After completing this chapter, students will be able to: Explain how currencies of different nations are exchanged when international transactions take place, analyze the balance sheet the United States uses to account for the international payments it makes and receives,...
38 TheBalanceofPayments,Exchange Rates,andTradeDeficits McGrawưHill/Irwin Copyrightâ2012byTheMcGrawưHillCompanies,Inc.Allrightsreserved InternationalTransactions International trade Buy/sell current goods or services • Imports and exports • International asset transactions • Buy/sell real or financial assets • Buy stock • Sell your house to a foreigner • Requires currency exchange LO1 38-2 Balance of Payments • Sum of international financial • LO2 transactions Current account • Balance on goods and services • Net investment income • Net transfers • Balance on current account 38-3 Balance of Payments • Capital and financial account • Capital account • Financial account • Balance of payments accounts sum • • LO2 to zero Current account deficits generate asset transfers to foreigners Official reserves 38-4 Balance of Payments LO2 38-5 Official Reserves • Foreign currencies, certain reserves • • LO2 with the IMF, and stocks of gold Owned by government or central bank Used as balancing mechanism in balance of payments 38-6 Flexible Exchange Rates • Demand for pounds • Supply of pounds • Market equilibrium • Increase in dollar price of pounds • Dollar depreciates • Pound appreciates • Decrease in dollar price of pounds • Dollar appreciates • Pound depreciates LO3 38-7 Flexible Exchange Rates The Market for Foreign Currency (Pounds) Dollar Price of Pound P $3 $2 $1 Dollar Depreciates (Pound Appreciates) Exchange Rate: $2 = £1 S1 Dollar Appreciates (Pound Depreciates) D1 Q1 Q Quantity of Pounds LO3 38-8 Flexible Exchange Rates • Determinants of exchange rates • Factors that shift demand/supply • Changes in tastes • Relative income changes • Relative price-level changes • Purchasing-power-parity theory • Relative interest rates • Relative expected returns on assets • Speculation LO3 38-9 Flexible Exchange Rates The Market for Foreign Currency (Pounds) P Dollar Price of Pound S1 c $3 a x $2 Balance Of Payments Deficit b D Exchange Rate: $2 = £1 $1 Exchange Rate: $3 = £1 D1 Q1 Q2 Q Quantity of Pounds LO3 38-10 Flexible Exchange Rates • Eliminate balance of payments • LO4 deficit or surplus Disadvantages of flexible exchange rates • Volatility • Uncertainty and diminished trade • Terms-of-trade changes • Instability 38-11 Fixed Exchange Rates • Government intervention • Use of reserves • Trade policies • Exchange controls and rationing • Distorted trade • Favoritism • Restricted choice • Black markets • Macroeconomic adjustments LO4 38-12 The Managed Float • Gold standard: 1879-1934 • Fixed exchange rate system • Bretton Woods: 1944-1971 • Fixed exchange rate system • LO4 indirectly tied to gold Managed float: 1971-present 38-13 The Managed Float • Dependence on foreign exchange • • • LO4 markets Occasional intervention In support of managed float Concerns with managed float 38-14 U.S. Trade Deficit • Large and persistent • Causes of trade deficits • High U.S growth (relatively) • China • Price of oil • Low U.S saving rate • Implications of trade deficits • Increased current consumption • Increased indebtedness LO5 38-15 ... Disadvantages of flexible exchange rates • Volatility • Uncertainty and diminished trade • Terms -of- trade changes • Instability 3 8-1 1 Fixed Exchange Rates • Government intervention • Use of reserves • Trade. .. Price of Pound S1 c $3 a x $2 Balance Of Payments Deficit b D Exchange Rate: $2 = £1 $1 Exchange Rate: $3 = £1 D1 Q1 Q2 Q Quantity of Pounds LO3 3 8-1 0 Flexible Exchange Rates • Eliminate balance of. .. transfers to foreigners Official reserves 3 8-4 Balance of Payments LO2 3 8-5 Official Reserves • Foreign currencies, certain reserves • • LO2 with the IMF, and stocks of gold Owned by government