CLLEGE OF AGRCULTURE AND VETERNARY MEDICINE

ASSIGNMENT TRITLE

BALANCE PAYMENT AND INTERNATIONAL TRADE LINKAGE

ASSIGNMENT OF INTERNATIONANL TRADE

NO. NAME ID
1 BIRUK GETACHEW RU
2 MEKONNEN TEGAFAW RU00900/12
3 FEYSEL MEKI RU
4 EYOSAFET MISHAMO RU
5 TSIGE MELESE RU
6 SAID ZAKIR RU
7 MENBERE RU
8 MEHALET ALAMAW RU
9 HAYAT RU

SUMMITED DATE

SUMMITED TO
 INTRODUCTION

International trade has been the cornerstone of the global economy, fostering economic
growth and development across nations. The Balance of Payment (BOP) is a vital
economic indicator that measures the flow of goods, services, and capital between
countries. The BOP is a reflection of a country's economic health, and it is closely linked
to international trade. This essay will explore the relationship between BOP and
international trade, highlighting the significance of their linkage in maintaining a healthy
global economy. The thesis statement of this essay argues that understanding the linkage
between BOP and international trade is essential for policymakers and business leaders to
make informed decisions that promote sustainable economic growth.

The world is becoming more interconnected than ever, and international trade has been a
significant contributor to this phenomenon. The Balance of Payment (BOP) is a crucial
indicator of the economic health of a country, which reflects the financial transactions
between the domestic economy and the rest of the world. The linkage between BOP and
international trade has been the subject of much debate among economists, policymakers,
and market analysts. This essay aims to analyze the relationship between BOP and
international trade and argue why it is crucial to maintain a balance between the two for
sustainable economic growth.

The balance of payment and international trade are closely linked. It's like a dance
between countries, where they exchange goods and money in a delicate balance.

If one country is importing more than it's exporting, the balance can become uneven and
lead to debt. On the other hand, if a country exports more than it imports, it can build up
reserves of wealth.

It may sound simple, but there are many factors that affect this relationship. For example,
currency exchange rates can play a big role in how much countries pay for each other's
goods.
Overall, keeping a healthy balance of payments and trade is important for the global
economy. It ensures fair exchanges between countries and helps keep everyone on solid
financial footing.

The balance of payment and international trade are two important things that go hand in
hand. It's like a dance where they both need to be in sync for everything to work out
smoothly. The balance of payment refers to the difference between a country's income
from exports and its expenses from imports. If a country is spending more on importing
goods than it is earning from exporting goods, then it can lead to a deficit in the balance
of payment.

This deficit can cause problems as it means that the country is borrowing money from
other countries to cover its expenses. This can lead to debt and can affect the value of the
country's currency. This surplus can be used to invest in other areas of the country's
economy. International trade also plays an important role in this equation. A country's
balance of payment is affected by the volume and terms of its international trade. For
example, if a country is trading with another country under unfavorable terms, such as
low prices for its exports or high prices for its imports, then it can negatively impact its
balance of payment.

In summary, the balance of

Have you ever wondered how countries trade with each other? Well, it's all connected to
something called the balance of payments and international trade.

Basically, the balance of payments is like a report card for a country's economy. It shows
all the money coming in and going out through things like exports (stuff we sell to other
countries) and imports (stuff we buy from other countries). If a country is selling more
than they're buying, that's good news! But if they're buying more than they're selling, that
could lead to some economic trouble.

Now let's talk about international trade. This is when countries exchange goods and
services with each other. It might seem simple, but there are actually a lot of factors at
play here. For example, different countries might have different resources or technologies
that make them better at producing certain things. But why does any of this matter? Well,
international trade can have a big impact on a country's economy. When businesses can
sell their products to people around the world, they can make more money and create
more jobs. And when consumers have access to goods from
Balance of payment and international linkages refer to the relationship between a
country's economy and its trade with other countries. The balance of payment is a record
of all the financial transactions between a country and the rest of the world, including the
import and export of goods and services, international investments, and the transfer of
funds

International linkages, on the other hand, refer to the economic ties between countries,
including trade deals, investment flows, and the exchange of goods and services. These
linkages are critical for a country's economic growth and stability, as they help to
facilitate the flow of goods and capital across borders.

