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					                    BALANCE OF TRADE

• The balance of trade measures visible goods (i.e. of a physical
  merchandise nature) in trade on current account

• Exports result in an inflow of money and are treated as a credit item;
  imports result in an outflow and are treated as a debit item

• Balance of Trade
  = visible exports - visible imports

• At present Ireland enjoys a substantial balance of trade surplus

• This is mainly due to the activities of multinational companies in
  Ireland who export in great amounts abroad (using transfer pricing)
                  BALANCE OF PAYMENTS
•   The balance of payments includes invisible items in trade

•   Factor flows relate to money which is earned in one country yet repatriated to
    - in Ireland multinational companies make large profits which are
      repatriated overseas (mainly US) leading to a negative flow; repatriation back
      home from Irish companies abroad would lead to a positive flow
    - repayment of interest on foreign debt would also lead to a negative flow
    - in past emigrants remittances were received in large amounts from
      Irish workers abroad

•   Services e.g. tourism, financial services, software development now
    increasingly are traded internationally.

•   Overall, services is now greater in value than merchandise trade with Ireland
    ranked 9th in the world for exports of services

    - There are very large invisible exports in software (with Ireland ranked no. 1
       internationally in this category
    - however equally there are large invisible imports with respect to consultancy
      services and royalty payments by multinational companies
            BALANCE OF PAYMENTS (con)
• Invisible payments also arise due to international transfers of funds

• Ireland is a member of the EU and contributes to and receives money
  from the EU budget
  - in past Ireland received much more from budget than it contributed
  - however because of substantial income growth during the Celtic
   Tiger years we are contributing more and receiving less

• Overall there is a massive deficit on invisible trade in Ireland

• This largely wipes out the surplus on the trading balance so that we
  now have just a small surplus on the balance of payments

• Balance of Payments (on current account)
  = (visible + invisible exports) – (visible + invisible imports)
                        BASIC BALANCE
• Trade also takes place in capital items

• Long term capital transactions involve activities such as investment by
  foreign companies in Ireland and Government foreign borrowing (for
  capital purposes)

• Short terms capital transactions reflect financial activity of stock

• Capital transactions by their nature tend to be very volatile

• When net capital transactions are added to current we get the overall
  balance of payments) referred to as the Basic Balance

• In the past corrective action had to be taken by governments when a
  large basic balance existed
  - now because of membership of the Eurozone the overall balance for
    this bigger region is more important
• An exchange rate measures the value of one currency in terms of

• As with goods and services, the values of a currency against another is
  determined by demand and supply

• When goods are exported from Ireland payment must be made in our
  currency (i.e. the euro)

• When goods are imported into Ireland - say from the UK - payment
  must be made in the UK’s currency (i.e. sterling)

• When the euro rises - say against sterling or the dollar - it becomes
  more expensive to sell goods in the UK and the US (but cheaper to
  import from these countries)

• When the euro falls against these currencies it becomes cheaper to sell
  abroad but more expensive to import
                EXCHANGE RATES (con)

• Factors determining exchange rates
  - demand for exports and imports
  - inflationary pressures
  - changes in interest rates
  - speculation
  - political factors

• Intervention on Foreign Markets
  - using reserves
  - borrowing abroad
  - raising interest rates
  - deflationary policy
  - supply-side policies
  - controls on imports
                      Determination of the rate of exchange
                                                     S by UK


$ price of £


                                    d        c

                                                    D by USA
                      0            QS       QD         Q of £
        Fixed versus Floating Exchange Rates

• Advantages of fixed exchange rates
   – certainty
   – no speculation (if rate is absolutely fixed)
   – prevents 'irresponsible' government policies

• Disadvantages of fixed exchange rates
   – conflicts with other macro objectives
   – danger of competitive deflations
   – problems of international liquidity
   – difficulties in adjusting to shocks
   – speculation
        Fixed versus Floating Exchange Rates
• Advantages of free-floating rates
   – automatic correction
   – no problem of international liquidity
   – insulation from external events
   – less constraint on domestic macro policy

• Disadvantages of free-floating rates
   – possibly unstable exchange rates
   – speculation
   – uncertainty for business
       but use of forward markets
   – lack of discipline on economy
             Fixed Exchange Rate Systems
• Gold Standard (1870 – 1914):
• Currencies fixed to gold.

• Bretton Woods (1945-71):
• $ fixed to gold ($35/1 ounce). All other currencies fixed
  to $.

• Establishment of IMF and World Bank.

• Snake System ( 1973-78):
• European currencies held inside a band of +/- 1.125%
  around a central rate.
       Leddin and Walsh Macroeconomy of the Eurozone, 2003
                   Gold Standard (1870-1914)

• Currencies fixed to gold.

• Automatic adjustment mechanism which removes BP
  surpluses or deficits.

• BP (-)  currency outflow  Ms  P 
  improvement in competitiveness  removal BP (-)

• Note incorporation of Quantity Theory.

           Leddin and Walsh Macroeconomy of the Eurozone, 2003
      Exchange Rates and Balance of Payments

• Exchange rates and the balance of payments: government
   – reducing short-term fluctuations
      • using reserves
      • borrowing from abroad
      • changes in interest rates

   – maintaining a fixed rate of exchange over the longer
      • deflation / reflation
      • supply-side policies
      • import controls

• Single market for persons, goods, services and capital

• High level of co-ordination of economic policy
  - esp. central control of fiscal policy

• Greater role for competition policies

• Structural Funds
  - transfer of funds to weaker countries

• Total and irreversible convertibility of currencies

• Complete liberalisation of capital movements

• Full integration of banking and other financial markets

• Elimination of margins of fluctuation and irrevocable
  locking of exchange rates (implying a single currency)
                     ADVANTAGES OF EMU
•   Symbolic of overall union

•   Would reduce transaction costs for business

•   Would eliminate uncertainty due to exchange rate adjustments facilitating

•   Individual countries do not have to hold reserves as all are pooled

•   Would encourage more co-ordination of economic policies

•   Beneficial effects on efficiency

•   Currency would become international reserve asset

•   Help to reduce interest rates

•   Help to reduce inflation

•   Could facilitate overall growth and employment in Community

• Considerable loss in national sovereignty

• Effects might not be equally spread throughout

• Possible difficulties in dealing with crisis situations

• No guarantees in relation to stability of currency in relation
  to other world currencies

• Special problems for Ireland (in relation to UK and US

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