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Transcript of Economics Chapter 7 Exchange rate. Currencies Major currencies USA: US Dollar [Code: USD; Sign: $]...
Economics
Chapter 7
Exchange rate
CurrenciesMajor currencies USA: US Dollar [Code: USD; Sign: $] British: Pound sterling [Code: GBP; Sign: £] Europe: Euro [Code: EUR; Sign:€] China: Renminbi [Code: RMB; Sign: ¥] Hong Kong Dollar [Code: HKD; Sign: $] Japanese yen [Code: JPY; Sign: ¥]
Exchange rate
Exchange rate
the price at which two currencies are exchange
the price of a foreign currency in terms of
the local currency, or vice versa
convertibility rate
Exchange rate
Expression (assume USD and HKD)
1. The exchange rate of USD
US$ 1 can be converted into HK$ 7.8
HKD/USD = 7.8 / 1 = 7.8
Exchange rate
Expression (assume USD and HKD)
2. The exchange rate of HKD
HK$ 1 can be converted into US$
USD/HKD =
Floating exchange rate Exchange rate is
Free-floating Depends on market demand and supply
Appreciation A rise in exchange rate
Depreciation A fall in exchange rate
Appreciation USD Euro
The USD appreciates relative to the EUR
HKD JPY
The HKD appreciates relative to the JPY
Date US$1 equals
1 April 2011 € 0.7
1 May 2011 € 0.8
Date HK$1 equals
1 April 2011 ¥10.40
1 May 2011 ¥11.00
Depreciation USD Euro
The EUR depreciates relative to the USD
HKD JPY
The JPY depreciates relative to the HKD
Date €1 equals
1 April 2011 US$ = US$1.43
1 May 2011 US$ = US$1,25
Date JP¥1 equals
1 April 2011 HK$ = HK$0.096
1 May 2011 HK$ = HK$0.091
Floating exchange rate
Depreciation: exchange rate
Appreciation: exchange rate
• There is only one exchange rate between two currencies.
• Appreciation of one currency = Depreciation of the other
Linked exchange rate system in HK
Since 1983
HKD linked with USD at a fixed exchange rate
Aim: To maintain stability of the exchange rate between
HKD and USD
Exchange rate: US$1:HK$7.75–7.85
Controlled by the HKSAR Gov’t (HKMA)
Brief history of linked exchange rates system in HK:
History of Hong Kong's Exchange Rate SystemPeriod Exchange rate regime Features
1863–1935 Silver Standard Silver dollars as legal tenderDecember 1935–June 1972
Sterling exchange •Standard exchange rate:£1:HK$16 (December 1935–November 1967)•£1:HK$14.55 (November 1967–June 1972)
July 1972–November 1974
Fixed exchange rate against the US dollar
•Exchange rate:US$1:HK$5.650 (June 1972–February 1973)•US$1:HK$5.085 (February 1973–November 1974)
November 1974–October 1983
Free floating •Exchange rates on selected days:US$1:HK$4.965 (25 November 1974)•US$1:HK$9.600 (24 September 1983)
1983–Present Linked exchange rate system
•US$1:HK$7.80 (1983–1998)(for issue and redemption of Certificates of Indebtedness)•US$1:HK$7.75 (1998–2005)(The HKMA undertakes to convert the HK dollars in licensed banks’ clearing accounts maintained with the HKMA into US dollars at the fixed exchange rate of HK$7.75 to US$1. The rate has been moving to 7.80 by 1 pip each calendar day starting from 1 April 1999 ending 12 August 2000.)•US$1:HK$7.75–7.85 (May 2005 onwards)HKMA set up upper and lower guaranteed limit since 18 May 2005
Source: http://en.wikipedia.org/wiki/Hong_Kong_dollar
Linked exchange rate system in HK
Revaluation
Originally, HKMA fixed the rate at US$1:HK$7.8
If HKMA set the rate at US$1:HK$6
(meaning that less HK dollar can be bought by US$1)
(value of HK dollar increases)
the rate of HKD against USD rises
The government re-pegs exchange rate at a higher level
Linked exchange rate system in HK
Devaluation
Originally, HKMA fixed the rate at US$1:HK$7.8
If HKMA set the rate at US$1:HK$9
(meaning that more HK dollar can be bought by US$1)
(value of HK dollar decreases)
the rate of HKD against USD falls
The government re-pegs exchange rate at a lower level
Difference:
Exchange rate system Floating Fixed
Exchange rate is determined by Market Government
Exchange rate of local currency against foreign
currency
Increase Appreciation Revaluation
Decrease Depreciation Devaluation
Example countries USA China
Linked exchange rate system in HK
Strong reserves support
A currency board system
HK monetary base is support by USD
Maintain the exchange rate when issuing banknotes
Linked exchange rate system in HK
Operation The bank is going to issue $7,800,000 banknotes It needs to pay USD of equivalent value (US$ 1 : HK$7.8) to
HKMA to buy Certificate of Indebtedness [CIs] (負責證明書 ) As a support for banknotes issued In this case, the bank pays US$1 million to HKMA
* In reverse, banks return HKD & CIs to the HKMA and get back the USD.
