance on Current Account
– Exports of goods & services plus net transfer
payments plus US income on assets abroad
 US
income on assets abroad
– direct investment receipts
– other private receipts
– US government receipts
– Imports of goods & services plus net transfer
payments plus foreign income on assets in US
 transfers
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 payments
to foreign assets in the US
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US Balance on Current Account, 1996, Millions $ .
1400000
1200000
Millions $
1000000
Investment income
transfers, net
Services
Goods
800000
600000
400000
200000
0
Exports
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Imports
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Receipts and Payments on Assets
.
250000
Receipts, US Assets Abroad
200000
Payments on Foreign Assets in US
Millions $
150000
Money income, net
100000
50000
94
91
88
85
82
79
76
73
70
67
64
61
58
55
52
49
46
0
-50000
Year
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US Balance on Current Account: Merchandise & T rade
.
50000
Debtor
Nation
Creditor Nation
Millions $
-50000
94
91
88
85
82
79
76
73
70
67
64
61
58
55
52
49
46
0
Merchandise Net
Balance of Trade
-100000
Balance on Current Account
-150000
-200000
Year
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
20
How Do We Pay Balance on
Current Account?
 We
Sell Bonds to Foreign Investors
 Capital Account, 1996
– Foreign Assets in the US, net change (Capital
Inflow)
 foreign
official assets in the US, net: $ 122354 M
 other foreign assets in the US, net: $ 425201 M
– US Assets Abroad, net change (Capital Outflow)
 US
official reserves, net $ -6668 M
 other US Government Assets, net $ -690 M
 US private assets, net: $ 358422 M
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Relation Between Capital Account and Current Account
 Capital Inflow: receipts from sale of US bonds & assets

Interest Payments
on Foreign Assets

Interest
Rate
Stock of
Foreign Assets
in US
Components of Current Account
+
Interest Receipts
on US Assets
Interest
Rate
StockofofUS
Stock
US Assets
Assets
Abroad
Abroad
capital account component
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
 Capital Outflow: payments for foreign bonds & assets
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US Balance of Payments, 1996
.
1800000
1600000
1400000
capital account
Investment income
transfers, net
Services
Goods
Millions $
1200000
1000000
800000
600000
400000
200000
0
Exports
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Imports
23
US: Capital Inflow and Capital Outflow, 1960-1996
.

600000
Creditor
Nation
500000
Debtor
Nation
Capital Inflow
Capital Outflow
Millions $
400000
300000
200000
100000
96
94
92
90
88
86
84
82
80
78
76
74
72
70
68
66
64
62
60
0
Year
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Puchasing Power Parity
 Exchange
Rate Ought to Reflect Puchasing
Power
– a bundle of goods that costs $1000 dollars in
the US should be purchasable for $1000 dollars
in Japan
 food,
clothing, shelter, etc.
 Exchange
Rate:119.6 yen to the dollar
– $1000 =119,600 yen
– so 119,600 yen should buy in Japan what $1000
buys in US
 Price
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of the dollar is 119.6 yen
25
Market for Foreign Exchange in Japan
Price of $
Demand for $
Supply of $
119.6 yen
Quantity of $
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Purchasing Power Parity
 real
exchange rate equals nominal exchange rate
divided by relative prices for a bundle of goods
– real x-ch rate = 119.6 yen per $ ÷(CPIJapan/CPIUS)
 For
Example, if there is inflation in Mexico, then
the number of pesos to buy a $ should increase
– real x-ch rate = 9.925 pesos per $ ÷(CPIMex/CPIUS)
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Source:
Yardeni
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Exchange Rate for Mexico: New Pesos per US $
.
10
96
95
94
93
92
91
90
89
88
87
86
85
84
83
82
81
80
Exchange Rate
1
0.1
0.01
Year
Source: International Monetary Fund, International Financial Statistics Yearbook, 1996
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Source: OECD
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Link Between Government
Deficits and Trade Deficits
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 US
Govt. runs a deficit
– citizens don’t want higher taxes
 US
Treasury finances deficit by selling treasuries
– US citizens & institutions buy in primary market
– foreign citizens & institutions buy in primary market
 Why
do foreigners invest in US?
– politically stable country
– may be attracted by:
 low
US inflation rate
 high US interest rate
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Central Bank Responsibilities: Domestic and Foreign
US Govt
Deficit
Treasury
Issues Bonds
Federal
Reserve
Foreigners
Buy Bonds
Foreign Concern
with US Inflation
Foreign Concern
with US Interest
Rates
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Capital Flight
1. foreigners sell their US securities
2. foreigners exchange their US $ proceeds for Yen
3. Supply of dollars shifts and price of the dollar falls
demand for $
supply of $
Yen price of US $
quantity of $
4. Federal Reserve may use its Yen Reserves to buy $, stabilize
x-ch rate
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Mexico in 1995
 Salinas
Government runs a deficit
– spending domestically to “buy” the election
 burst
of inflation
 capital flight from peso
– Mexicans sell pesos and demand $
– demand for $ increases, peso price of $ rises
 forces
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devaluation
35
Flight of Pesos from Mexico
Peso Price
of the $
Supply of S
Demand for $
Quantity of $
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Source:
Yardeni
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Exchange Rate for Mexico: New Pesos per US $
.
10
96
95
94
93
92
91
90
89
88
87
86
85
84
83
82
81
80
Exchange Rate
1
0.1
0.01
Year
Source: International Monetary Fund, International Financial Statistics Yearbook, 1996
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Thailand in 1997
 Production
down
source:
Business Week
11-17-97
– Toyota shuts down 2 large factories in Bangkok
 Banks
hold bad loans
– speculation in golf courses, condos, high rises
 West
worries: potential Intl. financial crisis
 International Monetary Fund: bailout loans
– Indonesia: $10 B
 US
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Treasury pledges $3B
– Thailand: $22 B
– Philippines: $1B
– South Korea: $40B
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Changing Scenario in Asia
Four Tigers: Hong Kong, Taiwan,
Singapore, South Korea
Thailand and Neighbors: China,
Malaysia, Indonesia
Source: Economic Report of the President ,
1997
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Llad Phillips
source: Federal Reserve Bank of St. Louis
1997.09
1996.11
1996.01
1995.03
1994.05
1993.07
1992.09
1991.11
1991.01
1990.03
1989.05
1988.07
1987.09
1986.11
1986.01
1985.03
1984.05
1983.07
1982.09
1981.11
1981.01
Rate
T hailand Exchange Rate: Bahts Per Dollar, 1981-1997 .
40
35
30
25
20
15
10
5
0
Date
41
source: CIA
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Source: http://interactive.wsj.com
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Source: Yardeni
‘94 Exports:
Manufactures: 73%
Partners: US 21%
Japan 17%
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Source: Yardeni
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Summary-Vocabulary-Concepts
 merchandise
trade balance
 balance of trade
 balance on current account
 creditor nation
 debtor nation
 income on US assets
abroad
 payments on foreign assets
in US
 capital account
 capital inflow
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 capital
outflow
 balance of payments
 purchasing power
parity
 real exchange rate
 Mexican Peso
 Japanese Yen
 Thailand Baht
 capital flight
 devaluation
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