Macro Review: BOP, Exchange Rates Jeffrey H. Nilsen http://thedailyshow.cc.com/videos/zjr96n/julian-cast ro
Macro Review:BOP, Exchange Rates
Jeffrey H. Nilsen
http://thedailyshow.cc.com/videos/zjr96n/julian-castro
Count transaction as:
CREDIT: in-flow of funds, +DEBIT: out-flow of funds, -
assume BNB buys & sells $ to ensure Lev won’t change (exchange rate “peg”)
Sell good to foreigners => credit (CA)Sell asset to foreigners => credit (private KFA)Sell ORA to foreigners => credit (public KFA, i.e. OSB)
Balance of PaymentsAccounting (part of N.I.P.A.)
Accounts for trade in currently produced goods & services, includes Net Exports Net Factor Payments Net unilateral transfers
Current Account
KFA accounts for trade in existing real & financial assets, including ORA (official reserve assets)
Capital & Financial Account (KFA)
If sell domestic house, inflow => KFA credit
If buy Boeing shares, outflow => KFA debit
KFA Surplus if BG sells more assets to foreigners than they do to BG
KR house
KFABG ROW
Boeing shares
Sell
Leva
Buy
Leva
Outflow (Debit)
Inflow (Credit)
OSB accounts for official purchase/sales of ORA ($, €, Yen, Renimbi, gold, special drawing rights) Officials: BOK, Fed, ECB
NO intervention => BNB, Fed don’t buy/sell ORA (the reason to intervene is to try to
influence the exchange rate)
Official Settlements BalanceOSB = 0 if no intervention
The OSB non-zero if Intervention
BNB buys/sells ORA to influence euro per lev exchange rate
If tends to appreciate : e.g. CA, private KFA > 0 (Germans want many Leva; BNB buys euro (ORA), selling leva (outflows)
OSB DEBIT offsets CA + (private KFA credit) so finallyCA + KFA = 0
FX
OSB|BG ROW
Sell €
Buy
Leva
(Debit)
(Credit)
Leva
€
11
US KFA
When the SNB buys $ from a Swiss person or bank :Private Swiss had bought US asset (US sold asset [BoPUS inflow])So transfer to official account OSB (OSBUS inflow)
OSB, 2 parts(on net positive)
CA deficit
KFA surplus
.
.
.
.
Sell good to foreigners => credit (CA)Sell asset to foreigners => credit (KFA)Sell ORA to foreigners => credit (KFA)
Fed buys ORA
Swiss buy US houses
SNB buys $
http://video.ft.com/3111207196001/Emerging-market-sell-off-spreads-across-Asia/Markets
Emerging Market Volatility in early 2014
Media Attention on Possible Argentine Currency Crisis
All nations are concerned with exchange rate, but those with pegsare more prone to problems; often Have CA, KFA deficits
How much depreciation should central bank allow??
To prevent peso from depreciating, Bank of Argentina sells $ for investors’ pesos
BUT : continuing private KFA deficit may deplete BOA’s $ ORA(FX reserves)
In 2014, many investors withdrew fundsfrom emerging markets since expected higher US r; (have pesos want $ assets). Private outflows.
Nominal vs. real PPP: absolute vs. relative Determination of “fundamental
exchange rate” where FX amount supplied = amount demanded
Peg en : over-valued vs. under-valued
Review Exchange RatesPlan
Exchange Rates Nominal: How much foreign currency you
receive for 1 unit of home currency, e.g. 0.50 € per 1 lev
Real (eR): how many German goods you get for 1 BG good
lev
euroeN 1
50.0
For
NR P
Pee
goodGermaneuro
goodBGlev
leveuro
eR*
2.15
)12()50.0(
Re
Real exchange rate > 1: Consumers choose 1 Bulgarian vs. > 1 identical German goods
If mavrud costs 12 leva & same wine costs 5
euro in Germany, eR = 1.2 (German wine per
bottle mavrud)
Nominal depreciation: eN falls (get fewer € for 1 lev)
eR rises (real appreciation) => Get more German wine for each case mavrud (so more difficult to sell mavrud in D)
ABSOLUTE PURCHASING POWER PARITY (PPP) => assuming free trade, identical goods: goods trade 1-for-1 only =>=> (same price in $ )
If doesn’t hold, pressure to return to PPP: PBG or eR falls due to unsold BG goods or PDE rises due to high demand for German goods
Purchasing Power Parity(long run influence)
1Re
eurolevaleveuro 512*)/(50.0 ForN PPe
For
NR P
Pee
Absolute PPP does NOT hold because: 1. services (especially) not subject to int’l
competition; 2. trade barriers don’t allow international P to
equalize
Relative PPP: instead of er = 1, assume er constant over time
Relative PPP => eN will appreciate to extent euro π > BG π
Relative PPP Instead ?
ForN
N
e
e
For
NR P
Pee
Lane (1999) What determines the nominal exchange rate, some cross sectional evidence. CJE
Nations with higher inflation (vs. $)experience greater depreciation
LevaS: BG public supplies leva to get euro $ to buy Airbus Jets & VW shares
LevaD: Germans demand Leva to buy Mavrud & real estate
Finding Eqbm eN
FX Market
Low eN: BG wants few euro since German goods high cost
High eN: BG want lots of euro since GermanGoods are cheap
Low eN: Germans want many Leva since Mavrud cheap
FX Market Shifts
(Lev appreciates)
Lev demand
Lev Supply
Quality of BG goods improves
Foreign interestRate rise ??
Pure peg: the BNB commits to buy/sell € to maintain 0.5 € per lev rate
Often not pure; even in float, national bank may intervene if believe currency overvalued (tough for exporters) e.g. Switzerland
“Fixed” Exchange Rate Regime (e.g. Bulgaria)
http://video.ft.com/1145014411001/Swissie-peg-destabilising/Editors-Choice (Switzerland generally allows its Swiss Franc to float)
Compare peg value to value that e would have without intervention (at fundamental value, where SFX = DFX )
Undervalued peg may be strategy to increase exports
Overvalued peg may bring currency crisis
Important Issue in Pegs
Recall: policy changes in exchange rate are “revaluation” & “devaluation”
ePEG < efundamental Low ePEG =>
American public buys many cheap Chinese goods, assets => Chinese CA, KFA both surplus
BUT EDYUAN: To maintain peg, PBoC must sell yuan & buy $ (ORA) OSB debit
Undervalued Peg
Central Bank $ ↑ Y ↑ Result: PBoC holds 2 trillion $
ePEG > eFUND: CA, KFA deficit
Policy choices: 1. Devalue to get to
eFUND
2. e.g. tax IM to cut LevS (raising eFUND)
3. Soak up ESLEV: sell $, buy lev (must abandon peg if no more $ !!)
Overvalued Peg(Bulgaria pre-financial crisis)
Central Bank $ ↓ lev ↓
Cheap VW, D. assets
Germans:Mavrud too costly
Germans fear lev assets lose value if BNB devalues
Sell lev assets => levS shifts out
Fear makes ESLEV worse, BNB needs more $ to maintain overvalued peg => peg less sustainable
Speculative Attack
At 0.5 €/lev, share of Bulgartabak at 100 levworth 50 € in GermanyIf BNB devalues to 0.25€/lev => value drops to 25 €