21 The Balance of Payments, Exchange Rates, and Trade Deficits McGraw-Hill/Irwin Copyright © 2012...
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Transcript of 21 The Balance of Payments, Exchange Rates, and Trade Deficits McGraw-Hill/Irwin Copyright © 2012...
21The Balance of Payments, Exchange
Rates, and Trade Deficits
McGraw-Hill/Irwin Copyright © 2012 by The McGraw-Hill Companies, Inc. All rights reserved.
International Transactions
• 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 21-2
Balance of Payments
• Sum of international financial transactions
• Current account
• Balance on goods and services
• Net investment income
• Net transfers
• Balance on current account
LO2 21-3
Balance of Payments
• Capital and financial account• Capital account• Financial account
• Balance of payments accounts sum to zero
• Current account deficits generate asset transfers to foreigners
• Official reserves
LO2 21-4
Balance of Payments
LO2 21-5
Official Reserves
• Foreign currencies, certain reserves with the IMF, and stocks of gold
• Owned by government or central bank
• Used as balancing mechanism in balance of payments
LO2 21-6
U.S. Trade Balances
LO2 21-7
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 depreciatesLO3 21-8
Q0
Do
llar
Pri
ce o
f 1
Po
un
d
Quantity of Pounds
P
Flexible Exchange Rates
The Market for Foreign Currency (Pounds)
D1
S1
DollarAppreciates(PoundDepreciates)
DollarDepreciates(PoundAppreciates)
ExchangeRate: $2 = £1
$2
$3
$1
Q1
LO3 21-9
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 21-10
Q0
Do
llar
Pri
ce o
f 1
Po
un
d
Quantity of Pounds
P
Flexible Exchange Rates
The Market for Foreign Currency(Pounds)
D1
S1
ExchangeRate: $2 = £1
$2
$3
$1
Q1
D2
ExchangeRate: $3 = £1
BalanceOf Payments
Deficit
Q2
x a
b
c
LO3 21-11
Flexible Exchange Rates
• Eliminate balance of payments deficit or surplus
• Disadvantages of flexible exchange rates• Volatility • Uncertainty and diminished trade• Terms-of-trade changes• Instability
LO4 21-12
Flexible Exchange Rates
LO4 21-13
Fixed Exchange Rates
• Government intervention• Use of reserves
• Trade policies• Exchange controls and rationing
• Distorted trade• Favoritism• Restricted choice• Black markets
• Macroeconomic adjustments
LO4 21-14
The Managed Float
• Gold standard 1879-1934
• Fixed exchange rate system
• Bretton Woods 1944-1971
• Fixed exchange rate system indirectly tied to gold
• Managed float 1971-present
LO4 21-15
The Managed Float
• Dependence on foreign exchange markets
• Occasional intervention
• In support of managed float
• Concerns with managed float
LO4 21-16
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 21-17
0-50
-100-150-200-250-300-350-400-450-500-550-600-650-700-750-800-850-900
2001 2002 2003 2004 2005 2006 2007 2008 2009
2001 2002 2003 2004 2005 2006 2007 2008 2009
0-50
-100-150-200-250-300-350-400-450-500-550-600-650-700-750-800-850-900
Goods and Services
Goods
Bill
ion
s o
f D
olla
rsB
illio
ns
of
Do
llars
Balance of Trade
Balance on Current Account
U.S. Trade Deficits
LO5 21-18
Speculation in Currency Markets
• Positive or negative influence?
• Contributes to currency market fluctuations
• Self-fulfilling expectations
• Smoothing short-term fluctuations
• Absorbing risk
• Futures market at work
• Positive role played overall
LO5 21-19