The balance of payment and international linkages are closely linked, as changes in one
can have a significant impact on the other. For example, a trade deficit (when a country
imports more than it exports) can lead to a decline in the value of its currency, which can
attract foreign investors and increase the flow of capital into the country. Conversely, a
trade surplus (when a country exports more than it imports) can lead to a strengthening of
the cu

What is the Balance of Payments (BOP )?

 The balance of payments (BOP), also known as the balance of international

payments, is a statement of all transactions made between entities in one country
and the rest of the world over a defined period, such as a quarter or a year. It
summarizes all transactions that a country's individuals, companies, and
government bodies complete with individuals, companies, and government
bodies outside the country. The balance of payments includes both the current
account and capita account.
 The current account includes a nation's net trade in goods and services, its net
earnings on cross-border investments, and its net transfer payments .
 The capital account consists of a nation's transactions in financial instruments
and central bank reserves.
The sum of all transactions recorded in the balance of payments should be zero;
however, exchange rate fluctuations and differences in accounting practices may hinder
this in practice.

Understanding the Balance of Payments (BOP )

The balance of payments (BOP) transactions consist of imports and exports of goods,
services, and capital, as well as transfer payments, such as foreign aid and remittances.
A country's balance of payments and its net international investment position together
constitute its international accounts.

The balance of payments divides transactions into two accounts: the current account and
the capital account. Sometimes the capital account is called the financial account, with a
separate, usually very small, capital account listed separately. The current account
includes transactions in goods, services, investment income, and current transfers.The
capital account, broadly defined, includes transactions in financial instruments and
central bank reserves. Narrowly defined, it includes only transactions in financial
instruments. The current account is included in calculations of national output, while the
capital account is not.

If a country exports an item (a current account transaction), it effectively imports foreign

capital when that item is paid for (a capital account transaction). If a country cannot fund
its imports through exports of capital, it must do so by running down its reserves. This
situation is often referred to as a balance of payments deficit, using the narrow definition
of the capital account that excludes central bank reserves. In reality, however, the
broadly defined balance of payments must add up to zero by definition.

In practice, statistical discrepancies arise due to the difficulty of accurately counting

every transaction between an economy and the rest of the world, including discrepancies
caused by foreign currency translations .

History of Balance of Payments (BOP)

Before the 19th century, international transactions were denominated in gold, providing
little flexibility for countries experiencing trade deficits. Growth was low, so stimulating
a trade surplus was the primary method of strengthening a nation's financial position.
National economies were not well integrated, however, so steep trade imbalances rarely
provoked crises. The industrial revolution increased international economic integration,
and balance of payment crises began to occur more frequently.

The Great Depression led countries to abandon the gold standard and engage in
competitive devaluation of their currencies, but the Bretton Woods system that prevailed
from the end of World War II until the 1970s introduced a gold-convertible dollar with
fixed exchange rates to other currencies.1

As the U.S. money supply increased and its trade deficit deepened, however, the
government became unable to fully redeem foreign central banks' dollar reserves for
gold, and the system was abandoned.2

Since the Nixon shock—as the end of the dollar's convertibility to gold is known—
currencies have floated freely, meaning that a country experiencing a trade deficit can
artificially depress its currency—by hoarding foreign reserves, for example—making its
products more attractive and increasing its exports. Due to the increased mobility of
capital across borders, balance-of-payments crises sometimes occur, causing sharp
currency devaluations such as the ones that struck in Southeast Asian countries in 1998.3

During the Great Recession, several countries embarked on competitive devaluation of

their currencies to try to boost their exports. All of the world’s major central banks
responded to the financial crisis at the time by executing dramatically expansionary.
monetary policy. This led to other nations’ currencies, especially in emerging markets,
appreciating against the U.S. dollar and other major currencies.
Many of those nations responded by further loosening the reins on their monetary policy
to support their exports, especially those whose exports were under pressure from
stagnant global demand during the Great Recession.

