Transcript Exchange Rate - McGraw Hill Higher Education

Chapter 21
Exchange Rates,
the Balance of
Payments, 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
21-2
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 reserves
21-5
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
Source: Bureau of Economic Analysis
10 20
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
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
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
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
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 adjustments
21-12
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 floatingexchange-rate system
• fixed-exchange-rate
system
• purchasing-powerparity theory
• currency interventions
• managed floating
exchange rate
21-17