Certificatesof
Indebtedness
US$ 1: HK$7.8
HKMA
Linked exchange rate system in HKExchange rates change with the USD Under the linked exchange rate system, the exchange rates of the HKD
against other foreign currencies change with the USD.
Against other currencies if USD appreciation HKD appreciation (against other currencies) if USD depreciation HKD depreciation (against other currencies)
DateUS$1 equals(EUR/USD)
US$1 equals(Linked exchange
rate system, HKD/USD)
Euro 1 equals(HKD/EUR)
1 April 2011 € 0.7 HK$ 7.8 HK$HK$11.14
1 May 2011 € 0.8 HK$ 7.8 HK$HK$9.75
USD appreciatesagainst EUR
Fixed EUR depreciates against HKD, (i.e. HKD appreciates against EUR)
HK people suffer from RMB appreciationExchange rates change with the USD RMB appreciates against USD
since 1994 Since 2006, exchange rose quickly USD depreciation is faster HKD is linked to USD,
so HKD follows USD and depreciates against RMB sharply
Meaning that HK people needs to pay more HKD to buy products fromthe mainland
Before that, HK people went shopping in the mainland
Nowadays, mainland visitor come to HKfor shopping
RMB annual average middle exchange rate from USD and HKD
(1 foreign currency unit to RMB)
year US dollar HK dollar
1996 8.3142 1.07510
1997 8.2898 1.07090
1998 8.2791 1.06880
1999 8.2783 1.06660
2000 8.2784 1.06180
2001 8.2770 1.06080
2002 8.2770 1.06070
2003 8.2770 1.06240
2004 8.2768 1.06230
2005 8.1917 1.05300
2006 7.9718 1.02620
2007 7.6040 0.97459
2008 6.9451 0.8919
2009 6.8310 0.8812
Source: http://en.wikipedia.org/wiki/List_of_Renminbi_exchange_rates
Balance of payment (BOP) account
Definition The record of an economy’s receipts and payments arising from
external transactions
BOP account of HK For a specific time period Economic transactions between HK residents and non-residents
Balance of payment (BOP) account
Components of the BOP account: Current account (經常帳 ) Capital and finance account (資本及金融帳 )
International purchases or sales of
assetsCapital transfers
All external transactions not
included in capital & financial account
Capital and financial account
Current account
BOP account
Balance of payment (BOP) account
Current account:1. Goods (visible trade) Net receipt brought by merchandise trade (商品貿易 ) Receipt: Exports of goods, e.g. garments, jewellery… Payment: Imports of goods, e.g. rice, cars…
Types of BOT:
Balance of visible trade = Total exports of goods – Total imports of goods
Trade deficit (貿易赤字 ) Exports < Imports BOT < 0
Balance BOT (貿易平衡 ) Exports = Imports BOT = 0
Trade surplus (貿易盈餘 ) Exports > Imports BOT > 0
Balance of payment (BOP) account
Current account:
2. Services (invisible trade)
Net receipt brought by services
Receipt: Exports of services, e.g. local airline…
Payment: Imports of services, e.g. World Cup broadcasting…
Balance of invisible trade = Total exports of services – Total imports of services
Balance of payment (BOP) account
Current account:3. Factor income Net income from abraod All forms of investment income
Dividends Interest from deposit
4. Current transfers Unilateral (單向 ) transfer of goods and capital No economic value being received in return For example: donations, remittances 匯款
