External Sector

Econ 102 _2013

External Sector

How is a country linked with other countries in the global world?

1) There are exchange of Goods and Services2) There are exchange of Assets

What is different?We have Turkish Lira (TL), US has US dollars ($) and European Union has Euro(€)

Foreign currency

• Exchange rate is the TL price of a foreign currency in Turkey.

Eg. 1 $= 2.08 TL (TL price of one dollar) or0.48 $ = 1 TL ( dollar price of one TL)

• If TL price of a $ increases, TL depreciates • (TL becomes less valuable compared to $)

Exchange of Goods and Services

• Exports are the goods that we sell (and foreign economies buy). Hence, it is a source of foreign exchange.

Exports= F( Yforeign, exchange rate)

• Imports are the good that we buy (foreign sell to us). Hence we use foreign exchange to purchase imports

Imports= F( Ydomestic, exchange rate)

Net Exports

• Net Exports = value of Exports- value of imports

Net Exports = F( Y domestic , Yforeign, exchange rate)

This is also called the Trade Balance

Exchange of Financial Assets

• We exchange Bonds, Shares, other assets.

Asset demand depends on relative returns, i.e. interest rates, hence investors compare

domestic interest rate < or > foreign interest rates

i < or > i*

Asset demand

• Example:Turkish treasury TL bonds: i = 10%,

German treasury Euro bonds: i* = 8%

Which one will the investors prefer to buy?

Asset demand

• Example:Turkish treasury TL bonds: i = 10%,

German treasury Euro bonds: i* = 8%

Which one will the investors prefer?

What if during this period it is expected that e will increase by 5 %, that is TL depreciates by 5 %, will you still prefer to buy Turkish Bonds.?

Asset demand

• Example:Turkish treasury TL bonds: i = 10%,

German treasury Euro bonds: i* = 8%

Which one will the investors prefer?

iEURO = iTL - expected % change in e.

8% = 10 % - expected D % in e

How are the foreign transaction recorded?

• Balance of Payments: (Ödemeler Dengesi)Accounting method of all monetary transactions, with double entry system. Every transaction is recorded in different parts of the Balance of Payments.

Balance of Payments

1. Current Account2. Financial Account3. Central Bank reserve positions4. Errors and Omissions

All adds up to zero.

Current Account- Exports of goods (+)- Imports of goods (-)

- Balance of trade- Exports of services(+)- Imports of services(-)

- Balance of services- Income received on investment (+)- Income payments on investment (-)

- Net income on investment- Net transfers (+) (-)

- Balance on current account

Financial Account- Increase in foreign holdings of assets in Turkey (+)- Increase in Turkey’s holding of assets in foreign countries

(-)

- Balance on Financial Account

Capital Account

- Statistical Discrepancy- Balance of Payments

BOP of Turkey

Foreign Exchange Market

• Systems of Foreign Exchange:1. Fixed Exchange Rate System: Central Bank

determines the rate at which domestic currency is exchanged in to foreign currency.

2. Flexible Exchange Rate System: market determines the the rate at which domestic currency is exchanged in to foreign currency

Foreign Exchange Market

TL price of foreign currency

Quantity of Foreign Currency

Demand for foreign currency Supply of Foreign Currency

Foreign Exchange Market

TL price of $

Quantity of $

Demand for $ Supply of $

The Change in Foreign Exchange Market Equilibrium when Turkish Imports increase

TL price of foreign currency

Quantity of Foreign Currency

Demand for foreign currency Supply of Foreign Currency

The TL price of US dollar increases, i.e. TL depreciates

The Change in Foreign Exchange Market Equilibrium when Turkish residents

purchase Foreign Bonds

TL price of foreign currency

Quantity of Foreign Currency

Demand for foreign currency Supply of Foreign Currency

The TL price of US dollar increases, i.e. TL depreciates

Exports of Good and Services

External Total Debt2000

2001

2002

2003

2004

2005

2006

2007

2008

2009

2010

2011

2012

104 109 118.3 118.3

147.3169 170.1

193.6

247.1

277.1 268.3 270.7

306.6

External Debt