Basic Macroeconomics Chapter 20 Exchange rates and the balance of payments

Chapter 20
Exchange rates and the balance of payments
07/11/2024 11:28:37 PM Prepared by Mr. Festus Tangeni KANDENGE 1

Balance of Payments
• When countries take part in international trade, money flows

out of the country and money flows into the country.
• All transactions relating to the flow of funds, goods, and services
across national boundaries are included in the balance of
payments of the countries concerned.
• The balance of payments is the summary of the flow of all
money between citizens of a country and foreigners across the
border of a country.
• In Namibia the balance of payments gives us the dallar value of
all the money that came into the country and that left the
country in one year.
• All the figures are given in nominal values and are not adjusted
for inflation.
Balance of Payments
• The balance of payments consists of four

components:
– The current account.
– The capital transfer account.
– The financial account (previously known as the
capital account).
– Unrecorded transaction

Balance of Payments
• Payments and receipts related to the flow of

goods and services and other flows of income
are recorded in the current account.
• The financial account includes international
transactions in financial assets that involve the
borrowing and lending of funds.
• The change in a country’s gold and other
foreign reserves is the balancing item of the
balance of payments.

The current account
• Merchandise exports and merchandise

imports show the dollar value of goods
exported and imported respectively.
• The Namibia balance of payments has a
unique characteristic in that a separate
heading is given for mineral export, which is
not included in merchandise exports.
• This is because mineral exports constitute such
a large percentage of total Namibia exports.
The current account
• Merchandise exports, plus mineral exports,
minus imports, form what is called the
trade balance.
• Service receipts and payments for services
are what is received and what must be paid
for in respect of services, such as
transportation of goods or people between
countries, travel, financial and insurance
services, or construction services.
The current account
• Income receipts refer to income earned by

Namibians in the rest of the world.
• Income payments include all income earned by
foreigners in Namibia. This income includes
remuneration for employees, as well as
investment income.
• In the national accounts, income receipts and
payments are included under the term ‘primary
income from (to) the rest of the world’.

The current account
• Income payments in the Namibian context

are much higher than income receipts.
• The last item, current transfers, includes
items such as social security contributions
and benefits, taxes levied by government,
and private transfers like gifts and
donations.

The financial account
• The financial account is a summary of

transactions in assets and liabilities.
• The financial account has three components:
direct investment, portfolio investment and
other investment.
• With direct investment, the purpose of the
investor is to gain control or at least a
meaningful say in the running of an enterprise
(for example, buying the majority share in a
company).
• With portfolio investment, the investor is
only interested in the financial return on the
investment (buying shares in an existing
firm).
• All investment not recorded under direct or
portfolio investment is recorded under
‘other investment’. This may include an
item such as short-term credit used to
finance imports and exports.
• The heading ‘unrecorded transactions’

serves the purpose of ensuring that the
balance of payments actually balances.
• Because a double entry accounting system is
used to record all transactions in the
balance of payments, the net sum of all
debit and credit entries should add up to a
country’s change in net fold and other
foreign reserves.
• In reality this is not the case and this
heading is needed because of errors and
omissions that occur while compiling the
other individual components of the balance
of payments.
• The balance on the financial account is
determined by adding net direct
investment, net portfolio investment, and
net other investment.
Gold and other foreign reserves
• When a country exports goods and services it earns

foreign currency.
• Conversely, when something is imported, foreign
currency flows out of Namibia.
• If the receipts of foreign currency exceed the payment of
foreign currency, the foreign reserves increase; the
opposite is true if the receipts are less than the payments.
• The sum of the balance on the current account, the
capital transfer account balance, the balance of the
financial account, and the unrecorded transactions
reflect the change in foreign reserves.

Gold and other foreign reserves
• The change in net gold and other foreign reserves
gives an indication of whether there was a net inflow
or outflow of reserves over a certain time period,
because the sum of the current account, capital
transfer account, financial account, and unrecorded
transactions gives the net change in gold and other
foreign reserves ‘owing to balance of payment
transactions’.
• Total reserves are calculated by adding together the
surpluses/deficits of all the years’ balance of
payments.
Exchange rate policy
• The choice of exchange rate regime for a

country will have a significant influence on
the impact of monetary and fiscal policies.
• From a historical point of view, fixed
exchange rate regime systems appear to
have been the norm.
• However, Namibia and many other
countries now have a flexible exchange rate
regime.
Flexible exchange rates
• A flexible exchange rate system is

one where the value of the
currency is determined by the
supply and demand for the
foreign exchange and there is no
interference by the Central Bank
or the government.
• The dollar is currently a
floating/flexible regime and is
determined by the interaction of
supply and demand.
• Supply of foreign exchange is
twofold: to pay for Namibian
exports of goods and services,
and through capital inflows.