Net income from abroad = Factor income from abroad – Factor income paid abroad
Balance of payment (BOP) account
Current account balance:Total balance of the 4 components: Visible trade Invisible trade Factor income Current transfer
Current account balance
= Balance of (Goods + Services + Factor income + Current
transfer)
Balance of payment (BOP) account
Given the following table, calculate the current account balance of HK:
Current account balance= ( $500 - $200 + $350 - $100 + $50 - $80 - $120 ) million= $400 million
Components Value ($ million)
Exports of goods 500
Imports of goods 200
Exports of services 350
Imports of services 100
Dividends from USA company 50
Compensation to employees in Europe 80
Donation to Japan 120
Think about:In your own consideration:
Do you think the gov’t should increase subsidies in the above items for you?
Types of services/facilities Frequently use Seldom use Never use
1. Education
2. Housing
3. Medicine and health (including hospital services)
4. Social welfare
5. Culture and entertainment (e.g. libraries, sports facilities)
6. Transportation
Public expenditure (公共開支 ) Types of expenditure
Functions : Examples Education : 9-yr free education… Support : wages of civil servants… Social welfare : C.S.S.A…. Health : medical services… Infrastructure: transportation, water supply… Security : police, law affairs… Housing : Public housing… Economic : postal, airport… Environment and food: Environment protection Community and external affairs: culture, sports…
Government revenue Types of revenue
Taxation
Direct tax
Indirect tax
Fee of selling of services
Medical services
Water supply
Application of ID card…
Fines / Penalties from punishment of illegality
Selling of land
Taxation Adam Smith’s principles of taxation
Equity Taxation should be fair. Taxes are directly proportion to people’s income,
i.e. those who earn more income need to pay higher tax
Certainty Clearly define the responsibilities to taxpayers Clear tax calculation method Clear tax payment deadline Clear modes of payment
(in person / online / PPS / credit card…)
Taxation Adam Smith’s principles of taxation
Convenience Deadline & payment method: convenient to taxpayers Allow enough time for payment E.g. Salary tax in Hong Kong:
May: Submission of Tax Return – Individual October: Notification of tax payment January: First installment April: Secondary installment
Economy Cost of tax collection should be kept minimum. Online / PPS tax payment Cost of tax collection
Tax base (稅基 ) The tax base of an economic territory means
activities (e.g. buying car, taking flight overseas) revenue (e.g. salaries, profits) assets (e.g. properties, cars)
on which taxes are charged.
The government’s scope of taxation.
Broader the tax base more people need to pay tax more source of taxation more stable tax revenue
Classification of tax
By tax burden Direct tax Indirect tax
By tax rate Progressive tax Proportional tax Regressive tax
Classification by tax burden
Direct tax The tax burden cannot be shifted to others by taxpayers. Examples:
Salaries tax Charges directly on the salary
Profits tax Charges directly on profit-making firms
Property tax Charges directly on rental income earned from land or properties.