Special Considerations
Balance of payments and international investment position data are critical in
formulating national and international economic policy. Certain aspects of the balance of
payments data, such as payment imbalances and foreign direct investment , are key
issues that a nation's policymakers seek to address,

While a nation's balance of payments necessarily zeroes out the current and capital
accounts, imbalances can and do appear between different countries' current accounts.
The U.S. had the world's largest current account deficit in 2020, at $616 billion. China
had the world's largest surplus, at $274 billion. The balance-of-payments theory forgets
that the volume of foreign trade is completely dependent upon prices; that neither
exportation nor importation can occur if there are no differences in prices to make trade
profitable.¹
The trade of goods and services is an important factor when it comes to the balance of
payments, which indeed, is very important for every country’s economy. What is the
balance of payments and how does foreign trade affect it? Let’s learn about the balance
of payments, its components, and why it is important for every nation. We have also
prepared for you examples and graphs based on UK and US balance of payments data.
The balance of payments (BOP) is like a country's financial report card, tracking its
international transactions over time. It shows how much a nation earns, spends, and
invests globally through three main components: current, capital, and financial accounts.

The balance of payments

Example is a comprehensive and systematic record of a country's economic transactions

with the rest of the world, encompassing goods, services, and capital flows within a
specified time frame? It comprises the current, capital, and financial accounts, each
reflecting different types of transactions.Imagine a fictional country called "Trade Land"
that exports toys and imports electronics. When Trade Land sells toys to other countries,
it earns money, which goes into its current account. When it buys electronics from other
countries, it spends money, which also affects the current account. The capital account
reflects the sale or purchase of assets like real estate, while the financial account covers
investments and loans. By tracking these transactions, the balance of payments offers a
clear picture of Trade Land’s economic health and its relationship with the global
economy.

Components of the balance of payments

Balance of payments comprises three components: current account, capital account and
financial account.

Current account

The current account indicates the country’s economic activity. The current account is
divided into four main components, which record the transactions of a country's capital
markets, industries, services, and governments. The four components are:

1. Balance of trade in goods. Tangible items are recorded here.

2. Balance of trade in services. Intangible items like tourism are recorded here.
3. Net income flows (primary income flows). Wages and investment income are
examples of what would be included in this section.
4. Net current account transfers (secondary income flows). Government transfers
to the United Nations (UN) or European Union (EU) would be recorded here.

The current account balance is calculated using this formula:

Current Account = Balance in trade + Balance in services + Net income flows + Net
current transfers
The current account can either be in a surplus or deficit.

Capital account

The capital account refers to the transfer of funds associated with buying fixed assets,
such as land. It also records transfers of immigrants and emigrants taking money abroad
or bringing money into a country. The money the government transfers, such as debt
forgiveness, is also included here.

Debt forgiveness refers to when a country cancels or reduces the amount of debt it has to
pay.

Financial account

The financial account shows the monetary movements into and out of the country.The
financial account is split into three main parts:

1. Direct investment. This records the net investments from abroad.

2. Portfolio investment. This records financial flows such as the purchasing of
bonds.

Other investments. This records other financial investments such as loans.

to calculate the balance of payments the balance of payments formula: Balance

of Payments = Net Current Account + Net Financial Account + Net Capital
Account + Balancing Item
fig.1 - Calculating the Balance of Payments
Net current account: £350,000 + (-£400,000) + £175,000 + (-£230,000) = -£105,000

Net capital account: £45,000

Net financial account: £75,000 + (-£55,000) + £25,000 = £45,000

Balancing item: £15,000

Balance of Payments = Net Current Account + Net Financial Account + Net Capital
Account + Balancing Item

Balance of payments:
(-£105,000) + £45,000 + £45,000 + £15,000 = 0
In this example, the BOP equals zero.

 The BoP or balance of payments records the undertakings or transactions of

commodities, assets, and services between the citizens of a nation with the rest of
the world for a stated time frame frequently every year. The balance of payment is
a systematic record of all the economic/monetary transactions between the
 residents (all the units) of a country and the rest of the world in an accounting
year.

 It is prepared on the principles of the double-entry system.

There are two main accounts in the BoP.

 Current account

 Capital account

The current account

The current account is a record of businesses in commodities, transfer payments, and
services. Trade-in commodities comprise the exports and imports of commodities. Trade-
in services comprise factor income and non-factor income transactions or undertakings.

Transfer payments are the receipts that the citizens of a nation get for free’, without
having to provide any commodities or services in return. They consist of remittances,
grants, and gifts. They could be provided by the government or by private residents living
abroad.

