Balance of payments and economic policy of the country, Balance...

Balance of payments and economic policy of the country

Given the complexity of obtaining representative information on foreign trade transactions of residents of the country and the difficulties of compiling the balance of payments, its data are necessary for developing an effective macroeconomic policy, whose effectiveness is significantly reduced in the conditions of a deficit in the balance of payments.

The main purpose of this chapter is to identify the relationship between the real exchange rate of the national currency and the country's balance of payments. A deep understanding of the mechanism of this relationship will effectively solve the problem of correcting the balance of payments deficit (or a surplus) in order to develop a macroeconomic policy that realizes both internal and external economic goals of the country, which, above all, is to maintain a reasonable balance of payments with the world economic community .

Key terms:

net exports; currency depreciation; appreciation of the currency; devaluation; revaluation; equilibrium exchange rate; adaptation of the balance of payments; elasticity of demand for imports; elasticity of demand for exports; the condition of Marshall - Lerner; jay-curve; world interest rate; a small open economy.

Balance of payments and real exchange rate

The state of the countries' balance of payments, as follows from the above, is largely determined by the volume of their net exports (XN), which in turn depends not only on the nominal exchange rates of the respective currencies, but also on the correlation of price levels in different countries, t .e. from real exchange rates (Chapter 3 of this textbook).

A graphical illustration of the relationship between the real exchange rate r * and the net export of XN = XN ( r *) is shown in Fig. 5.1.

Dependence of net exports on the real exchange rate

Fig. 5.1. The dependence of net exports on the real exchange rate

Given that ΧΝ represents the current account of the balance of payments, Fig. 5.1 illustrates, therefore, also the dependence of the current account of the balance of payments on the real exchange rate.

Factors determining the equilibrium real exchange rate

So, the real exchange rate is linked to the current balance of payments account.

Hence, the higher the real exchange rate (see Figure 5.1), the more expensive the goods produced domestically, as compared to the goods of foreign production, the lower the net export and the less the value of the surplus current account of the balance of payments.

In addition, the current account must balance the capital account, which means that the current account balance equals the difference between savings S and investment I: XN = S-I. Savings are determined by the consumption function and fiscal policy, and the volume of investments is a function of investment and the world interest rate.

Imagine all of the above in a graphical form (Figure 5.2).

Determination of the equilibrium real exchange rate (rE *): (S-I) - the balance of payments flow of capital, XN (r *) - current account of the balance of payments

Fig. 5.2. Determination of the equilibrium real exchange rate ( r E *): (S - I) is the balance of payments flow of capital; XN ( r *) - current account of the balance of payments

The line reflecting the relationship between the balance of the current account of the balance of payments and the real exchange rate has, as shown above, a downward trend, since a higher real exchange rate leads to a decrease in net exports. The line that reflects the excess of savings over investments is vertical, as neither savings nor investments are dependent on the real exchange rate.

At the point corresponding to the equilibrium value of the real exchange rate, the number of monetary units received as a result of operations with the capital account is equal to the number of monetary units required to cover the current account balance, and vice versa.

The model presented above can be viewed as a diagram of demand and supply for the national currency. In particular, the vertical line (S-I) denotes the excess of domestic savings over domestic investments and, accordingly, the supply of the national currency, which can be exchanged for foreign currency for investment abroad.

The descending line of XN represents the net demand for the national currency offered by foreigners wishing to purchase goods in a given country.

Thus, at the point corresponding to the equilibrium real exchange rate r E *, the offer of the national currency as credits abroad balances the demand for the national currency imposed by foreigners acquiring domestic "clean" export. In other words, at the point corresponding to the equilibrium real exchange rate, the supply of the national currency for capital transactions balances the demand for the national currency required for the implementation of current operations.

thematic pictures

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