unit 10 - foreign exchange rates and payment balances macroeconomics
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Unit 10 - Foreign Exchange Rates and Payment Balances
Macroeconomics
Unit 10 - Foreign Exchange Rates and Payment Balances
Foreign Exchange RatesForeign Exchange Rates
When countries trade, When countries trade,
they exchange products they exchange products
for currencies. for currencies.
In a free market, the valueIn a free market, the value
of the currencies isof the currencies is
determined by the demand and determined by the demand and
supply of the currencies.supply of the currencies.
Macroeconomics
Unit 10 - Foreign Exchange Rates and Payment Balances
Exchange Rate SystemsExchange Rate Systems
When currency values are allowed to fluctuate, When currency values are allowed to fluctuate, we speak of a flexible rate system. we speak of a flexible rate system.
When currency values are not allowed to When currency values are not allowed to fluctuate for a period of time, we speak of a fluctuate for a period of time, we speak of a fixed exchange rate system. fixed exchange rate system.
Macroeconomics
Unit 10 - Foreign Exchange Rates and Payment Balances
Devaluation and RevaluationDevaluation and Revaluation
In a fixed exchange rate system, when the In a fixed exchange rate system, when the currency values change after a period of time, currency values change after a period of time, we speak of we speak of devaluationdevaluation if there is a decrease if there is a decrease in the currency’s value, and in the currency’s value, and revaluationrevaluation if if there is an increase in the currency’s value.there is an increase in the currency’s value.
Macroeconomics
Unit 10 - Foreign Exchange Rates and Payment Balances
Devaluation and RevaluationDevaluation and RevaluationExampleExample
1 US Dollar = 3.64 Qatari Riyal1 US Dollar = 3.64 Qatari Riyal
After governments agree to a new “fixed” level:After governments agree to a new “fixed” level:
1 US Dollar = 3.50 Qatari Riyal (hypothetical example)1 US Dollar = 3.50 Qatari Riyal (hypothetical example)
Macroeconomics
Has the dollar Has the dollar revaluated or revaluated or devaluated relativedevaluated relativeto the Qatari Riyal?to the Qatari Riyal?
Unit 10 - Foreign Exchange Rates and Payment Balances
Devaluation and RevaluationDevaluation and Revaluation
If the dollar devaluates, it becomes cheaper for If the dollar devaluates, it becomes cheaper for Qatar to buy U.S. products.Qatar to buy U.S. products.
US exports become cheaper, and Qatari exports US exports become cheaper, and Qatari exports to the U.S. become more expensive.to the U.S. become more expensive.
Macroeconomics
Unit 10 - Foreign Exchange Rates and Payment Balances
Depreciation and AppreciationDepreciation and AppreciationIn a flexible exchange rate system, when the In a flexible exchange rate system, when the currency values change after a period of time, currency values change after a period of time, we speak of we speak of depreciationdepreciation if there is a decrease if there is a decrease in the currency’s value, and in the currency’s value, and appreciationappreciation if if there is an increase in the currency’s value.there is an increase in the currency’s value.
Macroeconomics
Unit 10 - Foreign Exchange Rates and Payment Balances
Depreciation and AppreciationDepreciation and Appreciation
ExampleExample$1 = 9.5 South African Rand$1 = 9.5 South African RandAfter currency change:After currency change:$1 = 10 South African Rand$1 = 10 South African Rand
Has the dollar depreciatedHas the dollar depreciatedor appreciated?or appreciated?
Macroeconomics
Unit 10 - Foreign Exchange Rates and Payment Balances
Depreciation and AppreciationDepreciation and Appreciation
If the dollar appreciates, it becomes more If the dollar appreciates, it becomes more expensive for South Africa to purchase dollars. expensive for South Africa to purchase dollars.
So if South Africa buys a U.S. car, it will have So if South Africa buys a U.S. car, it will have to pay more for the car (ceteris paribus). U.S. to pay more for the car (ceteris paribus). U.S. products become more expensive for South products become more expensive for South Africa. U.S. exports to South Africa become Africa. U.S. exports to South Africa become more expensive if the dollar appreciates.more expensive if the dollar appreciates.
Macroeconomics
Unit 10 - Foreign Exchange Rates and Payment Balances
Flexible Exchange Rate Systems Flexible Exchange Rate Systems
An advantage of a fixed exchange rate system An advantage of a fixed exchange rate system between two currencies is that the exchange rates between two currencies is that the exchange rates are constant for a period of time. Therefore, it are constant for a period of time. Therefore, it creates more certainty in international trading.creates more certainty in international trading.
