Net capital outflow (NCO) is the net flow of funds being invested abroad by a country during a certain period of time (usually a year). A positive NCO means that the country invests outside more than the world invests in it. NCO is one of two major ways of characterizing the nature of a country's financial and economic interaction with the other parts of the world (the other being the balance of trade).
NCO is linked to the market for loanable funds and the international foreign exchange market. This relationship is often summarized by graphing the NCO curve with the quantity of country A's currency in the x-axis and the country's domestic real interest rate in the y-axis. The NCO curve gets a negative slope because an increased interest rate domestically means an incentive for savers to save more at home and less abroad.
NCO also represents the quantity of country A's currency available on the foreign exchange market, and as such can be viewed as the supply-half that determines the real exchange rate, the demand-half being demand for A's currency in the foreign exchange market. As can be seen in the graph, NCO serves as the perfectly inelastic supply curve for this market. Thus, changes in the demand for A's currency (e.g. change from an increase in foreign demand for products made in country A) only cause changes in the exchange rate and not in the net amount of A's currency available for exchange.
By an accounting identity, Country A's NCO is always equal to A's Net Exports, because the value of net exports is equal to the amount of capital spent abroad (i.e. outflow) for goods that are imported in A. It is also equal to the net amount of A's currency traded in the foreign exchange market over that time period. The value of exports (bananas, ice cream, clothing) produced in country A is always matched by the value of reciprocal payments of some asset (cash, stocks, real estate) made by buyers in other countries to the producers in country A. This value is also equal to the total amount of A's currency traded in the foreign exchange market over that year, because essentially the buyers in other countries trade in their assets (e.g. foreign currency) to convert to equivalent amount in A's currency, and use this amount to pay for A's export products.
In finance, an exchange rate is the rate at which one currency will be exchanged for another. It is also regarded as the value of one country's currency in relation to another currency. For example, an interbank exchange rate of 114 Japanese yen to the United States dollar means that ¥114 will be exchanged for each US$1 or that US$1 will be exchanged for each ¥114. In this case it is said that the price of a dollar in relation to yen is ¥114, or equivalently that the price of a yen in relation to dollars is $1/114.The government has the authority to change exchange rate when needed.
A price is the quantity of payment or compensation given by one party to another in return for one unit of goods or services. A price is influenced by production costs, supply of the desired item, and demand for the product. A price may be determined by a monopolist or may be imposed on the firm by market conditions.
In finance, a futures contract is a standardized legal agreement to buy or sell something at a predetermined price at a specified time in the future, between parties not known to each other. The asset transacted is usually a commodity or financial instrument. The predetermined price the parties agree to buy and sell the asset for is known as the forward price. The specified time in the future—which is when delivery and payment occur—is known as the delivery date. Because it is a function of an underlying asset, a futures contract is a derivative product.
The balance of payments of a country is the difference between all money flowing into the country in a particular period of time and the outflow of money to the rest of the world. These financial transactions are made by individuals, firms and government bodies.
A hedge is an investment position intended to offset potential losses or gains that may be incurred by a companion investment. A hedge can be constructed from many types of financial instruments, including stocks, exchange-traded funds, insurance, forward contracts, swaps, options, gambles, many types of over-the-counter and derivative products, and futures contracts.
In economics, a country's current account is one of the three components of its balance of payments, the others being the capital account and the financial account. The current account consists of the balance of trade, net primary income or factor income and net unilateral transfers, that have taken place over a given period of time. The current account balance is one of two major measures of a country's foreign trade. A current account surplus indicates that the value of a country's net foreign assets grew over the period in question, and a current account deficit indicates that it shrank. Both government and private payments are included in the calculation. It is called the current account because goods and services are generally consumed in the current period.
In economics, hot money is the flow of funds from one country to another in order to earn a short-term profit on interest rate differences and/or anticipated exchange rate shifts. These speculative capital flows are called "hot money" because they can move very quickly in and out of markets, potentially leading to market instability.