Saw a widening deficit, primarily driven by an increase in the trade of goods and
secondary income, indicating that the US imported more goods and paid more income to
foreign residents than it exported and received. Despite the deficit, an increase in the
trade of services and primary income shows some positive signs for the economy, as the
country earned more from services and investments. The current account is a key
indicator of a nation's economic health, and a growing

Deficit may signal potential risks, such as reliance on foreign borrowing and potential
pressure on the currency.
 The capital account

Capital account is a part of an entity’s balance of payments. It is a general ledger account

that records the contributed capital of the shareholders plus the retained earnings.
Companies usually post details about their capital account at the bottom of their balance
sheet. In the case of a sole proprietorship, a capital account might be referred to as
owner’s equity. On the other hand, in the case of a company owned by shareholders, this
account becomes shareholder’s equity

The capital account of a business tracks the surplus cash, machinery, receivable accounts,
property, or houses of the owners. It reflects all financial resources a business has or uses
to operate.
Experienced a minor decrease, reflecting changes in capital-transfer receipts and
payments, such as infrastructure grants and insurance compensation for natural disasters.
Although the capital account's overall impact on the economy is relatively small, it helps
to provide a comprehensive picture of the country's financial transactions. The capital
account records all the international undertakings of assets. An asset is any one of the
types in which wealth can be held. For instance, stocks, bonds, government debt, money,
etc. The purchase of assets is a debit on the capital account. If an Indian purchases a UK
car company, it enters the capital account undertakings as a debit (as foreign exchange is
going out of India).On the other hand, the sale of assets, like the sale of the share of an
Indian company to a Japanese customer, is a credit on the capital account.

Types of Capital Accounts?

Upon knowing the capital account definition, it is crucial that you are well-versed with
the types of capital accounts.

Typically, there are two methods by which you can maintain a capital account in a
partnership firm. Find details about them below:
 1. Fixed Capital Account
This is the type of capital account where a business organization maintains two different
accounts. Both these accounts feature different types of transactions undertaken by the
partners’ capital. The two accounts created under this are current account and capital
account.
If you plan to display a fixed capital account, note that this type of account remains
constant and you need to mention it clearly in the partnership deed.

2. Fluctuating Capital Account

In this type of capital account, all partners’ capital keeps on fluctuating. Unlike fixed
capital accounts, it displays simply one account. There is no need for individuals to
showcase this detail in the partnership deed.

The financial account

Financial accounting is a specific branch of accounting involving a process of recording,

summarizing, and reporting the myriad of transactions resulting from business
operations over a period of time. These transactions are summarized in the preparation
of financial statements, including the balance sheet, income statement and cash flow
statement that record the company's operating performance over a specified period.

 Work opportunities for a financial accountant can be found in both the public and
private sectors. A financial accountant's duties may differ from those of a general
accountant, who works for himself or herself rather than directly for a company
or organization. Financial accounting is the framework that dictates the rules,
processes, and standards for financial recordkeeping.
 Nonprofits, corporations, and small businesses use financial accountants to
prepare their books and records and generate their financial reports.
It occurs through the use of financial statements such as the balance sheet, income
statement, statement of cash flow, and statement of changes in shareholder equity.

Financial accounting differs from managerial (or cost) accounting as financial reporting
is more for reporting to external parties while cost accounting is more for strategic
planning internally.

Financial accounting may be performed under the accrual method (recording expenses
for items that have not yet been paid) or under the cash method (only cash transactions
are recorded).

Reveals that the US continued borrowing from foreign residents, increasing financial
assets and liabilities. An increase in financial assets shows that US residents are investing
more in foreign securities and businesses, while the growth in liabilities indicates that the
US relies more on foreign investments and loans. This reliance on foreign borrowing can
affect the economy, such as increased vulnerability to global market fluctuations and
potential impacts on interest rates.
 INTERNATIONAL TRADE LINKAGE
International linkage refers to the connections between different countries in terms of
trade, financial flows, and other economic activities. In the context of the balance of
payments, international linkage refers to the interdependence between a country's
external economic transactions and its overall economic performance.

The balance of payments is a record of all the economic transactions that take place
between a country and the rest of the world over a given period. It tracks the flow of
goods, services, income, and financial capital in and out of a country.

International linkages affect the balance of payments in several ways. For example, an
increase in exports or decrease in imports can improve a country's balance of payments
surplus. Similarly, an increase in foreign investment in a country can improve its
financial account surplus. On the other hand, an increase in the outflow of capital from a
country can lead to a balance of payments deficit.

