Austrians do a great job of explaining economics but they don’t use the same terminology as mainstream so I still get confused when reading the newspaper.
“Setting a higher interest rate than other major central banks will tend to attract in funds via the nations capital account, and this will act to raise the value of its currency” - http://en.wikipedia.org/wiki/Capital_account
So why do we always hear ‘hot money’ inflows or inflows into a nation’s capital account in the news if the central bank is lowering interest rate.
I understand that a trade deficit or current account deficit is equal to a capital account surplus. But I am confused as to whether debasing the currency results in capital flowing in to a country OR capital flowing out of the country(more exports than imports)?
Do all BOPs in the world balance each other out on a net basis?
What is the reserve account and what does an increase/decrease of it imply?
I’m not expert on these things, but I’ll give them a try.
For your first question about "hot money’, perhaps you could cite a link where this is being said.
Capital Inflows/Capital Outflows are different than surplus/deficit in the capital account. A capital inflow is when foreigners increase their posession of domesic assets or domestic citizens decrease their possession of foreign assets. A capital outflow is when domestic citizens increase their possession of foreign assets or when foreigners decrease their possession of domestic assets. A capital outflow always occurs with a export, (U.S merchants increase their possession of foreign currency units when they sell goods) while a capital inflow always occurs with an import (Foreign merchants increase their possession of U.S dollars when we buy goods from them). The analysis does not change if the exchange rate is used.
AFAIK, a simplistic way of looking at the capital account is thinking it as the money individuals use for transactions. When we “import” goods in our daily lives, we also “export” money with every exchange. If a country has a trade deficit, than the capital account is positive beause they are exporting money/assets to pay for this spending. This will result in a capital inflow because foreigners will increase their possession of domestic assets.
Debasing the currency will result in a lower interest rate, and foreigners will not invest in the domestic country as much because of the lower return (they could take their foreign currency elsewhere and invest where the return in higher). A lower exchange rate, in theory, will decrease the price of domestic goods to foreigners while increasing the price of foreign goods to domestic citizens. This “should” result in a trade surplus.
The BOPs should in theory balance out, just like everyman’s defict has to be another man’s surplus. There are always statistical discepancies in calculating statistics because 1)either something is cooking the books or 2)its just impossible to record every transaction.
The reserve account refers to a nation’s reserves of currency. Under a fixed rate regime a central bank has to exchange/accept the domestic currency at a particular price if it wants to maintain their desired rate. A fixed rate regime usually implies that the balance of payments is usually in a deficit or surplus, and foreign reserves will either be positive or negative. When there is a surplus in the B.O.P (the exchange rate is undervalued), foreigners will want to exchange their foreign currency for the domestic country, and the country will accumulate reserves. This accumulation of reserves however, will increase the money supply. The opposite occurs for a country whose currency is overvalued.
When I say accumulation of reserves, i don’t mean the accumulation of foreign currency will cause the money supply to increase per se, I mean that the accumulation of foreign currency will go hand in hand with the central bank printing domestic currency to keep the exchange rate from rising, which increases the money supply.
Just noticed that it could sound a bit confusing.