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McGraw-Hill/Irwin Copyright © 2012 by The McGraw-Hill Companies, Inc. All rights reserved.

The Balance of Payments, Exchange Rates, and Trade Deficits

International Transactions

• International trade• Trade goods and services or

assets for money• When using different currencies,

currencies must be converted for trade to occur

LO1

Balance of Payments

• Sum of all of a nation’s international financial transactions

• Balance of payments accounts sum to zero

• Current account deficits generate asset transfers to foreigners

• Can use official reserves to balance payments if necessary like a savings account

LO2

Balance of Payments

LO2

U.S. Trade Balances

LO2

Flexible Exchange Rates

• Flexible or floating exchange rates

• Exchange rates are determined in the free market

• Fixed exchange rates

• Government determines exchange rates and makes adjustments to maintain them

LO3

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

LO3

Flexible Exchange Rates

• Eliminate balance of payments deficit or surplus

• Disadvantages of flexible exchange rates • Uncertainty and diminished trade• Terms-of-trade changes• Instability

LO4

Flexible Exchange Rates

LO4

Fixed Exchange Rates

• Government intervention• Use of reserves

• Trade policies• Exchange controls and rationing

• Distorted trade• Favoritism• Restricted choice• Black markets

• Macroeconomic adjustments

LO4

The Managed Float

• Occasional intervention

• In support of managed float

• More successful than expected even during severe financial crises

• Concerns with managed float

• Too volatile

• Guidelines are too vague

LO4

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

LO5

U.S. Trade Deficits

• U.S. Trade Deficits, 2001-2009

LO5