Transcript Unit10Macro

Unit 10 - Foreign Exchange
Rates and Payment Balances
Macroeconomics
Unit 10 - Foreign Exchange
Rates and Payment Balances
 Foreign
Exchange Rates
When countries trade,
they exchange products
for currencies.
In a free market, the value
of the currencies is
determined by the demand and
supply of the currencies.
Macroeconomics
Unit 10 - Foreign Exchange
Rates and Payment Balances

Exchange Rate Systems
When currency values are allowed to fluctuate,
we speak of a flexible rate system.
When currency values are not allowed to
fluctuate for a period of time, we speak of a
fixed exchange rate system.
Macroeconomics
Unit 10 - Foreign Exchange
Rates and Payment Balances

Devaluation and Revaluation
In a fixed exchange rate system, when the
currency values change after a period of time,
we speak of devaluation if there is a decrease
in the currency’s value, and revaluation if
there is an increase in the currency’s value.
Macroeconomics
Unit 10 - Foreign Exchange
Rates and Payment Balances

Devaluation and Revaluation
Example
1 US Dollar = 3.64 Qatari Riyal
After governments agree to a new “fixed” level:
1 US Dollar = 3.50 Qatari Riyal (hypothetical example)
Has the dollar
revaluated or
devaluated relative
to the Qatari Riyal?
Macroeconomics
Unit 10 - Foreign Exchange
Rates and Payment Balances

Devaluation and Revaluation
If the dollar devaluates, it becomes cheaper for
Qatar to buy U.S. products.
US exports become cheaper, and Qatari exports
to the U.S. become more expensive.
Macroeconomics
Unit 10 - Foreign Exchange
Rates and Payment Balances

Depreciation and Appreciation
In a flexible exchange rate system, when the
currency values change after a period of time,
we speak of depreciation if there is a decrease
in the currency’s value, and appreciation if
there is an increase in the currency’s value.
Macroeconomics
Unit 10 - Foreign Exchange
Rates and Payment Balances

Depreciation and Appreciation
Example
$1 = 9.5 South African Rand
After currency change:
$1 = 10 South African Rand
Has the dollar depreciated
or appreciated?
Macroeconomics
Unit 10 - Foreign Exchange
Rates and Payment Balances

Depreciation and Appreciation
If the dollar appreciates, it becomes more
expensive for South Africa to purchase dollars.
So if South Africa buys a U.S. car, it will have
to pay more for the car (ceteris paribus). U.S.
products become more expensive for South
Africa. U.S. exports to South Africa become
more expensive if the dollar appreciates.
Macroeconomics
Unit 10 - Foreign Exchange
Rates and Payment Balances
 Flexible
Exchange Rate Systems
An advantage of a fixed exchange rate system
between two currencies is that the exchange rates
are constant for a period of time. Therefore, it
creates more certainty in international trading.
Macroeconomics
Unit 10 - Foreign Exchange
Rates and Payment Balances
 Variable
Exchange Rate Systems
Advantages of a variable exchange rate system are:
 the currency always has its true (market) value.
 no surpluses or shortages of a currency.
 no government (central bank) interference necessary
(and no central bank losses).
 Modern day futures markets can fix the exchange rate
via futures contracts.
Macroeconomics
Unit 10 - Foreign Exchange
Rates and Payment Balances

Balance of Payments
The Balance of Payment (BOP) is
an accounting record of a
country’s inflows and outflows of
money exchanged in international
trade.
Macroeconomics
Unit 10 - Foreign Exchange
Rates and Payment Balances

Balance of Payments
The BOP consists of two main accounts:
1. The current account
2. The capital account
Macroeconomics
Unit 10 - Foreign Exchange
Rates and Payment Balances

Balance of Payments
The current account includes transactions related
to international:
1. merchandise trade (cars, computers, food)
2. services trade (insurance, tourism, consulting)
3. investment income (earnings from stocks,
bonds)
4. transfer payments (gifts, pensions)
Macroeconomics
Unit 10 - Foreign Exchange
Rates and Payment Balances

Balance of Payments
The capital account includes transactions related
to international:
5. purchases of financial assets (stocks, bonds)
6. purchases of real assets (land, buildings,
businesses)
7. purchases of foreign currency (by banks or
speculators)
Macroeconomics
Unit 10 - Foreign Exchange
Rates and Payment Balances

Balance of Payments
By definition:
the balance on the current account +
the balance on the capital account +
statistical discrepancy = 0.
Macroeconomics
Unit 10 - Foreign Exchange
Rates and Payment Balances

Balance of Payments
For BOP statistics, visit:
http://www.bea.gov
Macroeconomics
Unit 10 - Foreign Exchange
Rates and Payment Balances

BOP Issues
Controversial BOP issues include:
1. Is a trade deficit bad for the economy?
2. Should countries protect their domestic
industries (through trade restrictions) to
improve their balance of payments?
3. Should countries discourage domestic
investments by foreigners?
Macroeconomics

Unit 10 - Foreign Exchange
Rates and Payment Balances
BOP Issues
Is a trade deficit bad for the economy?
 A trade deficit can be a sign of strength. The
more purchasing power a country has, the
more it will import.
 Imports adds to a country’s wealth.
 Imports help foreign countries; this will
eventually benefit the importing country.
Macroeconomics
Unit 10 - Foreign Exchange
Rates and Payment Balances

BOP Issues
Should countries protect their domestic
industries (through trade restrictions) to improve
their balance of payments?
 If a country protects its industries, other
countries will protect theirs (retaliation).
 Protectionism results in less specialization,
less competition, less efficiency, lower
production, and a lower standard of living.
Macroeconomics
Unit 10 - Foreign Exchange
Rates and Payment Balances

BOP Issues
Should countries discourage domestic investments by
foreigners?
 Investments by foreign companies in our country
results in more capital and more employment in our
country.
 It is a sign of a strong economy that other countries
want to invest in our country.
 Foreign investors invest for economic, not political
reasons.
 Economic interdependency strengthens, not weakens,
political ties.
Macroeconomics