Lecture 9

Balance of Payments Account
Exchange Rates
Balance of Payment and Exchange Rates
UGBS 204: Macroeconomics And Business
UGBS 204: Lecture nine

Exchange Rates
Outline
1 Balance of Payments Account

Measurement
2 Exchange Rates
Meaning and Types
Determinants of Nominal Exchange Rates

Balance of Payments Account Measurement
Exchange Rates
Outline

Measurement
2 Exchange Rates
Meaning and Types

Exchange Rates
A country's balance of payments (BOP) accounts is a

systematic statement of all economic transactions between
that country and the rest of the world

Exchange Rates
A country's balance of payments (BOP) accounts is a

systematic statement of all economic transactions between
that country and the rest of the world
It records all economic transactions of goods and services and
movements of nancial assets between a country and the rest
of the world

Exchange Rates
The BOP records each transaction as either a credit or a debit

Exchange Rates

Transactions that the earns a country foreign currency is
entered as a credit

Exchange Rates

entered as a credit
Transactions that involve spending foreign currency are
entered as debits

Exchange Rates

entered as a credit
Transactions that involve spending foreign currency are
entered as debits
This means that in general exports enter the BOP as credits
while imports enter as debits

Exchange Rates
Components of the BOP
The BOP consist of two main accounts: the Current Account

(CA) and Financial accounts (FA)
in some texbooks, the FA is called capital and nancial
accounts (KFA)

Exchange Rates

accounts (KFA)
The CA records all income and expenditures related to imports
and exports of goods and services, investment income and
unilateral transfers

Exchange Rates

accounts (KFA)
The FA records transactions of assets between a country and
the rest of the world

Exchange Rates

accounts (KFA)
The FA records transactions of assets between a country and
A last component is Ocial Settlements Accounts

Exchange Rates
The Current Account (1)
The CA is subdivided into the trade balance, services,

investment income and unilateral transfers

Exchange Rates

The trade balance is the dierence between merchandize
imports and exports
that is the trade in goods

Exchange Rates

The trade balance is the dierence between merchandize
imports and exports
that is the trade in goods
The services component include shipping & freight, nancial
services and foreign travel

Exchange Rates
Investment income records earnings on foreign investments

this includes interest rate payments, dividends, royalties and
other returns on assets eg return on stocks and patents

Exchange Rates
Investment income records earnings on foreign investments

this includes interest rate payments, dividends, royalties and
other returns on assets eg return on stocks and patents
Unilateral transfers refer to payments that made but not in
return for goods or services
examples include ocial foreign aid, gifts from residents of one
country to another

Exchange Rates
Financial Account
The FA records asset transactions between the country and


Exchange Rates
Financial Account

In general transactions that increases a country's assets and/or
decreases its liabilities are entered as debits
If a country borrows to nance a CA decit it will show up as
a credit

Exchange Rates
Financial Account

a credit
It is subdivided into the capital accounts and nancial accounts

Exchange Rates
Financial Account

a credit
It is subdivided into the capital accounts and nancial accounts
The capital account encompasses unilateral transfer of assets
between countries
items included in the capital account include debt forgiveness,
remittances from international migrants

Exchange Rates
Financial Account
The nnancial account (previously called the capital acount)

records other transactions of assets between countries

Exchange Rates
Financial Account

Sales of a country's assets results in nancial inow into the
country and is recorded as a credit in the nancial account

Exchange Rates
Financial Account

Transactions that results in a nancial outlow is recorded as a
debit

Exchange Rates
Financial Account

Transactions that results in a nancial outlow is recorded as a
debit
Transactions recorded in the nancial accounts include direct
and portfolio investments, and purchases of sovereign bonds

Exchange Rates
Ocial Settlements Balance
The ocial settlements balance refers to nancial transactions

by the central bank

Exchange Rates

by the central bank
It includes changes in ocial reserve assets
Items in the balance include gold reserves, holdings of foreign
gov't securities by the central bank and special assets created
by the IMF

Exchange Rates

by the central bank
by the IMF
The ocial settlements balance is the net change in a
country's ocial reserve assets

Exchange Rates

by the central bank
by the IMF
The ocial settlements balance is the net change in a
country's ocial reserve assets
When a country runs a BOP surplus, ist net holdings of
reserve assets will increase

Exchange Rates
The BOP always Balances
The balance of both CA and FA must add up to zero

ie CA+FA=0
when a country runs a CA decit, the decit is nanced by
borrowed or reducing its holdings of foreign assets, which is a
surplus on the FA