Macroeconomics
Unit 10 - Foreign Exchange Rates and Payment Balances
Variable Exchange Rate SystemsVariable Exchange Rate Systems
Advantages of a variable exchange rate system are:Advantages of a variable exchange rate system are: the currency always has its true (market) value.the currency always has its true (market) value. no surpluses or shortages of a currency.no surpluses or shortages of a currency. no government (central bank) interference necessary no government (central bank) interference necessary
(and no central bank losses).(and no central bank losses). Modern day futures markets can fix the exchange rate Modern day futures markets can fix the exchange rate
via futures contracts.via futures contracts.
Macroeconomics
Unit 10 - Foreign Exchange Rates and Payment Balances
Balance of PaymentsBalance of Payments
The Balance of Payment The Balance of Payment (BOP) is (BOP) is an accounting record an accounting record of a of a country’s inflows and country’s inflows and outflows of outflows of money exchanged in money exchanged in international international trade.trade.
Macroeconomics
Unit 10 - Foreign Exchange Rates and Payment Balances
Balance of Payments Balance of Payments
The BOP consists of two main accounts:The BOP consists of two main accounts:
1.1. The current accountThe current account
2.2. The capital accountThe capital account
Macroeconomics
Unit 10 - Foreign Exchange Rates and Payment Balances
Balance of PaymentsBalance of Payments
The current account includes transactions related The current account includes transactions related to international:to international:1.1. merchandise trade (cars, computers, food)merchandise trade (cars, computers, food)2.2. services trade (insurance, tourism, consulting)services trade (insurance, tourism, consulting)3.3. investment income (earnings from stocks, investment income (earnings from stocks,
bonds)bonds)4.4. transfer payments (gifts, pensions)transfer payments (gifts, pensions)
Macroeconomics
Unit 10 - Foreign Exchange Rates and Payment Balances
Balance of Payments Balance of Payments
The capital account includes transactions related The capital account includes transactions related to international:to international:
5.5. purchases of financial assets (stocks, bonds)purchases of financial assets (stocks, bonds)
6.6. purchases of real assets (land, buildings, purchases of real assets (land, buildings, businesses)businesses)
7.7. purchases of foreign currency (by banks or purchases of foreign currency (by banks or speculators) speculators)
Macroeconomics
Unit 10 - Foreign Exchange Rates and Payment Balances
Balance of Payments Balance of Payments
By definition:By definition:the balance on the current account +the balance on the current account +
the balance on the capital account + the balance on the capital account +
statistical discrepancy = 0.statistical discrepancy = 0.
Macroeconomics
Unit 10 - Foreign Exchange Rates and Payment Balances
Balance of Payments Balance of Payments
For BOP statistics, visit:For BOP statistics, visit:
http://www.bea.govhttp://www.bea.gov
Macroeconomics
Unit 10 - Foreign Exchange Rates and Payment Balances
BOP IssuesBOP Issues
Controversial BOP issues include:Controversial BOP issues include:1.1. Is a trade deficit bad for the economy?Is a trade deficit bad for the economy?2.2. Should countries protect their domestic Should countries protect their domestic
industries (through trade restrictions) to industries (through trade restrictions) to improve their balance of payments?improve their balance of payments?
3.3. Should countries discourage domestic Should countries discourage domestic investments by foreigners?investments by foreigners?
Macroeconomics
Unit 10 - Foreign Exchange Rates and Payment Balances
BOP IssuesBOP Issues
Is a trade deficit bad for the economy?Is a trade deficit bad for the economy? A trade deficit can be a sign of strength. The A trade deficit can be a sign of strength. The
more purchasing power a country has, the more purchasing power a country has, the more it will import.more it will import.
Imports adds to a country’s wealth.Imports adds to a country’s wealth. Imports help foreign countries; this will Imports help foreign countries; this will
eventually benefit the importing country.eventually benefit the importing country.
Macroeconomics
Unit 10 - Foreign Exchange Rates and Payment Balances
BOP IssuesBOP Issues
Should countries protect their domestic industries Should countries protect their domestic industries (through trade restrictions) to improve their balance of (through trade restrictions) to improve their balance of payments?payments?
If a country protects its industries, other countries If a country protects its industries, other countries will protect theirs (retaliation). will protect theirs (retaliation).
Protectionism results in less specialization, less Protectionism results in less specialization, less competition, less efficiency, lower production, and competition, less efficiency, lower production, and a lower standard of living.a lower standard of living.
Macroeconomics
Unit 10 - Foreign Exchange Rates and Payment Balances
BOP IssuesBOP Issues
Should countries discourage domestic investments by Should countries discourage domestic investments by foreigners?foreigners? Investments by foreign companies in our country Investments by foreign companies in our country
results in more capital and more employment in our results in more capital and more employment in our country.country.
It is a sign of a strong economy that other countries It is a sign of a strong economy that other countries want to invest in our country.want to invest in our country.
Foreign investors invest for economic, not political Foreign investors invest for economic, not political reasons. reasons.
Economic interdependency strengthens, not weakens, Economic interdependency strengthens, not weakens, political ties. political ties.
Macroeconomics