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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 $= 2.65 TL (TL price of one dollar) or0.378 $ = 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%
(if all the conditions in the economy, such as the risk and expectations are the same in both economies)
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- Details
- Foreign Direct Investment- Portfolio Investment- Other Investment
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
US Dollar in Turkish Lira(1950-2015)
19501952
19541956
19581960
19621964
19661968
19701972
19741976
19781980
19821984
19861988
19901992
19941996
19982000
20022004
20062008
20102012
20142015
0.0
500000.0
1000000.0
1500000.0
2000000.0
2500000.0
3000000.0
TL/$
TL/$
Foreign Exchange Market
TL price of foreign currency
Quantity of Foreign Currency
Demand for foreign currency Supply of Foreign Currency
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