INTERNATIONAL LINKAGES
National economies are becoming more closely interrelated.
• Economic influences from abroad have affects on the U.S. economy.
• Economic occurrences and policies in the U.S. affect economies abroad.
 When the U.S. moves into a recession, it tends to pull down other economies.
 When the U.S. is in an expansion, it tends to stimulate other economies.

Economies are linked through two broad channels

1. Trade in goods and services
•A trade linkage:
 Some of a country’s production is exported to foreign countries  increase
demand for domestically produced goods
 Some goods that are consumed or invested at home are produced abroad and
imported  a leakage from the circular flow of income
2. Finance

• U.S. residents can hold U.S. assets OR assets in foreign countries

 Portfolio managers shop the world for the most attractive yields
 As international investors shift their assets around the world, they link assets
markets here and abroad  affect income, exchange rates, and the ability of
monetary policy to affect interest rates

The Balance of Payments and Exchange Rates

• Balance of payments: the record of the transactions of the residents of a country with
the rest of the world
• Two Main accounts Current account: records trade in goods and services, as well
transfer payments.
 Capital account: records purchases and sales of assets, such as stocks, bonds, and land
any transaction that gives rise to payment by a country’s residents is a deficit item in that
country’s balance of payments.

External Accounts Must Balance

• The central point of international payments is very
simple: Individuals and firms have to pay for what they
buy abroad
• If a person spends more than her income, her deficit needs to be
financed by selling assets or by borrowing
• Similarly, if a country runs a deficit in its current account the deficit needs to be
financed by selling assets or by borrowing abroad.
• Selling/borrowing implies the country is running a capital account surplus  any
current account deficit if of necessity financed by an offsetting capital inflow.
Current account + Capital account = 0 Exchange rate is the price of one currency in terms
of another Two different exchange rate systems:

FIXED vs. FLOATING Fixed Exchange Rates

in fixed exchange rate system foreign central banks stand ready to buy and sell their
currencies at a fixed price in terms of dollars.
• Ensures that market prices equal to the fixed rates
 No one will buy dollars for more than fixed rate since know that they can get them for
the fixed rate
 No one will sell dollars for less than fixed rate since know can sell them
for the fixed rate
• Foreign central banks hold reserves to sell when have to intervene in the foreign
exchange market
• Intervention: the buying or selling of foreign exchange by the central bank

Fixed Exchange Rates

• the balance of payments measures the amount of foreign

exchange intervention needed from the central banks
• Ex. If the U.S. were running a current account deficit vis-à-vis
Japan, the demand for yen in exchange for dollars exceeded the
supply of yen in exchange for dollars, the Bank of Japan would buy
the excess dollars, paying for them with yen
 Under a fixed exchange rate, price fixers must make up the excess
demand or take up the excess supply
 Makes it necessary to hold an inventory for foreign currencies that can be provided in
exchange for the domestic currency.
As long as the central bank has the necessary reserves, it can
continue to intervene in the foreign exchange markets to keep the exchange rate constant.
• If a country persistently runs deficits in the balance of payments.
• The central bank eventually will run out of reserves on of foreign exchange.
• Will be unable to continue its intervention.
• Before this occurs, the central bank will likely devalue the currency.
Flexible (Floating) Exchange Rates
• In a flexible (floating) exchange rate system, central banks allow the exchange rate to
adjust to equate the supply and demand for foreign currency.

The Exchange Rate in the Long Run

• In the long run, the exchange rate between a pair of countries is determined by the
relative purchasing power of currency within each country.
• Two currencies are at purchasing power parity (PPP) when a unit of domestic
currency can buy the same basket of goods at home or abroad
• The relative purchasing power of two currencies is measured by the real exchange rate.
• The real exchange rate, R, is defined as (3), where Pf and P are the price levels abroad
and domestically, respectively
 If R =1, currencies are at PPP
 If R > 1, goods abroad are more expensive than at home
 If R < 1, goods abroad are cheaper than those at home
• Best estimate for modern times is that it takes about 4 years to reduce deviations from
PPP by half
• PPP holds in the LR, but only one of the determinants of the exchange rate.

