International Finance - Open Economies Summary
Open Economy Overview
Flows of goods and services, financial assets, and their relation to national accounting.
Importance of exchange rates: nominal and real.
Balance of Payments structure: Current Account and Financial Account.
Flow of Goods and Services
Definitions:
- Exports: Goods/services sold abroad.
- Imports: Goods/services sold domestically from abroad.
Net Exports (Trade Balance): NX = Exports - Imports.
- Trade surplus (NX > 0), trade deficit (NX < 0), balanced trade (NX = 0).
Flow of Financial Resources
Financial inflows (foreign investments in Canada) and outflows (Canadian investments abroad).
Types of financial flows:
- Foreign Direct Investment
- Portfolio Investment
- Deposits and Loans
Exchange Rates
Nominal Exchange Rate: Price of one currency in terms of another.
- Example: 0.74 USD per CAD.
Appreciation vs Depreciation:
- Depreciation: Currency value falls.
- Appreciation: Currency value rises.
Impacts on imports/exports based on dollar strength.
Foreign Exchange Market
Supply/Demand for currencies determined by trade and investment flows.
Equilibrium exchange rate set by the interaction of demand and supply.
Shifting demand/supply based on changes in exports or financial inflows/outflows.
Balance of Payments
Summarizes transactions with the rest of the world:
- Current Account: Income differences across borders.
- Financial Account: Tracks financial inflows vs outflows.
In 2019, Canada had a current account deficit of $50 billion.
Current Account and National Savings
Current account deficit indicates that investment exceeds national savings.
May lead to increased foreign dependence but can stimulate economic growth through investments.
Common Misconceptions
A trade deficit with a single partner (e.g., China) does not inherently harm the national economy.
Current account deficits can be beneficial if they fund productive investments.