Sunday, April 18, 2010

Unit 10 - International Economics

This unit discussed the basic principles of international economics. The unit described the trade balance of a country is total exports – total imports. As seen in the following graph New Zealand has a negative trade balance with imports being greater than exports for most of the since 2004, meaning New Zealand has had a negative trade balance since 2004.

Figure 1-New Zealand Income and Exports
Regarding New Zealand’s current account balance, which is made up of Net Imports, Net Income and Net Transfers, as shown in the table below. It can be seen that New Zealand’s is negative largely due to net income being negative, i.e. meaning that New Zealand pays a lot more investment income to foreigners compared to the amount it receives by its own residents investment income. This means that New Zealand has a large number of foreigners investing in New Zealand. It is interesting to note that New Zealand has a positive negative transfer, even though New Zealanders give a large amount of aid to foreign countries each year. The positive net transfers is probably mainly due to the large number of English retirees receiving their pension from the British Government in New Zealand.
The negative current account balance correlates that New Zealand has a net foreign investment. I.e. that New Zealand has more domestic assets purchased by foreigners than foreign assets purchased by New Zealand residents. This would help explain why New Zealand has a large negative net income. Having a negative net foreign investment is not a bad thing as it means there is more money being invested into infrastructure within New Zealand than the New Zealanders would likely invest without foreigners. More investment into infrastructure should help New Zealand’s productivity and i.e. economic and wage growth.

Table 1 – Current Account Balance 2004-2009
As show in the following graph New Zealand’s current account balance has been declining since at least 1990.

Figure 2 – Current Account Balance 1990 to 2009
As a side note to this unit, using the purchasing-power parity New Zealand has a relatively low inflation and therefore it should have a appreciating currency. ( However, this is to be discussed in a later blog).

New Zealands increasing negative net foreign investments (NFI) is putting pressure both real interest rates and real exchange rates to move upwards. Using the open economy models in the Net foreign Investment curve has moved to the left since 1990. Now two things happen here, we will fix one variable to show the effect on the other. If we fix the real exchange rate, with the NFI curve moving to the left, the supply of dollars (from NFI) will decrease and move to the left, if the demand of dollars curve stays in the same position the real exchange rate will so increase to find equilibrium can be found between supply of dollars and demand of dollars.
The other case is where the supply of dollars remains constant. With the NFI curve moving to the left, there will be pressure to drop interest rates. Therefore, either the supply or demand or both will move so that they can find equilibrium with the natural exchange rate.

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