• The supply of foreign
exchange curve is upward
sloping because as the value
of the dollar becomes
cheaper against the US
dollar, it means that
Namibian goods and
services become cheaper
for foreigners, who will
increase their purchases
and thus increase the
quantity of foreign
exchange supplied.
• The demand for foreign
exchange stems from the need
for Namibian to pay for
foreign goods and services.
• The demand for foreign
exchange curve is therefore
downward sloping because as
the value of the dollar
strengthens against the US
dollar, the quantity demanded
will increase because foreign
goods and services, foreign
loans, now all become
relatively cheaper.

Determination of the exchange rate
• Combing the two curves,

supply of and demand for
foreign exchange, results
in our determining the
value of the rand under a
flexible exchange rate
system.
• The equilibrium
exchange rate is
determined by the
interaction between
supply and demand.
Fixed exchange rates
• In a fixed exchange rate regime, national governments

agree to maintain the convertibility of their currency at
a fixed exchange rate.
• A currency is convertible when, if the government
acting through the Central Bank, agrees to buy and sell
as much of the currency as people wish to trade at the
fixed exchange rate.
• The greatest virtue of the fixed exchange rate system is
that it removes the uncertainty from international
trade and encourages long-term investments in such
trade.
• Under a fixed exchange rate system the government has to
defend the fixed value of the currency by either buying or
selling foreign exchange reserves.
• For as long as the government, through the Central bank is
willing and able to defend the currency, a fixed exchange
rate will prevail.
• The ability of the Central Bank to defend the rand depends
on the actual availability of foreign exchange reserves held
by the bank.
• If the Central Bank runs out of foreign currency to defend
the rand, the government has no option but to devalue the
dollar.
• A depreciation or appreciation of the dollar occurs
when the laws of supply and demand cause the
dollar to decrease or increase in value.
• A devaluation or revaluation is a forced change in
the value of the currency activated by the
government.
• This occurs only under fixed exchange rate regimes.
• The fundamental cause for changes in the supply
and demand for foreign currency rests in the
balance of payments.
• An increase in the supply of foreign exchange will lead
to an appreciation of the dollar under a flexible
exchange rate system.
• If the exchange rate system is fixed, it will lead to an
increase in foreign exchange reserves held by the
Central Bank.
• An increase in demand for foreign currency will lead to
a depreciation of the rand under a flexible exchange
rate system, whereas under a fixed exchange rate
system it will lead to the depletion of foreign exchange
reserves because of Central Bank intervention.
The managed float exchange rate system
• There is a third exchange rate system that tends to combine

features from both the fixed and flexible exchange rate
systems.
• The managed float exchange rate system is one in which
the currency is allowed to fluctuate as the market changes
but where the Central Bank intervenes to smooth out
short-term fluctuations in the exchange rate.
• However, if the Central believes that the depreciation is
likely to endure for a long period of time, it will not defend
the currency because to do so would mean using up foreign
exchange reserves and still not being able to maintain the
fixed value of the dollar.

Basic Macroeconomics Chapter 20 Exchange rates and the balance of payments

Uploaded by

Document Information

Copyright

Available Formats

Share this document

Share or Embed Document

Sharing Options

Did you find this document useful?

Is this content inappropriate?

Copyright:

Available Formats

Basic Macroeconomics Chapter 20 Exchange rates and the balance of payments

Uploaded by

Copyright:

Available Formats

Chapter 20

Exchange rates and the balance of payments

07/11/2024 11:28:37 PM Prepared by Mr. Festus Tangeni KANDENGE 1

• When countries take part in international trade, money flows

• The balance of payments consists of four

07/11/2024 11:28:38 PM Prepared by Mr. Festus Tangeni KANDENGE 3

• Payments and receipts related to the flow of

07/11/2024 11:28:38 PM Prepared by Mr. Festus Tangeni KANDENGE 4

• Merchandise exports and merchandise

• Income receipts refer to income earned by

07/11/2024 11:28:38 PM Prepared by Mr. Festus Tangeni KANDENGE 7

• Income payments in the Namibian context

07/11/2024 11:28:38 PM Prepared by Mr. Festus Tangeni KANDENGE 8

• The financial account is a summary of

• The heading ‘unrecorded transactions’

• When a country exports goods and services it earns

07/11/2024 11:28:38 PM Prepared by Mr. Festus Tangeni KANDENGE 13

• The choice of exchange rate regime for a

• A flexible exchange rate system is

07/11/2024 11:28:39 PM Prepared by Mr. Festus Tangeni KANDENGE 16

07/11/2024 11:28:39 PM Prepared by Mr. Festus Tangeni KANDENGE 18

• Combing the two curves,

• In a fixed exchange rate regime, national governments

• There is a third exchange rate system that tends to combine

You might also like