The Balance of Payments, Exchange Rates, and Trade Deficits Chapter 21 Copyright © 2015 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.
Dec 28, 2015
The Balance of Payments, Exchange Rates, and Trade Deficits
Chapter 21
Copyright © 2015 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.
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
LO1LO1
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
LO2LO2
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
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21-5
Official Reserves
• Foreign currencies, certain reserves with the IMF, and stocks of gold
• Owned by government or central bank• Used as balancing mechanism in balance of
payments
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21-6
Q0
Do
llar
Pri
ce o
f 1
Po
un
d
Quantity of Pounds
P
Flexible Exchange Rates
The Market for Foreign Currency (Pounds)
D1
S1
DollarAppreciates(PoundDepreciates)
DollarDepreciates(PoundAppreciates)
ExchangeRate: $2 = £1
$2
$3
$1
Q1
LO3LO3
21-7
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
LO3LO3
21-8
Q0
Do
llar
Pri
ce o
f 1
Po
un
d
Quantity of Pounds
P
Flexible Exchange Rates
The Market for Foreign Currency(Pounds)
D1
S1
ExchangeRate: $2 = £1
$2
$3
$1
Q1
D2
ExchangeRate: $3 = £1
BalanceOf Payments
Deficit
Q2
x a
b
c
LO3LO3
21-9
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
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21-10
Fixed Exchange Rates
• Government intervention• Use of reserves
• Trade policies• Exchange controls and rationing• Distorted trade• Favoritism• Restricted choice• Black markets
• Macroeconomic adjustments
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21-11
The Managed Float
• Gold standard 1879-1934• Fixed exchange rate system
• Bretton Woods 1944-1971• Fixed exchange rate system indirectly tied
to gold• Managed float 1971-present
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21-12
The Managed Float
• Dependence on foreign exchange markets• Occasional intervention• In support of managed float• Concerns with managed float
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21-13
U.S. Trade Deficit
• Large and persistent• Causes of trade deficits• High U.S. growth (relatively)• China• Price of oil• Low U.S. saving rate
• Implications of trade deficits• Increased current consumption• Increased indebtedness
LO5LO6