Classification by tax burden
Indirect tax The tax burden can be shifted to others by taxpayers Examples:
Duties (應課稅品 ) Liquors (酒類 ) Tobacco (煙草 ) Hydrocarbon (燃油 ) Methyl alcohol (甲醇 )
Rates (差餉 ) Betting duty (博彩稅 ) Stamp duty (印花稅 ) First registration tax (汽車首次登記稅 )
Classification by tax burden
Indirect tax How is the tax burden shifted? Examples:
Duties: Tobacco Gov’t charges tax on tobacco traders
Tobacco traders raise the price of cigarettes Consumers need to pay more for the cigarettes
i.e. The tax burden is shifted to consumers through increase in price
all kinds of sales taxes are indirect tax
Tax base: Direct tax vs. Indirect tax
Direct tax Levied on companies and salaried workers Only tax on profit or income earning Number of taxpayers is limited Even worse if no profit or salary Tax base is narrow
Indirect tax Imposed on taxable goods and services Tax on anyone who made consumption Number of taxpayers is large Tax base is broader
Tax base (稅基 )
Which of the following can broaden (擴闊 ) the tax base of Hong Kong?
(1) Greatly decrease the basic tax allowance of the salaries tax.
(2) Impose a general sales tax.(3) Increase the current indirect tax rate.
A. (2) onlyB. (1) and (2) onlyC. (2) and (3) onlyD. (1), (2) and (3)
Answer: B
Stable tax revenue: Direct tax vs. Indirect tax
Gov’t revenue fluctuates with economic cycles (經濟週期 ) Direct tax
During economic recession (經濟衰退 ) Companies: Low profit Workers: Low salaries Therefore, gov’t has less profit and salaries taxes
During the time of economic boom (經濟繁榮 ) Greatly increase in tax revenue
Tax revenue is not stable
Indirect tax No matter what the time is, people need to consume Tax revenue is relatively more stable
Tax rate and tax revenue:Why is there smuggling (走私 )?
Suppose the gov’t wants to raise tax revenue Way to achieve: tax rate (e.g. duty on tobacco) Traders shift the tax burden to consumer People needs to pay more To avoid higher price, consumers buy smuggled cigarettes incentive of smuggling market Finally, lower tax revenue gained
Conclusion Higher tax rate
illegal activities: smuggling and tax evasion (逃稅 ) tax revenue cost to fight crime
Tax rate and tax revenue Laffer Curve (textbook p.189)
Two extremes (e.g. salaries tax): 0% tax rate No tax revenue 100% tax rate All income paid for tax (i.e. no personal income)
No one will work No tax revenue
Optimum level (t*) If current tax rate < t*,
tax rate tax revenue If current tax rate > t*, tax rate tax revenue
To tax revenue Increase tax rate if tax rate < t* Decrease tax rate if tax rate > t*
Tax revenue ($)
0Tax rate (%)100t*
Classification by tax rate
Basic terms Taxable income Tax rate Tax payment
Basic calculation Tax rate =
Taxable income = Total income – Tax allowance – Tax deduction
e.g. parent, children…
e.g. donation, study fee…
Classification by tax rate
Calculate the tax rates on each person at different scheme. Tax scheme
Mr. Lee Mr. Chan Miss Wong
Income ($)
Tax payment ($)
Income ($)
Tax payment($)
Income ($)
Tax payment ($)
A 10,000 1,000 100,000 2,200 1,000,000 12,000
B 10,000 1,000 100,000 10,000 1,000,000 100,000
C 10,000 1,000 100,000 15,000 1,000,000 200,000
Tax scheme Mr. Lee Mr. Chan Miss Wong Types
A 10% 2.2% 1.2% Regressive
B 10% 10% 10% Proportional
C 10% 15% 20% Progressive
Classification by tax rate
Progressive tax (累進稅 ) Higher the taxable income, higher the tax rate. When taxable income increases, the tax rate increases.
Taxable income ($)
Tax payment ($) Tax rate (%)
Mr. A 100,000 5,000 5
Mr. B 200,000 20,000 10
Mr. C 300,000 45,000 15
Classification by tax rate Progressive tax
Relationship between Taxable income Tax rate
Tax rate (%)
0Taxable income ($)
100,000 200,000
5
10
15
300,000
Classification by tax rate Progressive tax
Relationship between Taxable income Tax payment
Tax payment ($)
0Taxable income ($)
100,000 200,000
5,000
20,000
45,000
300,000
Classification by tax rate
Proportional tax (比例稅 ) No matter the taxable income is, the same tax rate. When taxable income increases or decreases,
the tax rate remains unchanged.
