Transcript Présentation PowerPoint - McGraw

Copyright 2005 © McGraw-Hill Ryerson Ltd.
Slide 0
CHAPTER
5
International Trade and
Exchange Rates
Learning objectives





Understand that the balance of payments is composed of
the current account and the capital account.
Understand that the current account balance and the
capital account balance must sum to zero.
Understand that a small open economy takes the foreign
real interest rate.
Understand that given the foreign real rate of interest,
domestic savings does not have to equal domestic
investment in equilibrium.
Understand that if domestic savings is greater than
domestic investment, then there is a balance of trade
surplus and net foreign lending is positive.
PowerPoint® slides prepared by Marc Prud’Homme, University of Ottawa
PowerPoint® slides prepared by Marc Prud’Homme, University of Ottawa
Copyright 2005 © McGraw-Hill Ryerson Ltd.
CHAPTER
5
International Trade and
Exchange Rates
Learning objectives (cont’d)


Understand that Canada has operated under both a
floating and a flexible rate system.
Understand that purchasing power parity predicts that the
exchange rate will move to equate purchasing power
internationally.
PowerPoint® slides prepared by Marc Prud’Homme, University of Ottawa
Copyright 2005 © McGraw-Hill Ryerson Ltd.
International Trade
Copyright 2005 © McGraw-Hill Ryerson Ltd.
Chapter 5: International Trade and Exchange Rates
o Open economy: An economy that trades
goods, services, and assets with other
countries.
o Closed economy: An economy that does
not engage in any international trade.
Slide 3
The Balance of Payments Accounts
Copyright 2005 © McGraw-Hill Ryerson Ltd.
Chapter 5: International Trade and Exchange Rates
o The Balance of payments: A record of the
transactions of a country with the rest of the
world.
o Rule A: Any transaction that gives rise to a
payment by Canadian residents to a foreign
country is an outflow and is recorded as a debit
item (minus signs in Table 5-1).
o Rule B: Any transaction that gives rise to a
payment by foreigners to a Canadian resident is
an inflow and is recorded as a credit item. (plus
signs in Table 5-1).
Slide 4
Table 5-1: Canada’s International Balance of Payments, 2002 (Billion of dollars)
Current Account
Net Exports
Exports
Imports
Net Income and Assets
Receipts on Investments
Payments on Investments
Net Transfers
Transfer Receipts
Transfer Payments
Current Account Balance
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49.5
472.6
423.1
-27.5
31.6
-59.1
1.4
7.0
-5.6
23.4
Slide 5
Table 5-1: Canada’s International Balance of Payments, 2002 (Billion of dollars)
Capital and Financial Account
Capital Account Net Flow
Inflow
Outflow
Financial Account Net Flow
Canadian Liabilities Net Inflow
Canadian Assets Net Outflow
Official Reserves
Other Assets
Current Account Balance
Statistical Discrepancy
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4.8
5.6
-0.8
-18.0
62.9
-80.8
0.3
-80.1
-13.2
-10.2
Slide 6
The Balance of Payments Accounts
o Net exports: The difference between exports
and imports.
o Merchandise trade balance: The difference
between export goods and import goods.
o Capital and Financial Account: Financial
account records direct investment and
portfolio investment, while capital
account includes items such as
inheritances and trade in intellectual
property.
Copyright 2005 © McGraw-Hill Ryerson Ltd.
Chapter 5: International Trade and Exchange Rates
o Current Account: Net exports, net
income from assets, and net transfers.
Slide 7
The Balance of Payments Accounts
o If a country runs a deficit in current account,
spending more abroad than it receives from
sales to the rest of the world, the deficit
needs to be financed selling assets thereby
borrowing abroad.
1) Current account + Capital account = 0
Copyright 2005 © McGraw-Hill Ryerson Ltd.
Chapter 5: International Trade and Exchange Rates
o Official Reserves: Assets held by central
banks that can be used to make
international payments.
o The overall balance of payments must be
zero.
Slide 8
Savings and Investment in a Small Open Economy
• NX: Net exports
• YNR: Net investment income from non
residents
Copyright 2005 © McGraw-Hill Ryerson Ltd.
Chapter 5: International Trade and Exchange Rates
o In a closed economy (Chapter 3):
Y=C+I+G
o In an open economy:
Y = C + I + G +NX
(2)
o From Chapter 2:
S = I + (NX + YNR)
(3)
Slide 9
Savings and Investment in a Small Open Economy
Copyright 2005 © McGraw-Hill Ryerson Ltd.
Chapter 5: International Trade and Exchange Rates
S = I + CA
(4)
S - I = CA
(5)
o Equation 5) in terms of trade in goods
and services:
S - I = NX
(6)
o If S > I, then excess domestic savings is
loaned to foreigners.
o Net Foreign Investment: The amount that
domestic residents are lending
foreigners.
Slide 10
Savings and Investment in a Small Open Economy
o Foreign (or World) Real Rate of Interest:
The real interest rate that prevails in
international capital markets; individuals,
businesses, and governments are
assumed to be able to borrow and lend
at this rate.
o In Canada, the foreign real rate of interest is
exogenous.
