Lecture Macroeconomics - Chapter 18: Exchange rates and the balance of payments

In this chapter you will learn: What determines the supply of and demand for a nation’s currency, about a nation’s balance of payments, what a flexible exchange rates system is and its effects on the domestic economy, what a fixed exchange rates system is and its effects on the domestic economy, about the history of the world’s international exchange-rate systems.

EXCHANGE RATES AND THE BALANCE OF PAYMENTS CHAPTER 18 SLIDES PREPARED BY JUDITH SKUCE, GEORGIAN COLLEGE © 2002 McGraw-Hill Ryerson Ltd Macroeconomics, Chapter 18 In this chapter you will learn What determines the supply of and demand for a nation’s currency About a nation’s balance of payments What a flexible exchange rates system is and its effects on the domestic economy What a fixed exchange rates system is and its effects on the domestic economy About the history of the world’s international exchange-rate systems © 2002 McGraw-Hill Ryerson Ltd Macroeconomics, Chapter 18 Chapter 18 Topics Financing International Trade The Balance of Payments Flexible Exchange Rates Fixed Exchange Rates International Exchange Rate Systems © 2002 McGraw-Hill Ryerson Ltd Macroeconomics, Chapter 18 Financing International Trade Assume $2 = £1 $300,000 in Canadian telecommunications equipment purchased by a British buyer for £150,000 £150,000 cheque drawn on British bank to pay for equipment £150,000 cheque is exchanged for $300,000 at a Canadian bank Canadian bank sends £150,000 cheque to London bank for future transactions © 2002 McGraw-Hill Ryerson Ltd Macroeconomics, Chapter 18 Points to Remember Canadian exports create: a foreign demand for Canadian $ an increase in the supply of foreign currency owned by Canadian banks © 2002 McGraw-Hill Ryerson Ltd Macroeconomics, Chapter 18 Points to Remember Canadian imports: create a domestic demand for foreign currencies reduce the supplies of foreign currencies held by Canadian banks © 2002 McGraw-Hill Ryerson Ltd Macroeconomics, Chapter 18 Points to Remember Canadian exports supply the foreign currencies needed to “pay for” imports Demand for & supplies of foreign currencies also arise from transactions involving services & payment of interest & dividends on foreign investments © 2002 McGraw-Hill Ryerson Ltd Macroeconomics, Chapter 18 Chapter 18 Topics Financing International Trade The Balance of Payments Flexible Exchange Rates Fixed Exchange Rates International Exchange Rate Systems © 2002 McGraw-Hill Ryerson Ltd Macroeconomics, Chapter 18 The Balance of Payments The Canadian balance of payments shows the balance between – all the payments that Canada receives from foreign countries & – all the payments which we make to them © 2002 McGraw-Hill Ryerson Ltd Macroeconomics, Chapter 18 Current Account shows the flows resulting from imports & exports of goods & services – the trade balance is the net amount of imports & exports of goods only – the balance on goods & services includes services as well – trade in services, investment income & transfers are included to get the current account balance – normally a deficit © 2002 McGraw-Hill Ryerson Ltd Macroeconomics, Chapter 18 10 Adjustments Under Flexible Exchange Rates Figure 18-3 Dollar price of pound P S demand for pounds increases D D Quantity of pounds © 2002 McGraw-Hill Ryerson Ltd Q Macroeconomics, Chapter 18 26 Adjustments Under Flexible Exchange Rates Figure 18-3 Dollar price of pound P S Canadian balance of payments deficit a b D D Quantity of pounds © 2002 McGraw-Hill Ryerson Ltd Q Macroeconomics, Chapter 18 27 Adjustments Under Flexible Exchange Rates Figure 18-3 Dollar price of pound P c a Schange in the exchange rate to $3=£1 would b correct the deficit D D Quantity of pounds © 2002 McGraw-Hill Ryerson Ltd Q Macroeconomics, Chapter 18 28 Flexible Exchange Rates with a lower $, Canadians will want to import less, & the British will want to buy more Canadian goods & services © 2002 McGraw-Hill Ryerson Ltd Macroeconomics, Chapter 18 29 Disadvantages of Flexible Rates Uncertainty & Diminished Trade Terms of Trade Change Instability © 2002 McGraw-Hill Ryerson Ltd Macroeconomics, Chapter 18 30 Chapter 18 Topics Financing International Trade The Balance of Payments Flexible Exchange Rates Fixed Exchange Rates International Exchange Rate Systems © 2002 McGraw-Hill Ryerson Ltd Macroeconomics, Chapter 18 31 Fixed Exchange Rates Use of Reserves Trade Policies Exchange Controls & Rationing •distorted trade •favouritism © 2002 McGraw-Hill Ryerson Ltd •restricted choice •black markets Macroeconomics, Chapter 18 32 Fixed Exchange Rates Use of Reserves Trade Policies Exchange Controls & Rationing Domestic Macroeconomic Adjustments © 2002 McGraw-Hill Ryerson Ltd Macroeconomics, Chapter 18 33 Chapter 18 Topics Financing International Trade The Balance of Payments Flexible Exchange Rates Fixed Exchange Rates International Exchange Rate Systems © 2002 McGraw-Hill Ryerson Ltd Macroeconomics, Chapter 18 34 Exchange Rate Systems The Gold Standard: Fixed Exchange Rates 1879 - 1934 – currency defined in gold – fixed relationship between gold stock & money supply maintained – gold freely exported & imported © 2002 McGraw-Hill Ryerson Ltd Macroeconomics, Chapter 18 35 Exchange Rate Systems Gold flows resulted in fixed exchange rates Domestic macroeconomic adjustments sometimes distasteful Gold standard collapsed in the worldwide depression of the 1930s – series of devaluations © 2002 McGraw-Hill Ryerson Ltd Macroeconomics, Chapter 18 36 Exchange Rate Systems The Bretton Woods System 19441971 – adjustable-peg system – International Monetary Fund (IMF) Maintaining pegged rates – Official international reserves – Gold sales – IMF borrowing © 2002 McGraw-Hill Ryerson Ltd Macroeconomics, Chapter 18 37 Exchange Rate Systems Fundamental Imbalances: Adjusting the Peg Demise of the Bretton Woods System – 1971: the US floated the dollar © 2002 McGraw-Hill Ryerson Ltd Macroeconomics, Chapter 18 38 Exchange Rate Systems The Current System: The Managed Float – G-7 Interventions In Support of the Managed Float – world trade continues to expand – severe economic turbulence successfully weathered Concerns with the Managed Float – – – exchange rate volatility trade imbalances persist a “nonsystem” © 2002 McGraw-Hill Ryerson Ltd Macroeconomics, Chapter 18 39 Chapter 18 Topics Financing International Trade The Balance of Payments Flexible Exchange Rates Fixed Exchange Rates International Exchange Rate Systems © 2002 McGraw-Hill Ryerson Ltd Macroeconomics, Chapter 18 40 ... Rate Systems © 2002 McGraw-Hill Ryerson Ltd Macroeconomics, Chapter 18 The Balance of Payments The Canadian balance of payments shows the balance between – all the payments that Canada receives... 2002 McGraw-Hill Ryerson Ltd Macroeconomics, Chapter 18 Chapter 18 Topics Financing International Trade The Balance of Payments Flexible Exchange Rates Fixed Exchange Rates International Exchange. .. account balance +115.5* - 132.1* - 16.6 Official settlements account 13 Official international reserves balance of payments surplus Balance of payments - 2.3 $ *includes one-half of a $2.3 billion