Essay on Mgec61 Note - Chapter 13

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MGEC61 – International Economics: Finance


International finance is a study of problems and policies of an open economy.

International finance studies the issues like unemployment, savings, trade imbalances, money and price levels (include exchange rates).

Organization of the course
1) Introduction – chapter 13
2) Interest rate parity (how exchange rate is determined by the flows of capital) and exchange rate overshooting – chapters 14 & 15
3) Purchasing power parity and the exchange rate in the long run (how exchange rate is determined by the flows of goods and the determinants of exchange rate in the long run) – chapter 16
4) The DD-AA model (the model that explains how exchange rate and output are determined in
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Financial account (KA): the difference between sales of assets to foreigners and purchases of assets from abroad.

Capital account: the transfers of wealth between countries. It usually arises from non-market activities such as changes in ownership of existing assets, represents the acquisition or disposal of non-produced, non-financial, and possibly intangible assets.

MGEC61 – Chapter 13

© Iris Au


The Financial Account (KA)

The financial account consists of 2 portions (KA = KAnon-res + ORT):
1) The non-reserve portion (KAnon-res) – the purchases and sales of assets by the private sector (households and firms).
2) The reserve portion (ORT) – the purchases and sales of foreign assets by the country’s monetary authority.

The financial account records movement of financial capital across national borders.
 When foreigners purchase assets from us:

 When we purchase assets from foreigners:

Note: Change in a country’s net foreign wealth = – KA

When a country runs a KA deficit (KA < 0), the exports of assets < the imports of assets  the country is a net importer of assets  holding of foreign assets .

MGEC61 – Chapter 13

© Iris Au


Reserve Portion of KA – Official Reserve Transactions (ORT)

Official reserves//foreign exchange reserves: foreign-currency denominated assets
(foreign assets) held by central banks,