BALANCE OF TRADE:Balance of Payments Equilibrium, Public Policy and Financial Stability

<< POLICY INSTRUMENTS:Open Market Operations, Capital Requirements

STATE BANK OF PAKISTAN:History, Regulation of Liquidity, Departments >>

Management of Financial Institutions - MGT 604

Lecture # 5

BALANCE OF TRADE

The balance of trade is the difference between the monetary value of exports and

imports in an economy over a certain period of time.

A positive balance of trade is known as a trade surplus and consists of exporting

more than is imported;

A negative balance of trade is known as a trade deficit or, informally, a trade gap.

Physical balance of trade

Monetary balance of trade is different from physical balance of trade (which is

expressed in amount of raw materials). Developed countries usually import a lot of primary

raw materials from developing countries at low prices.

Often, these materials are then converted into finished products, and a significant

amount of value is added

Factors that can affect BOT

Exchange rates

Trade agreements or barriers

Other tax, tariff and trade measures

Business cycle at home or abroad.

Balance of Payment

The Balance of Payments (or BOP) measures the payments that flow between any

individual country and all other countries. It is used to summarize all international economic

transactions for that country during a specific time period, usually a year.

The BOP is determined by the country's exports and imports of goods, services, and

financial capital, as well as financial transfers. It reflects all payments and liabilities to

foreigners (debits) and all payments and obligations received from foreigners (credits).

Current Account

The current account is the sum of net sales from trade in goods and services, net

factor income (such as interest payments from abroad), and net unilateral transfers from

abroad.

Positive net sales to abroad correspond to a current account surplus; a negative net

sale to abroad correspond to a current account deficit.

Capital account (or financial account)

The financial account is the net change in foreign ownership of domestic assets. If

foreign ownership of domestic assets has increased more quickly than domestic ownership

of foreign assets in a given year, then the domestic country has a financial account

surplus.

The financial account is the net change in foreign ownership of domestic assets. If

foreign ownership of domestic assets has increased more quickly than domestic ownership

of foreign assets in a given year, then the domestic country has a financial account

surplus.

Management of Financial Institutions - MGT 604

Balance of Payments Equilibrium

Is defined as a condition where the sum of debits and credits from the Current Account and

the Financial Account equal zero;

Current Account + Financial Account = 0

Challenges of a Central Bank

1. Economic Growth

Economic growth is the increase in value of the goods and services produced by an

economy. It is conventionally measured as the percent rate of increase in real gross

domestic product, or GDP.

2. Poverty Reduction

In politics, the fight against poverty is usually regarded as a social goal and many

governments have -- secondarily at least -- some dedicated institutions or departments.

3. Unemployment

Unemployment is the condition of willing workers lacking jobs or "gainful employment".

In economics, unemployment statistics measure the condition and extent of joblessness

within an economy.

4. Inflation

Inflation is the persistent rise in the general price level as measured against a standard level

of purchasing power. There are many varying measures of inflation in use because different

prices affect different people.

5. Stability in Forex Rate

Central banks play an important role in the foreign exchange markets. They try to control

the money supply, inflation, interest rates and often have official or unofficial target rates

for their currencies.

Public Policy and Financial Stability

· It seems useful at the outset to define financial stability and to do so by defining it's

opposite, financial instability. The most useful concept of financial instability for central

banks and other authorities involves some notion of market failure or externalities that can

potentially impinge on real economic activity.

· With this definition of financial instability, a clear public policy interest arises for

central banks and other authorities to act in two distinct roles in pursuing financial

stability--prevention of instability and management of the consequences once markets

become unstable.

Independence of Central Banks

· In this context, independence is usually defined as the central bank's operational and

management independence from the government.

· World Bank, the BIS, and the IMF are strong supporters of central bank independence.

Governments generally have some degree of influence over even "independent" central

banks; the aim of independence is primarily to prevent short-term interference.

· For example, the chairman of the U.S. Federal Reserve Bank is appointed by the

President of the U.S., and his choice must be confirmed by the Congress.

Table of Contents: