Transcript Chapter 36
Chapter 38 The Balance of Payments, Exchange Rates, and Trade Deficits 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 deficits 38-2 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 38-3 Balance of Payments • Sum of international financial transactions • Current account –Balance on goods and services –Net investment income –Net transfers –Balance on current account 38-4 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 reserves 38-5 U.S. Trade Balances Goods and Services, Select Nations, 2007 Deficit Surplus +10.0 Australia Belgium +9.8 Canada -67.0 China -256.6 Germany -45.3 Japan -85.0 Mexico -77.3 +14.3 Netherlands -250 -70 -60 -50 -40 -30 -20 -10 10 20 Source: Bureau of Economic Analysis 38-6 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 38-7 Flexible Exchange Rates The Market for Foreign Currency (Pounds) P Dollar Price of 1 Pound S1 $3 $2 Dollar Depreciates (Pound Appreciates) Exchange Rate: $2 = £1 Dollar Appreciates (Pound Depreciates) $1 D1 0 Q1 Q Quantity of Pounds 38-8 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 38-9 Flexible Exchange Rates The Market for Foreign Currency (Pounds) P Dollar Price of 1 Pound S1 c $3 $2 $1 a x Exchange Rate: $3 = £1 Balance Of Payments Deficit b D 2 Exchange Rate: $2 = £1 D1 0 Q1 Q2 Q Quantity of Pounds 38-10 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 38-11 Fixed Exchange Rates • Government intervention –Use of reserves • Trade policies • Exchange controls and rationing –Distorted trade –Favoritism –Restricted choice –Black markets • Macroeconomic adjustments 38-12 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 38-13 Managed Float • Dependence on foreign exchange markets • Occasional intervention • In support of managed float • Concerns with managed float 38-14 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 38-15 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 38-16 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 floatingexchange-rate system • fixed-exchange-rate system • purchasing-powerparity theory • currency interventions • managed floating exchange rate 38-17