Trade and the Exchange Rate

1. Trade and the Exchange Rate

2. NZ Exchange Rate • We have several different exchange rates, one for each currency. • It measures how much we would get in terms of the other currency per $1 NZ. http://www.x-rates.com/calculator.html

3. NZ Exchange Rate • If an exchange rate increases, our $NZ is appreciating. • This means that we are now getting more of the other currency per $1 NZ. • If an exchange rate is decreasing, our $NZ is depreciating. • This means that we are now getting less of the other currency per $1 NZ.

4. Why do we have exchange rates? • When we buy goods or services from other countries we must pay them in their currency. Therefore we must sell (SUPPLY) our dollar in return for the other currency. • Hence why we have exchange rates, we need to know how much of other countries currency we would get in return for every $1 NZ. • This also works in reverse: when other countries want to buy our exports they must sell their currency in return for our $NZ (DEMAND for the $NZ) in order to pay for the goods.

5. Floating Exchange Rate • This means that the ‘market’ (demand and supply) for our NZ dollar determines the exchange rate. • Things that will increase the demand for the $NZ: • Exports increase (more demand for our $NZ to pay for these) • Foreigners investing in NZ (they must invest in NZ in our currency) i.e. our interest rate is high. • Borrowing from abroad (they must lend us the money in $NZ in order for us to use it) • Increase in tourists coming to NZ.

6. Floating Exchange Rate • Things that will increase the supply of the $NZ: • Imports increase (we need to sell more of our $ to get more of the foreign currency to pay for these) • NZer’s invest more overseas (we must invest in the currency that the country uses i.e. Japan-Yen) • Paying back loans to overseas lenders. • More NZer’s traveling overseas (we must sell our $NZ to get the currency to spend in the country we are traveling overseas).

7. Appreciation/Depreciation • The supply and demand model shows both appreciation and depreciation. Market for the $NZ (depreciation) Market for the $NZ (appreciation) Price ($US) Price ($US) d d d’ s’ s s Quantity Quantity

8. Trade Weighted Index (TWI) • Trade weighted index is a weighted average from five different currencies in terms of the NZ exchange rate. • Australian dollar, UK pound, US dollar, Japanese yen, and the euro. • When the TWI is increasing, on average our exchange rate is increasing which means our $NZ is appreciating. • When the TWI is decreasing, on average our exchange rate is decreasing which means our $NZ is depreciating.

9. Exports • When the exchange rate appreciates it becomes relatively more expensive for foreign countries to buy our exports, therefore we lose our international competitiveness. • If the Australian dollar increases from 0.5 to 1.0 a good that will cost $10 NZ will have cost them: • $5 originally • $10 when the NZ dollar appreciates. • Our goods are now relatively more expensive therefore we lose our international competitiveness. Australia will demand less of our goods and more of another countries.

10. Exports for Price Taker Countries • The exchange rate effects our NZ exports because we are a price taker country. • So no matter what happens people pay for our exports in terms of a price in usually $US.

11. Exports for Price Taker Countries • When the exchange rate rises and the NZ dollar appreciates, exports stay the same price in terms of the $US. • Example: Exchange rate in $US is 0.5, and it appreciates to 1.0. A kg of cheese costs US$10. • At the original exchange rate NZ exporters of cheese would receive $20. At the new exchange rate NZ exporters would receive $10. NZ exporters are worse off. • When the exchange rate falls and the NZ dollar depreciates, our exporters are better off because they are receiving more for their goods.

12. Imports • When the $NZ appreciates, imports become relatively cheaper. • NZ exchange rate in terms of the $US goes from 0.5 to 1.0. (US$1 originally cost us $2 NZ (1÷0.5), to $1(1÷1.0)). A good that costs US$10 originally cost us $20, now costs us $10. • When the $NZ depreciates, imports become relatively more expensive. • NZ exchange rate in terms of the $US goes from 1.0 to 0.5. A good that costs US$10 originally costs us $10, now costs us $20 (1÷0.5=$2).

13. Market for the $NZ (depreciating) HAPPY farmers (X), therefore unhappy importers! Market for the $NZ (appreciating) UNHAPPY farmers (X), therefore happy importers! Price ($) Price ($) S S S’ D’ D D Quantity (units) Quantity (units)

14. Terms of Trade • This measures the purchasing power of a nation’s exports (in terms of what we receive for exports and what we pay for our imports). • T of T = Index of export prices× base yr index Index of imported prices value • When it becomes more expensive to buy imports our purchasing power decreases (ToT). • When it becomes less expensive to buy imports our purchasing power increases (ToT).

15. Questions to answer… • What does the terms of trade measure? • Explain what a favourable movement in the ToT means. • Explain what an unfavourable movement in the ToT means.

16. ANSWERS!!! • Measures the volume of imports that can be bought by a given volume of exports sold. • More imports can be bought by a given volume of exports sold than previously. • Less imports can be bought by a given volume of exports sold than previously.