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Chapter 34

Chapter 34. Exchange Rates and the Balance of Payments. Chapter Outline. The Balance of Payments and International Capital Movements Determining Foreign Exchange Rates. The Balance of Payments and International Capital Movements (cont'd). Balance of Payments

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Chapter 34

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  1. Chapter 34 Exchange Rates and the Balance of Payments

  2. Chapter Outline The Balance of Payments and International Capital Movements Determining Foreign Exchange Rates

  3. The Balance of Payments and International Capital Movements (cont'd) Balance of Payments A system of accounts that measures transactions of goods, services, income and financial assets between domestic households, businesses, and governments and residents of the rest of the world during a specific time period • Balance of Trade (merchandise) • The difference between exports and imports of goods

  4. The Balance of Payments and International Capital Movements (cont'd) Three categories of balance of payments transactions Current account transactions (goods & services) Capital account transactions (foreign investment) Official reserve account transactions (difference of the above two)

  5. Table 34-2 U.S. Balance of Payments Account, 2009 (in billions of dollars)

  6. The Balance of Payments and International Capital Movements (cont'd) Balancing the current account Net exports plus unilateral transfers plus net investment income exceeds zero Current account surplus Net exports plus unilateral transfers plus net investment income is negative Current account deficit

  7. The Balance of Payments and International Capital Movements (cont'd) A current account deficitmeans that we are importing more goods and services than we are exporting. A current account deficit must be paid by the export of money or money equivalent. What happens to the foreigners who have more of your money?

  8. The Balance of Payments and International Capital Movements (cont'd) The current account and capital account must sum to zero In the absence of interventions by finance ministries or central banks Capital account  Current account  0 or Capital account = - Current account

  9. Figure 34-1 The Relationship Between the Current Account and the Capital Account Sources: International Monetary Fund; Economic Indicators.

  10. Determining Foreign Exchange Rates When you buy foreign products, you have dollars. But the foreign country can’t pay workers in dollars. So there must be a way of exchanging these dollars.

  11. Determining Foreign Exchange Rates (cont’d) Foreign Exchange Market A market in which households, firms and governments buy and sell national currencies Exchange Rates The price of one nation’s currency in terms of another

  12. Determining Foreign Exchange Rates (cont'd) The equilibrium foreign exchange rate Appreciation An increase in the exchange value of one nation’s currency in terms of the currency of another nation Depreciation An decrease in the exchange value of one nation’s currency in terms of the currency of another nation

  13. International Example: Going Loony over an Appreciating Loonie One face of a Canadian dollar coin displays an image of a bird called the loon, so the Canadian dollar is informally known as the “loonie.” In the mid-2000s, the loonie was worth only about 75 U.S. cents. In the late 2000s, however, its value had soared to over 1 U.S. dollar. • Hence, U.S. residents cut back on visits to Canada, because prices of touring Canada and its goods and services increased. • Which groups in the United States gained and which lost when the loonie appreciated?

  14. Determining Foreign Exchange Rates (cont'd) Appreciation and depreciation of Euros We say your demand for euros is derived from your demand for European drugs. • Example • Assume the pharmaceuticals cost 100 euros per package. • If 1 euro costs $1.45, then a package of pharmaceuticals would cost $145 (100 euros).

  15. Figure 34-4 Total Demand for and Supply of Euros

  16. Figure 34-5 A Shift in the Demand Schedule More imports from Europe (by Americans) raise the demand for the euro

  17. Figure 34-6 A Shift in the Supply of Euros More imports of US goods (by Europeans) raise the supply for the euro (and raise the demand for the US dollar)

  18. Myth #34: Because of trade deficits, we are in trouble • Not yet. It’s just toys for tots. • Give me toys and I’ll give you buildings.

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