This document is posted to help you gain knowledge. Please leave a comment to let me know what you think about it! Share it to your friends and learn new things together.
In this chapter you will learnIn this chapter you will learn
17.117.1 How international trade is financed How international trade is financed
17.2 17.2 About a nation’s balance of paymentsAbout a nation’s balance of payments
17.317.3 What a flexible exchange-rate system is What a flexible exchange-rate system is and its effects on the domestic economyand its effects on the domestic economy
17.417.4 What a fixed exchange-rate system is and What a fixed exchange-rate system is and its effects on the domestic economyits effects on the domestic economy
17.517.5 About the history of the world’s exchange- About the history of the world’s exchange-rate regimesrate regimes
Canadian Export TransactionCanadian Export Transaction
Assume $2 = £1Assume $2 = £1
1.1. $300,000 in Canadian telecommunications $300,000 in Canadian telecommunications equipment purchased by a British buyer for equipment purchased by a British buyer for £150,000£150,000
2.2. £150,000 cheque drawn on British bank to £150,000 cheque drawn on British bank to pay for equipmentpay for equipment
3.3. £150,000 cheque is exchanged for $300,000 £150,000 cheque is exchanged for $300,000 at a Canadian bankat a Canadian bank
4.4. Canadian bank sends £150,000 cheque to Canadian bank sends £150,000 cheque to London bank for future transactionsLondon bank for future transactions
Canadian exports create:Canadian exports create: a foreign demand for Canadian $ a foreign demand for Canadian $ an increase in the supply of foreign an increase in the supply of foreign
currency owned by Canadian bankscurrency owned by Canadian banks
Canadian exports supply the foreign Canadian exports supply the foreign currencies needed to “pay for” importscurrencies needed to “pay for” imports
Demand for & supplies of foreign Demand for & supplies of foreign currencies also arise from transactions currencies also arise from transactions involving services & payment of interest involving services & payment of interest & dividends on foreign investments& dividends on foreign investments
The Canadian The Canadian balance of paymentsbalance of payments shows the balance between shows the balance between – all the payments that Canada receives all the payments that Canada receives
from foreign countries &from foreign countries &– all the payments which we make to themall the payments which we make to them
shows the flows resulting from imports & shows the flows resulting from imports & exports of goods & servicesexports of goods & services– the the balance on goodsbalance on goods is the net amount of is the net amount of
imports & exports of goods onlyimports & exports of goods only– the the balance on goods & servicesbalance on goods & services includes goods includes goods
& services& services– trade in services, investment income & transfers trade in services, investment income & transfers
are included to get the are included to get the current account balancecurrent account balance– in 2002, Canada had a current account surplus of in 2002, Canada had a current account surplus of
shows capital inflows & outflowsshows capital inflows & outflows– purchase or sale of real or financial assetspurchase or sale of real or financial assets– official settlements accountofficial settlements account
TIPTIP: : – a + sign indicates a “source” of foreign a + sign indicates a “source” of foreign
exchange, exchange, – a - sign indicates a “use” of foreign a - sign indicates a “use” of foreign
A drawing down of official international A drawing down of official international reserves (a + official reserves entry) reserves (a + official reserves entry) measures a nation’s balance of payments measures a nation’s balance of payments deficitdeficit
A building up of official reserves (a – official A building up of official reserves (a – official reserves entry) measures a balance of reserves entry) measures a balance of payments surpluspayments surplus
Deficits not necessarily bad, but cannot be Deficits not necessarily bad, but cannot be maintained indefinitely, because international maintained indefinitely, because international reserves are limitedreserves are limited
GLOBAL PERSPECTIVE 17.1GLOBAL PERSPECTIVE 17.1
Canada's Trade Balance with Selected Nations, 2002
Rates by which national currencies are Rates by which national currencies are exchanged are determined by demand exchanged are determined by demand & supply& supply
P
Q
D
The Market for Foreign Currency (Pounds)The Market for Foreign Currency (Pounds)D
olla
r p
ric
e o
f 1
po
un
d
Quantity of pounds
Figure 17-2Figure 17-2
who are the who are the demanders of demanders of pounds in fx pounds in fx
markets?markets?
P
Q
D
S
Do
llar
pri
ce
of
1 p
ou
nd
Quantity of pounds
The Market for Foreign Currency (Pounds)The Market for Foreign Currency (Pounds)
who are the who are the suppliers of suppliers of pounds to fx pounds to fx
markets?markets?
