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Exchange Rates, the Balance of Payments, and Trade Deficits Chapter 21 McGraw-Hill/Irwin Copyright...
Transcript of Exchange Rates, the Balance of Payments, and Trade Deficits Chapter 21 McGraw-Hill/Irwin Copyright...
Exchange Rates, the Balance of Payments, and Trade Deficits
Chapter 21
McGraw-Hill/Irwin Copyright © 2009 by The McGraw-Hill Companies, Inc. All rights reserved.
Chapter Objectives
• How currencies are exchanged• Balance sheet for recording
international payments• How exchange rates are
determined • Flexible vs. fixed exchange
rates • Causes and consequences of
trade deficits21-2
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
21-3
Balance of Payments
• Sum of international financial transactions
• Current account–Balance on goods and services
–Net investment income
–Net transfers
–Balance on current account 21-4
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 reserves21-5
U.S. Trade Balances
Goods and Services, Select Nations, 2007
SurplusDeficit
Australia
Belgium
Canada
China
Germany
Mexico
Netherlands
+10.0
-67.0
-45.3
+9.8
-256.6
-77.3
+14.3
Source: Bureau of Economic Analysis
-10-20-30-40-50-60-70-250 10 20
Japan -85.0
21-6
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
21-7
Q0
Do
llar
Pri
ce o
f 1
Po
un
d
Quantity of Pounds
P
Flexible Exchange RatesThe Market for Foreign Currency (Pounds)
D1
S1
DollarDepreciates(PoundAppreciates)
DollarAppreciates(PoundDepreciates)
ExchangeRate: $2 = £1
$2
$3
$1
Q1
21-8
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
21-9
Q0
Do
llar
Pri
ce o
f 1
Po
un
d
Quantity of Pounds
P
Flexible Exchange RatesThe 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
21-10
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
21-11
Fixed Exchange Rates
• Government intervention–Use of reserves
• Trade policies• Exchange controls and rationing
–Distorted trade–Favoritism–Restricted choice–Black markets
• Macroeconomic adjustments21-12
Exchange Rate Systems
• Gold standard 1879-1934–Fixed exchange rate system
• Bretton Woods 1944-1971–Fixed exchange rate system
indirectly tied to gold
• Managed float 1971-present
21-13
Managed Float
• Dependence on foreign exchange markets
• Occasional intervention
• In support of managed float
• Concerns with managed float
21-14
U.S. Trade Deficit
• Large and persistent• Causes of trade deficits
–High U.S. growth (relatively)–China–Price oil–Low U.S. saving rate
• Implications of trade deficits–Increased current consumption–Increased indebtedness 21-15
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
21-16
Key Terms• balance of payments• current account• balance on goods and
services• trade deficit• trade surplus• balance on current
account• capital and financial
account• balance on capital and
financial• balance-of-payments
deficits and surpluses• official reserves
• flexible- or floating- exchange-rate system
• fixed-exchange-rate system
• purchasing-power-parity theory
• currency interventions• managed floating
exchange rate
21-17