o Twin deficit: In a small open economy, a
government budget deficit leads to a
balance of trade deficit.
Copyright 2005 © McGraw-Hill Ryerson Ltd.
Chapter 5: International Trade and Exchange Rates
The Role of the World Real Rate of Interest
Slide 11
Savings and Investment in a Small Open Economy
S
Real Rate of Interest
r
rf
r
NX > 0
Savings, Investment
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I
S, I
If the foreign
real rate of
interest, rf, is
greater than
the domestic
real rate of
interest, r, then
net exports are
greater than
zero. In this
situation, net
foreign
investment
(lending) must
also be
positive.
Chapter 5: International Trade and Exchange Rates
Figure 5-1: Savings and investment in a Small Open Economy
Slide 12
Savings and Investment in a Small Open Economy
S
Real Rate of Interest
r
r
rf
NX < 0
Savings, Investment
Copyright 2005 © McGraw-Hill Ryerson Ltd.
I
S, I
If the foreign
real rate of
interest, rf, is
less than the
domestic real
rate of interest,
r, then net
exports are
negative (trade
deficit). In this
situation, net
foreign
investment
(lending) must
also be
negative.
Chapter 5: International Trade and Exchange Rates
Figure 5-2: Savings and investment in a Small Open Economy
Slide 13
Savings and Investment in a Small Open Economy
Figure 5-3: A Government Budget Deficit and a Balance of Trade Deficit
Real Rate of Interest
S’
S
r1
At the foreign
real rate of
interest,
savings is less
than
investment,
and there is a
balance of
trade deficit
equal to S’ - I.
r0 = r f
I
S’
I
Savings, Investment
Copyright 2005 © McGraw-Hill Ryerson Ltd.
S, I
Chapter 5: International Trade and Exchange Rates
r
A government
budget deficit
shifts the
savings curve
left to S’.
Slide 14
Savings and Investment in a Small Open Economy
Figure 5-4: The Twin Deficits, 1961-2002
Chapter 5: International Trade and Exchange Rates
Copyright 2005 © McGraw-Hill Ryerson Ltd.
Slide 15
Exchange Rates
o Nominal Exchange Rate: The
number of Canadian dollars that
must be given up in order to
purchase a unit of foreign currency.
o $Can1.17 = 100 Yen or $Can1.40 =
$US1.00.
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Chapter 5: International Trade and Exchange Rates
Exchange Rate Determination
Slide 16
Exchange Rates
o Flexible (or floating) Exchange Rate: The
central bank allows the exchange rate to
be determined by the foreign exchange
market.
o Currency Appreciation or Depreciation: A
change in the price of foreign exchange
under flexible exchange rate.
o Appreciation: From $C1.40 = $US1.00 to
$C1.35 = $US1.00
o Depreciation: From $C1.40 = $US1.00 to
$C1.45 = $US1.00
Copyright 2005 © McGraw-Hill Ryerson Ltd.
Chapter 5: International Trade and Exchange Rates
Exchange Rate Determination
Slide 17
Exchange Rates
o Fixed Rate System: Central banks buy
and sell currency at a fixed rate in terms
of foreign exchange. (Figure 5-5)
o A devaluation (revaluation) takes place
when the value of the currency in terms
of foreign exchange is reduced
(increased) by official sanction.
Copyright 2005 © McGraw-Hill Ryerson Ltd.
Chapter 5: International Trade and Exchange Rates
Exchange Rate Determination
Slide 18
Exchange Rates
S
Domestic Currency Price of
Foreign Exchange
e
To fix the
exchange rate
at e2 below the
equilibrium rate
e1, the central
bank has to
meet the
excess demand
by selling
foreign
currency.
E
e1
e2
D
Foreign Exchange
Copyright 2005 © McGraw-Hill Ryerson Ltd.
S, I
Chapter 5: International Trade and Exchange Rates
Figure 5-5: The Foreign Exchange Market
Slide 19
Exchange Rates
o Intervention: Occurs when the central bank has
to buy or sell currency to make up for any
excess supply or demand arising from private
transactions.
o Managed (or Dirty) Floating: Central banks
intervene by buying or selling foreign currency
and attempt to influence exchange rates.
Copyright 2005 © McGraw-Hill Ryerson Ltd.
Chapter 5: International Trade and Exchange Rates
Exchange Market Intervention
Slide 20
Exchange Rates
Figure 5-6: The Canadian Dollar, 1913-2003
Chapter 5: International Trade and Exchange Rates
Copyright 2005 © McGraw-Hill Ryerson Ltd.
Slide 21
Exchange Rates
o Bilateral exchange rate: The value
of one exchange rate against
another.
o Multilateral exchange rate: The
value of one currency against a
basket of other currencies.
Copyright 2005 © McGraw-Hill Ryerson Ltd.
Chapter 5: International Trade and Exchange Rates
Alternative Measures of the Exchange Rate
Slide 22
Exchange Rates
Table 5-2: Alternative Measure of Exchange Rate, 1990-2003 (Canadian Dollars)
Chapter 5: International Trade and Exchange Rates
Copyright 2005 © McGraw-Hill Ryerson Ltd.
Slide 23
BOX
The Euro
5-1
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Slide 24
Purchasing Power Parity
www.economist.com/markets/bigmac
Copyright 2005 © McGraw-Hill Ryerson Ltd.
Chapter 5: International Trade and Exchange Rates
o Purchasing Power Parity (PPP):
Theory of the exchange rate that
states that in the long run, the
nominal exchange rate moves
primarily as a result of difference in
price level behaviour between two
countries.
o Example:
Slide 25
Purchasing Power Parity
P
P
C
US
C
US