Exchange Rates
The BOP always Balances
The balance of both CA and FA must add up to zero

ie CA+FA=0
when a country runs a CA decit, the decit is nanced by
borrowed or reducing its holdings of foreign assets, which is a
surplus on the FA
If the BOP balances, why do we hear BOP decits?
It is common to hear BOP decit when people actually mean a
CA or trade decit

Balance of Payments Account Meaning and Types
Exchange Rates Determinants of Nominal Exchange Rates
Outline

Measurement
2 Exchange Rates
Meaning and Types

Nominal Exchange Rate
In discussions of exchange rates, we distinguish between

nominal and real exchange rates


The nominal exchange rate is refers to the rate at which
currencies of two countries are traded
specically, the nominal exchange rate is the number of units
of a foreign currency that can be purchased with a unit of the
domestic currency


The nominal exchange rate is refers to the rate at which
currencies of two countries are traded
specically, the nominal exchange rate is the number of units
of a foreign currency that can be purchased with a unit of the
domestic currency
The denition above is based on indirect quotation, an
alternative quotation is
price or direct quotation measures the units of domestic
currency need to purchase one unit of the foreign currency eg:
GHC 3.4 = $1
We will be using this quotation

Appreciation and Depreciation
Using the direct quotation, an increase in the nominal

exchange rate means a depreciation of the domestic currency


This means more units of the domestic currency is needed to
buy the same unit of the foreign currency
that is the domestic currency has weakened


This means more units of the domestic currency is needed to
buy the same unit of the foreign currency
that is the domestic currency has weakened
When the value nominal exchange rate falls, we say the
domestic currency has appreciated
fewer units of the domestic currency are needed to purchase a
unit of the foreign currency

Real Exchange Rate
Real exchange rates measures the price of domestic goods

relative to foreign goods
it measures the number of domestic goods needed to purchase
a unit of foreign goods

Real Exchange Rate

The real exchange rate depends on: the domestic price level,
foreign price level and the nominal exchange rate
P
ereal = ePfor
where e is the nominal exchange rate in direct quotation

Real Exchange Rate

The real exchange rate depends on: the domestic price level,
foreign price level and the nominal exchange rate
P
ereal = ePfor
where e is the nominal exchange rate in direct quotation
Suppose a bottle of coke sells for GHC 2 in Ghana and N100
in Nigeria. If you need 2 pesewas to buy 1 naira, then real
exchange rate is:
2
ereal = 0.02∗100 or one Ghana coke equal 1 Nigeria coke

Purchase Power Parity
In the example above, a bottle of coke has the same price in

both country
This reects the idea of purchasing power parity (PPP)


both country
PPP states that similar baskets of goods should have the same
price in terms of currency


both country
From the expression for real exchange rate above, if the real
exchange rate equals unity, then P = ePfor


both country
From the expression for real exchange rate above, if the real
exchange rate equals unity, then P = ePfor
The concept of PPP is important for international comparions
of standards of living
you will frequently see GDP per capita measured in PPP

Outline

Measurement
2 Exchange Rates
Meaning and Types

Exchange Rate Regimes

The processes and institutional arrangements that government
the determination of a country's exchange rate is the exchange
rate regime


rate regime
There are two major regimes: xed exchange rate regime and
exible/oating exchange rate regimes


rate regime
In xed exchange rate regimes, the exchange rate is ocial
determined by the central bank/gov't


rate regime
In exible exchange rate regimes, the exchange rate is
determined by conditions of demand and supply


rate regime
In exible exchange rate regimes, the exchange rate is
determined by conditions of demand and supply
Many countries practice a form of managed oating system
where the exchange rate is largely market-determined with
occasional interventions by central banks to keep the rate
within a particular range
Exchange Rate in a Floating System
The nominal exchange rate in the exible regime is determined

by the forces of demand and supply like any other nancial
asset


asset
In this market, the equilibrium quantity of domestic currency
and the exchange rate are determined


asset
To the supply cedis in this market means to oer cedis in
exchange for other currencies

Exchange rate determination

asset


asset


asset
This explains why the strength of the economy, local versus
foreign interest rates on nancial assets, structure of imports
and exports, scal and monetary policy aect the exchange
rate


asset
This explains why the strength of the economy, local versus
foreign interest rates on nancial assets, structure of imports
and exports, scal and monetary policy aect the exchange
rate
We consider the example of the determination of the exchange
rate between the Ghanaian cedi and the US dollar