Trade in Goods, Market Equilibrium,

and the Balance of Trade
• Need to incorporate foreign trade into the IS-LM model
• Assume the price level is given, and output demanded will be supplied (flat AS curve)
• With foreign trade, domestic spending no longer solely
determines domestic output  spending on domestic
goods determines domestic output
 Spending by domestic residents is DS=C+I+G________(4)
 Spending on domestic goods is
DS+NX=(C+G+I)+(X-Q)______(5)
 Assume DS depends on the interest rate and income:
DS DS(Y,i)

Net Exports
• Net exports, (X-Q), is the excess of exports over imports
• NX depends on:
 domestic income NX=X(Yf,R)-Q(Y,R)=NX(Y,Yf,R)
 foreign income, Yf
 A rise in foreign income improves the home country’s trade
balance and raises their AD
 A real depreciation by the home country improves the trade balance and increases AD
A rise in home income raises import spending and worsens the trade balance,

decreasing AD12-12

Goods Market Equilibrium

• Marginal propensity to import = fraction of an extra
dollar of income spent on imports
• IS curve will be steeper in an open economy compared to a
closed economy
• For a given reduction in interest rates, it takes a smaller increase in
output and income to restore equilibrium in the goods market
• IS curve now includes NX as a component of AD
(8)

IS : Y=DS(Y,i)+NX(Y,Yf,R)
• level of competitiveness (R) affects the IS curve
• A real depreciation increases the demand for domestic goods 
shifts IS to the right
• An increase in Yf results in an increase in foreign spending on
domestic goods shifts IS to the right12-13
Goods Market Equilibrium

• Figure .3 shows the effect of a rise in foreign income

• Higher foreign spending on our goods raises demand and requires an increase in output
at given interest rates
• Rightward shift of IS
• Full effect of an increase in foreign demand is an increase in interest rates an
 12-14

Capital Mobility
• High degree of integration among financial markets markets in which bonds and
stocks are traded
• Start our analysis with the assumption of perfect capital mobility
• Capital is perfectly mobile internationally when investors can
purchase in any country they choose quickly, with low transaction costs , and in
unlimited amounts
• Under this assumption, asset holders are willing and able to move large amounts of
funds across borders in search of the highest return or lowest borrowing cost
• Implies that interest rates in a particular country cannot get too far out of line without
bringing capital inflows/outflows that bring it back in line

12-15
The Balance of Payments and Capital Flows
• Assume a home country faces a given price of imports, export demand, and world
interest rate, if
• Additionally, capital flows into the home country when the interest rate is above the
world rate
• Balance of payments surplus is: (9), where CF is the capital account surplus
• The trade balance is a function of domestic and foreign income
• An increase in domestic income worsens the trade balance
• The capital account depends on the interest differential
 An increase in the interest rate above the world level pulls in
capital from abroad, improving the capital account

Mundell-Fleming Model: Perfect Capital

Mobility Under Fixed Exchange Rates
• The Mundell-Fleming model incorporates foreign exchange under
perfect capital mobility into the standard IS-LM framework
• Under perfect capital mobility, the slightest interest differential provokes
infinite capital inflows  central bank cannot conduct an independent
monetary policy under fixed exchange rates
WHY?
• Suppose a country tightens money supply to increase interest rates
• Portfolio holders worldwide shift assets into country
• Due to huge capital inflows, balance of payments shows a large surplus
• The exchange rate appreciates and the central bank must intervene to hold the
exchange rate fixed
• The central bank buys foreign currency in exchange for domestic currency
• Intervention causes domestic money stock to increase, and interest rates drop
• Interest rates continue to drop until return to level prior initial intervention
 Monetary Expansion
• Figure 12-5 shows the IS-LM curves in addition to the BP=0
• BP schedule is horizontal under perfect capital mobility (i = if)
• Consider a monetary expansion that starts from point E  shifts LM down and to the
right to E’
• At E’ there is a large payments deficit, and pressure for the exchange
rate to depreciate
• Central bank must intervene, selling foreign money, and receiving
domestic money in exchange
• Supply of money falls, pushing up interest rates as LM moves back
to original position
Fiscal Expansion
• Monetary policy is infeasible, but fiscal expansion under fixed exchange rates and
perfect capital mobility is effective
• A fiscal expansion shifts the IS curve up and to the right increases interest rates and
output
• The higher interest rates creates a capital inflow with the tendency to appreciate the
exchange rate
• To manage the exchange rate the central bank must expand the money supply 
shifting the LM curve to the right
• Pushes interest rates back to their initial level, but output increases yet again. 12-19