 PUS  e
US
(7)
 $2.511.47  $3.69Cdn.
e : nominal exchange rate, measured as the
Canadian dollar price of one US dollar.

Copyright 2005 © McGraw-Hill Ryerson Ltd.
Chapter 5: International Trade and Exchange Rates
o April 2000: Big Mac cost $2.51 US in the
United States and $2.85 Cdn. In Canada.
o Convert US price in Canadian dollars:
Slide 26
Purchasing Power Parity
e
P

P
US
Relative BM price
US
C
(8)
C
$3.69 Cdn.

$2.85 US
 1.29
The US Big Mac costs 29 percent more than the
Canadian Big Mac.

Copyright 2005 © McGraw-Hill Ryerson Ltd.
Chapter 5: International Trade and Exchange Rates
o The relative price of a Big Mac in
two currencies:
Slide 27
Purchasing Power Parity
e ppp 
P
P
C
US
(9)
US
$2.85 Cdn.

$2.51 US
 1.14

If e = 1.14 in equation 8), then eppp = 1. The Canadian
dollar is undervalued by 29 percent.

Copyright 2005 © McGraw-Hill Ryerson Ltd.
Chapter 5: International Trade and Exchange Rates
o The PPP level of nominal exchange rate is the
level that would make this relative price equal to
1:
C
Slide 28
Purchasing Power Parity
eP
R
P
f
P : Domestic price level
Pf: Foreign price level
e : Nominal exchange rate
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(10)
Chapter 5: International Trade and Exchange Rates
o Real Exchange Rate: The ratio of foreign prices
to domestic prices, measured in a common
currency.
Slide 29
Exchange Rates
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Chapter 5: International Trade and Exchange Rates
Figure 5-7: The Real Exchange Rate, 1914-2002
Slide 30
BOX
Burgernomics
5-2
www.economist.com/markets/bigmac
Copyright 2005 © McGraw-Hill Ryerson Ltd.
Slide 31
Chapter Summary
Copyright 2005 © McGraw-Hill Ryerson Ltd.
Chapter 5: International Trade and Exchange Rates
• The balance of payments is a record of transactions
of Canadians with foreigners.
• Canada is a small open economy, which takes the
foreign (world) real interest rate as exogenous.
• If domestic savings is greater than domestic
investment, then there is a balance of trade surplus
and net foreign lending is positive.
• The foreign exchange rate can be measured as a
nominal exchange rate or as a real exchange rate.
• Purchasing power parity predicts that the exchange
rate will move to equate purchasing power
internationally.
Slide 32
The End
Chapter 5: International Trade and Exchange Rates
Copyright 2005 © McGraw-Hill Ryerson Ltd.
Slide 33