Foreign exchange market
This is a market where currencies (quantity) are traded and

the (nominal) exchange rate is determined


We can analyze this market using demand and supply as we
did for goods and services


On the exchange rate market, the demand for the USD comes
people in Ghana who want to make purchases of
dollar-denominated goods, services or nancial assets
importers, people buying US assets, people paying foreign
workers in USD


On the exchange rate market, the demand for the USD comes
people in Ghana who want to make purchases of
dollar-denominated goods, services or nancial assets
importers, people buying US assets, people paying foreign
workers in USD
The supply dollars comes from people who need to with USD
who need to make cedi-denominated transactions
Ghanaians who have exported goods, foreign remittances,
foreigners investing in cedi-denominated assets, FDI

The Supply of Dollars
The supply curve is upward-sloping

when the exchange rate is high (value of the cedi is low), there
is more dollars to market

The Supply of Dollars
The supply curve is upward-sloping

when the exchange rate is high (value of the cedi is low), there
is more dollars to market
Intuition: if the exchange rate is high Ghanaian goods &
services become more cheaper, foreigner buy more Ghanaian
goods and more dollars become available in the exchange rate
market

The Demand for Dollars
The demand curve is downward-sloping

when the exchange rate is high (value of the cedi is low), the
quantity of dollars of demanded

The Demand for Dollars
The demand curve is downward-sloping

when the exchange rate is high (value of the cedi is low), the
quantity of dollars of demanded
Intuition: if the exchange rate is high foreign goods & services
become more expensive, this reduces the demand for US
dollars

Equilibrium in the exchange rate market

Eect of falling commodity prices on the value of Cedi

Lecture 9

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Balance of Payments Account

Balance of Payment and Exchange Rates

UGBS 204: Macroeconomics And Business

UGBS 204: Lecture nine

1 Balance of Payments Account

UGBS 204: Lecture nine

1 Balance of Payments Account

UGBS 204: Lecture nine

Balance of Payments Account

A country's balance of payments (BOP) accounts is a

UGBS 204: Lecture nine

Balance of Payments Account

A country's balance of payments (BOP) accounts is a

UGBS 204: Lecture nine

Balance of Payments Account

The BOP records each transaction as either a credit or a debit

UGBS 204: Lecture nine

Balance of Payments Account

The BOP records each transaction as either a credit or a debit

UGBS 204: Lecture nine

Balance of Payments Account

The BOP records each transaction as either a credit or a debit

UGBS 204: Lecture nine

Balance of Payments Account

The BOP records each transaction as either a credit or a debit

UGBS 204: Lecture nine

Components of the BOP

The BOP consist of two main accounts: the Current Account

UGBS 204: Lecture nine

Components of the BOP

The BOP consist of two main accounts: the Current Account

UGBS 204: Lecture nine

Components of the BOP

The BOP consist of two main accounts: the Current Account

UGBS 204: Lecture nine

Components of the BOP

The BOP consist of two main accounts: the Current Account

UGBS 204: Lecture nine

The Current Account (1)

The CA is subdivided into the trade balance, services,

UGBS 204: Lecture nine

The Current Account (1)

The CA is subdivided into the trade balance, services,

UGBS 204: Lecture nine

The Current Account (1)

The CA is subdivided into the trade balance, services,

UGBS 204: Lecture nine

The Current Account (2)

Investment income records earnings on foreign investments

UGBS 204: Lecture nine

The Current Account (2)

Investment income records earnings on foreign investments

UGBS 204: Lecture nine

The FA records asset transactions between the country and

UGBS 204: Lecture nine

The FA records asset transactions between the country and

UGBS 204: Lecture nine

The FA records asset transactions between the country and

UGBS 204: Lecture nine

The FA records asset transactions between the country and

UGBS 204: Lecture nine

The nnancial account (previously called the capital acount)

The nnancial account (previously called the capital acount)

The nnancial account (previously called the capital acount)

The nnancial account (previously called the capital acount)

The nnancial account (previously called the capital acount)

Ocial Settlements Balance

The ocial settlements balance refers to nancial transactions

Ocial Settlements Balance

The ocial settlements balance refers to nancial transactions

Ocial Settlements Balance

The ocial settlements balance refers to nancial transactions

Ocial Settlements Balance

The ocial settlements balance refers to nancial transactions