Perfect Capital Mobility and Flexible

Exchange Rates
• Use the Mundell-Fleming model to explore how
monetary and fiscal policy work in an economy with a flexible exchange rate and perfect
capital mobility
• Assume domestic prices are fixed
• Under a flexible exchange rate system, the central bank does not intervene in the market
for foreign exchange
• The exchange rate must adjust to clear the market so that the demand for and supply of
foreign exchange balance
• Without central bank intervention, the balance of payments must equal zero
• The central bank can set the money supply at will since there is no obligation to
intervene  no automatic link between BP and money supply

Perfect Capital Mobility and Flexible

Exchange Rates
• Perfect capital mobility implies that the balance of payments
balances when i = if (10)
• A real appreciation means home goods are relatively more expensive, and IS shifts to
the left
• A depreciation makes home goods relatively cheaper, and is shifts to the right
• The arrows in Figure 12-6 make the link between the interest rate and AD
• When i > if, the currency appreciates
• When i < if, the currency depreciates
[Insert Figure.2.here]

Adjustment to a Real Disturbance

• Using equations 8-10 we can show how various changes
affect the output level, interest rate, and exchange rate
• Suppose exports increase:
 At a given output level, interest rate, and exchange rate, there is an excess demand for
goods
 IS shifts to the right
 The new equilibrium, E’, corresponds to a higher income level and interest rate
 But don’t reach E’ since BP in disequilibrium  exchange rate
appreciation will push economy back to E