Taxable income ($)
Tax payment ($) Tax rate (%)
Mr. A 100,000 5,000 5
Mr. B 200,000 10,000 5
Mr. C 300,000 20,000 5
Classification by tax rate Proportional tax
Relationship between Taxable income Tax rate
Tax rate (%)
0Taxable income ($)
100,000 200,000
5
300,000
Classification by tax rate Proportional tax
Relationship between Taxable income Tax payment
Tax payment ($)
0Taxable income ($)
100,000 200,000
5000
10,000
15,000
300,000
Classification by tax rate
Regressive tax (累退稅 ) Higher the taxable income, lower the tax rate. When taxable income increases, the tax rate decreases.
Taxable income ($)
Tax payment ($) Tax rate (%)
Mr. A 100,000 12,000 12
Mr. B 200,000 20,000 10
Mr. C 300,000 24,000 8
Classification by tax rate Progressive tax
Relationship between Taxable income Tax rate
Tax rate (%)
0Taxable income ($)
100,000 200,000
12
10
8
300,000
Classification by tax rate Progressive tax
Relationship between Taxable income Tax payment
Tax payment ($)
0Taxable income ($)
100,000 200,000
12,000
20,000
24,000
300,000
Indirect taxes are regressive taxes Duty on tobacco ($1.706 per cigarettes)
Suppose 3 persons consume 1000 cigarettes per year. Their income and tax payment on cigarettes are list below. To simplify calculation, assume tax on each cigarette = $2
Mr. A, with the least taxable income, pays the highest tax rate. Mr. C, with the most taxable income, pays the lowest tax rate.
It is a regressive tax.
Taxable income ($)
Tax payment ($) Tax rate (%)
Mr. A 60,000 2,000 3.33
Mr. B 180,000 2,000 1.11
Mr. C 1,000,000 2,000 0.2
Hong Kong tax system
Types Classification by tax rate
Items Description
Direct taxes
Progressive Salaries taxOrdinary salary earners pay a progressive tax
Proportional
1. Profit tax2. Property tax3. Salaries tax
(standard rate)
Profit tax rate - limited companies: 16.5%- other companies: 15%Property tax rate: 15% of balance after deduction of 20% rental incomeStandard tax rate of the salary tax: 15%
Indirect taxes
Regressive Duties
Taxes imposed on goods:- Hydrocarbon oil- Alcoholic beverage- Methyl alcohol- Tobacco
Calculation of salaries taxMr. A’s monthly salary in fiscal year 2010/11 = $40,000 Annual salary = $40,000 x 12 = $480,000 Personal allowance = $108,000 Assume no other deductions Then, taxable income = $480,000 - $108,000 = $372,000
Net Chargeable Income ($) Rate Tax Remaining
372,000
On the First 40,000 2% 800 332,000
On the Next 40,000 7% 2,800 292,000
Sub-total 80,000 3,600
On the Next 40,000 12% 4,800 252,000
Sub-total 120,000 8,400
Remainder 252,000 17% 42,840
Total 51,240
Calculation of salaries taxMr. B’s monthly salary in fiscal year 2010/11 = $20,000 Annual salary = $20,000 x 12 = $240000 Personal allowance = $108,000 Assume no other deductions Then, taxable income = $240,000 - $108,000 = $132,000
Net Chargeable Income ($) Rate Tax Remaining
132,000
On the First 40,000 2% 800 92,000
On the Next 40,000 7% 2,800 52,000
Sub-total 80,000 3,600
On the Next 40,000 12% 4,800 12,000
Sub-total 120,000 8,400
Remainder 12,000 17% 2,040
Total 10,440
Calculation of salaries taxMr. C’s monthly salary in fiscal year 2010/11 = $12,000 Annual salary = $12,000 x 12 = $144,000 Personal allowance = $108,000 Assume no other deductions Then, taxable income = $144,000 - $108,000 = $36,000
Net Chargeable Income ($) Rate Tax Remaining
36,000
On the First 36,000 2% 720 0
On the Next 0 7% 0 0
Sub-total 720
On the Next 0 12% 0 0
Sub-total 0 720
Remainder 0 17% 0
Total 720
Calculation of salaries tax
Mr. A: Higher the salary Higher the tax rate Mr. C: Lower the salary Lower the tax rate Salaries tax is a progressive tax.
