unit 10 - foreign exchange rates and payment balances macroeconomics

Unit 10 - Foreign Exchange Rates and Payment Balances

Macroeconomics


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


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


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


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?


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


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


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


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


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


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


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


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


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



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



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



For BOP statistics, visit:For BOP statistics, visit:

http://www.bea.govhttp://www.bea.gov

Macroeconomics


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



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



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



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

unit 10 - foreign exchange rates and payment balances macroeconomics

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