In modern monetary policy, a devaluation is an official lowering of the value of a country's currency within a fixed exchange-rate system, in which a monetary authority formally sets a lower exchange rate of the national currency in relation to a foreign reference currency or currency basket. The opposite of devaluation, a change in the exchange rate making the domestic currency more expensive, is called a revaluation. A monetary authority maintains a fixed value of its currency by being ready to buy or sell foreign currency with the domestic currency at a stated rate; a devaluation is an indication that the monetary authority will buy and sell foreign currency at a lower rate.
The foreign exchange market is a global decentralized or over-the-counter (OTC) market for the trading of currencies. This market determines foreign exchange rates for every currency. It includes all aspects of buying, selling and exchanging currencies at current or determined prices. In terms of trading volume, it is by far the largest market in the world, followed by the credit market.
Foreign exchange reserves are cash and other reserve assets held by a central bank or other monetary authority that are primarily available to balance payments of the country, influence the foreign exchange rate of its currency, and to maintain confidence in financial markets. Reserves are held in one or more reserve currencies, nowadays mostly the United States dollar and to a lesser extent the euro.
An open economy is a type of economy where not only domestic actors but also entities in other countries engage in trade of products. Trade can take the form of managerial exchange, technology transfers, and all kinds of goods and services.
In macroeconomics and international finance, the capital account is one of two primary components of the balance of payments, the other being the current account. Whereas the current account reflects a nation's net income, the capital account reflects net change in ownership of national assets.
The Mundell–Fleming model, also known as the IS-LM-BoP model, is an economic model first set forth (independently) by Robert Mundell and Marcus Fleming. The model is an extension of the IS–LM model. Whereas the traditional IS-LM model deals with economy under autarky, the Mundell–Fleming model describes a small open economy. Mundell's paper suggests that the model can be applied to Zurich, Brussels and so on.
A J curve is any of a variety of J-shaped diagrams where a curve initially falls, then steeply rises above the starting point.
Capital began to flow in and out of Japan following the Meiji Restoration of 1868, but policy restricted loans from overseas. In the aftermath of World War II, Japan was a debtor nation until the mid-1960s. Subsequently, capital controls were progressively removed, in part as a result of agreements with the United States. This process led to rapid expansion of capital flows during the 1970s and especially the 1980s, when Japan became a creditor nation and the largest net investor in the world. This credit position resulted both from foreign direct investment by Japanese corporations, and portfolio investment. In particular, the rapid increase of Japan's direct investments overseas, much exceeding foreign investment in Japan, led to some tension with the US at the end of the 1980s.
Foreign exchange risk is a financial risk that exists when a financial transaction is denominated in a currency other than the domestic currency of the company. The exchange risk arises when there is a risk of an unfavourable change in exchange rate between the domestic currency and the denominated currency before the date when the transaction is completed.
The overshooting model, or the exchange rate overshooting hypothesis, first developed by economist Rudi Dornbusch, is a theoretical explanation for high levels of exchange rate volatility. The key features of the model include the assumptions that goods' prices are sticky, or slow to change, in the short run, but the prices of currencies are flexible, that arbitrage in asset markets holds, via the uncovered interest parity equation, and that expectations of exchange rate changes are "consistent": that is, rational. The most important insight of the model is that adjustment lags in some parts of the economy can induce compensating volatility in others; specifically, when an exogenous variable changes, the short-term effect on the exchange rate can be greater than the long-run effect, so in the short term, the exchange rate overshoots its new equilibrium long-term value.
Currency intervention, also known as foreign exchange market intervention or currency manipulation, is a monetary policy operation. It occurs when a government or central bank buys or sells foreign currency in exchange for its own domestic currency, generally with the intention of influencing the exchange rate and trade policy.
A fixed exchange rate, sometimes called a pegged exchange rate, is a type of exchange rate regime in which a currency's value is fixed or pegged by a monetary authority against the value of another currency, a basket of other currencies, or another measure of value, such as gold.
This glossary of economics is a list of definitions of terms and concepts used in economics, its sub-disciplines, and related fields.
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