MGT604 - Management of Financial Institutions - Lecture Handout 05

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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

  1. Exchange rates
  2. Trade agreements or barriers
  3. Other tax, tariff and trade measures
  4. 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.
  • 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 shortterm 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.