Figure 17-2Figure 17-2
P
Q
D
S
dollar price of dollar price of pounds is pounds is
determined by determined by demand & supplydemand & supply
Do
llar
pri
ce
of
1 p
ou
nd
Quantity of pounds
The Market for Foreign Currency (Pounds)The Market for Foreign Currency (Pounds)Figure 17-2Figure 17-2
P
Q
D
S
2
Do
llar
pri
ce
of
1 p
ou
nd
Quantity of poundsQ1
The Market for Foreign Currency (Pounds)The Market for Foreign Currency (Pounds)Figure 17-2Figure 17-2
P
Q
D
S
Poundappreciates
D
Do
llar
pri
ce
of
1 p
ou
nd
Quantity of pounds
The Market for Foreign Currency (Pounds)The Market for Foreign Currency (Pounds)
2
Q1
Figure 17-2Figure 17-2
P
Q
D
S
D
Pounddepreciates
Do
llar
pri
ce
of
1 p
ou
nd
Quantity of pounds
The Market for Foreign Currency (Pounds)The Market for Foreign Currency (Pounds)
Advantages of Flexible RatesAdvantages of Flexible Rates
automatic adjustment to eventually automatic adjustment to eventually eliminate balance of payments deficits eliminate balance of payments deficits or surplusesor surpluses
P
Q
D
S
suppose suppose tastestastes
change change & Canadians& Canadianswant to buywant to buymore British more British automobilesautomobilesD
olla
r p
ric
e o
f 1
po
un
d
Quantity of pounds
2
Adjustments Under Flexible Exchange RatesAdjustments Under Flexible Exchange RatesFigure 17-3Figure 17-3
P
Q
D
S
demand for demand for poundspounds
increasesincreases
Do
llar
pri
ce
of
1 p
ou
nd
Quantity of pounds
D
2
Adjustments Under Flexible Exchange RatesAdjustments Under Flexible Exchange RatesFigure 17-3Figure 17-3
P
Q
D
S
Canadian Canadian balance of balance of payments payments
deficitdeficit
Do
llar
pri
ce
of
1 p
ou
nd
Quantity of pounds
D
2
Adjustments Under Flexible Exchange RatesAdjustments Under Flexible Exchange Rates
a b
Figure 17-3Figure 17-3
P
Q
D
S
Do
llar
pri
ce
of
1 p
ou
nd
Quantity of pounds
D
2
change in change in the the
exchange exchange rate to rate to $3=$3=£1£1would would
correct the correct the deficitdeficit
Adjustments Under Flexible Exchange RatesAdjustments Under Flexible Exchange Rates
with a lower $, Canadians will want to with a lower $, Canadians will want to import less, & the British will want to import less, & the British will want to buy more Canadian goods & servicesbuy more Canadian goods & services
Disadvantages of Flexible RatesDisadvantages of Flexible Rates
reduced trade because of risks reduced trade because of risks associated with constantly changing associated with constantly changing exchange ratesexchange rates
worsening terms of trade if there is a worsening terms of trade if there is a sizeable depreciationsizeable depreciation
challenges in designing domestic challenges in designing domestic macroeconomic policies in nations macroeconomic policies in nations heavily dependent on tradeheavily dependent on trade
The Gold Standard: Fixed Exchange The Gold Standard: Fixed Exchange RatesRates 1879 - 1934 1879 - 1934 – currency defined in goldcurrency defined in gold– fixed relationship between gold stock & fixed relationship between gold stock &
Gold flows resulted in fixed exchange Gold flows resulted in fixed exchange ratesrates
Domestic macroeconomic adjustments Domestic macroeconomic adjustments sometimes distastefulsometimes distasteful
Gold standard collapsed in the Gold standard collapsed in the worldwide depression of the 1930sworldwide depression of the 1930s– series of devaluationsseries of devaluations
The Bretton Woods System The Bretton Woods System 1944-19711944-1971– adjustable-peg systemadjustable-peg system– International Monetary FundInternational Monetary Fund (IMF) (IMF)
Maintaining pegged ratesMaintaining pegged rates– Official international reservesOfficial international reserves– Gold salesGold sales– IMF borrowingIMF borrowing