Adjustment to a Change in the Money Stock

Suppose there is an increase in the nominal money supply:
The real stock of money, M/P, increases since P is fixed
At E there will be an excess supply of real money balances
To restore equilibrium, interest rate will have to fall  LM shifts to the right
At point E’, goods market is in equilibrium, but i is below the world level  capital
inflows depreciate the exchange rate
 Import prices increase, domestic goods more competitive, and demand for home goods
expands
 IS shifts right to E”, where i = if
Adjustment to a Change in the Money Stock
Suppose there is an increase in the nominal money supply Result: A monetary expansion
leads to an increase in output and a depreciation of the exchange rate under flexible
rates
 CNCLUSION
International trade has been the cornerstone of the global economy, fostering economic
growth and development across nations. The world is becoming more interconnected than
ever, and international trade has been a significant contributor to this phenomenon.
Balance of payment and international linkages refer to the relationship between a
country's economy and its trade with other countries. International linkages, on the other
hand, refer to the economic ties between countries, including trade deals, investment
flows, and the exchange of goods and services. These linkages are critical for a country's
economic growth and stability, as they help to facilitate the flow of goods and capital
across borders. The balance of payment and international linkages are closely linked, as
changes in one can have a significant impact on the other. Conversely, a trade surplus
(when a country exports more than it imports) can lead to a strengthening of the cu. It
summarizes all transactions that a country's individuals, companies, and government
bodies complete with individuals, companies, and government bodies outside the
country. The balance of payments includes both the current account and capita account.
The balance of payments (BOP) transactions consist of imports and exports of goods,
services, and capital, as well as transfer payments, such as foreign aid and remittances. A
country's balance of payments and its net international investment position together
constitute its international accounts. Narrowly defined, it includes only transactions in
financial instruments. The current account is included in calculations of national output,
while the capital account is not. . If a country exports an item (a current account
transaction), it effectively imports foreign capital when that item is paid for (a capital
account transaction). In reality, however, the broadly defined balance of payments must
add up to zero by definition. Before the 19th century, international transactions were
denominated in gold, providing little flexibility for countries experiencing trade deficits.
National economies were not well integrated, however, so steep trade imbalances rarely
provoked crises. As the U.S. money supply increased and its trade deficit deepened,
however, the government became unable to fully redeem foreign central banks' dollar
reserves for gold, and the system was abandoned.2. Since the Nixon shock—as the end of
the dollar's convertibility to gold is known—currencies have floated freely, meaning that
a country experiencing a trade deficit can artificially depress its currency—by hoarding
foreign reserves, for example—making its products more attractive and increasing its
exports. Due to the increased mobility of capital across borders, balance-of-payments
crises sometimes occur, causing sharp currency devaluations such as the ones that struck
in Southeast Asian countries in 1998.3. During the Great Recession, several countries
embarked on competitive devaluation of their currencies to try to boost their exports. This
led to other nations’ currencies, especially in emerging markets, appreciating against the
U.S. Balance of payments and international investment position data are critical in
formulating national and international economic policy. While a nation's balance of
payments necessarily zeroes out the current and capital accounts, imbalances can and do
appear between different countries' current accounts. had the world's largest current
account deficit in 2020, at $616 billion. The trade of goods and services is an important
factor when it comes to the balance of payments, which indeed, is very important for
every country’s economy. What is the balance of payments and how does foreign trade
affect it? Let’s learn about the balance of payments, its components, and why it is
important for every nation. We have also prepared for you examples and graphs based on
UK and US balance of payments data. When Trade Land sells toys to other countries, it
earns money, which goes into its current account. When it buys electronics from other
countries, it spends money, which also affects the current account. The current account
indicates the country’s economic activity. The current account is divided into four main
components, which record the transactions of a country's capital markets, industries,
services, and governments. Balance of trade in goods. Balance of trade in services.
Intangible items like tourism are recorded here. Net income flows (primary income
flows). Wages and investment income are examples of what would be included in this
section. Net current account transfers (secondary income flows). Government transfers to
the United Nations (UN) or European Union (EU) would be recorded here. The capital
account refers to the transfer of funds associated with buying fixed assets, such as land.
The money the government transfers, such as debt forgiveness, is also included here.
Direct investment. This records the net investments from abroad. Portfolio investment.
This records financial flows such as the purchasing of bonds. Other investments. This
records other financial investments such as loans. In this example, the BOP equals zero.
The BoP or balance of payments records the undertakings or transactions of
commodities, assets, and services between the citizens of a nation with the rest of the
world for a stated time frame frequently every year. The balance of payment is a
systematic record of all the economic/monetary transactions between the residents (all the
units) of a country and the rest of the world in an accounting year. The current account is
a record of businesses in commodities, transfer payments, and services. They consist of
remittances, grants, and gifts. They could be provided by the government or by private
residents living abroad. Despite the deficit, an increase in the trade of services and
primary income shows some positive signs for the economy, as the country earned more
from services and investments. The current account is a key indicator of a nation's
economic health, and a growing. Capital account is a part of an entity’s balance of
payments. Companies usually post details about their capital account at the bottom of
their balance sheet. The capital account of a business tracks the surplus cash, machinery,
receivable accounts, property, or houses of the owners. It reflects all financial resources a
business has or uses to operate. . The capital account records all the international
undertakings of assets. An asset is any one of the types in which wealth can be held.
Typically, there are two methods by which you can maintain a capital account in a
partnership firm. 1. Fixed Capital Account. This is the type of capital account where a
business organization maintains two different accounts. Both these accounts feature
different types of transactions undertaken by the partners’ capital. 2. Fluctuating Capital
Account. In this type of capital account, all partners’ capital keeps on fluctuating.
Financial accounting is a specific branch of accounting involving a process of recording,
summarizing, and reporting the myriad of transactions resulting from business operations
over a period of time. These transactions are summarized in the preparation of financial
statements, including the balance sheet, income statement and cash flow statement that
record the company's operating performance over a specified period. Work opportunities
for a financial accountant can be found in both the public and private sectors. Financial
accounting is the framework that dictates the rules, processes, and standards for financial
recordkeeping. Reveals that the US continued borrowing from foreign residents,
increasing financial assets and liabilities. International linkage refers to the connections
between different countries in terms of trade, financial flows, and other economic
activities. The balance of payments is a record of all the economic transactions that take
place between a country and the rest of the world over a given period. It tracks the flow
of goods, services, income, and financial capital in and out of a country. International
linkages affect the balance of payments in several ways. Similarly, an increase in foreign
investment in a country can improve its financial account surplus. • Economic influences
from abroad have affects on the U.S. • Economic occurrences and policies in the U.S.
( When the U.S. moves into a recession, it tends to pull down other economies. ( When
the U.S. is in an expansion, it tends to stimulate other economies. 1. Trade in goods and
services. 2. residents can hold U.S. assets OR assets in foreign countries. FIXED vs.
FLOATING Fixed Exchange Rates. If the U.S. were running a current account deficit
vis-à-vis. • Pushes interest rates back to their initial level, but output increase
References

1. BEA, U.S. International Tra nsactions, 4th Quarter and Year

2022, https://www.bea.gov/news/2023/us-international-
transactions-4th-quarter-and-year-202

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