Annual income ($)
Tax payment ($) Tax rate (%)
Mr. A 480,000 51,240 10.68
Mr. B 240,000 10,440 4.35
Mr. C 144,000 720 0.5
Calculation of salaries tax (high income)Mr. D’s monthly salary in fiscal year 2010/11 = $80,000 Annual salary = $80,000 x 12 = $960,000 Personal allowance = $108,000 Assume no other deductions Then, taxable income = $960,000 - $108,000 = $852,000
Net Chargeable Income ($) Rate Tax Remaining
852,000
On the First 40,000 2% 800 92,000
On the Next 40,000 7% 2,800 52,000
Sub-total 80,000 3,600
On the Next 40,000 12% 4,800 12,000
Sub-total 120,000 8,400
Remainder 732,000 17% 124,440
Total 208,440
Calculation of salaries tax (high income)
Mr. D’s annual salary in fiscal year 2010/11 = $960,000
By usual calculation, tax payment = $208,440
Tax rate = = 21.71%
Since tax rate > standard tax rate (15%)
Standard tax rate will be charged
Actual tax payment = $960,000 x 15% = $144,000
Calculation of salaries tax (low income)
Mr. E’s monthly salary in fiscal year 2010/11 = $6,000
Annual salary = $6,000 x 12 = $72,000
Personal allowance = $108,000
Assume no other deductions
Then, taxable income = $0,
because annual income < personal allowance
No need to pay salaries tax
The structure of salaries tax in HKTax rate (%)
0Income ($)
A
Tax allowance
Standard tax rate
B
Progressivetax
Proportionaltax
The effects of tax on income redistribution
1. Narrow the gap between the rich and the poor The government’s revenue and expenditure
Tax revenue from the taxpayers who earn taxable salaries the companies which gain profit
Expenditure provide inexpensive or free services for the poor or low income earners subsidies for the unemployed or low income groups
Progress income tax Higher income earners pay higher a tax rate. Lower income earners pay lower a tax rate.
The effects of tax on income redistribution
2. Salaries tax be adjusted A more equal income distribution
A. Increase the basic tax allowance
Personal allowance
Dependent children
Dependent parents/grandparents maintained by you
More low income earners can be excluded from paying tax
The effects of tax on income redistribution
2. Salaries tax be adjusted A more equal income distribution
b. Decrease the tax rates of all tax bands
That is, tax rate of the first three bands of $40,000 taxable
income
Lower tax burden of the middle class
More low and middle classes pay less tax burden.
The effects of tax on income redistribution
2. Salaries tax be adjusted A more equal income distribution
c. Increase the standard tax rate
Very higher income earners pay a standard tax rate
Increase in standard tax rate will affect high income groups only
More tax revenue can be collected from the high income groups
The effects of tax on income redistribution
3. Goods and Services Tax (GST)
Suppose 20% GST is charged on buying a book ($100).
Therefore, $20 is the tax payment.
To a low income (income = $200) buyer,
tax rate = = 10%
To a high income (income = $40,000) buyer
tax rate = = 0.05%
GST is a regressive tax, more uneven income distribution.
Argument of imposing GST in HK
For Broaden the tax base Many examples from foreign countries, e.g. Japan, U.S.A. Reasonable to “buy more goods, pay more tax” Fair tax system. All people need to pay GST.
Against Increase tax burden Worry of increase in tax rate High cost of tax calculation High cost of tax collection P Qd , lower consumption lower GDP Destroy the simple tax system of HK Income disparity