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Chap038

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  • 1. The Balance ofPayments,Exchange Rates,and Trade DeficitsChapter 38McGraw-Hill/Irwin Copyright © 2009 by The McGraw-Hill Companies, Inc. All rights reserved.
  • 2. Chapter Objectives• How currencies are exchanged• Balance sheet for recordinginternational payments• How exchange rates aredetermined• Flexible vs. fixed exchangerates• Causes and consequences oftrade deficits38-2
  • 3. International Transactions• International trade–Buy/sell current goods or services–Imports and exports• International asset transactions–Buy/sell real or financial assets–Buy stock–Sell your house to a foreigner• Requires currency exchange38-3
  • 4. Balance of Payments• Sum of international financialtransactions• Current account–Balance on goods and services–Net investment income–Net transfers–Balance on current account38-4
  • 5. Balance of Payments• Capital and financial account–Capital account–Financial account• Balance of payments accountssum to zero• Current account deficits generateasset transfers to foreigners• Official reserves38-5
  • 6. U.S. Trade BalancesGoods and Services, Select Nations, 2007SurplusDeficitAustraliaBelgiumCanadaChinaGermanyMexicoNetherlands+10.0-67.0-45.3+9.8-256.6-77.3+14.3Source: Bureau of Economic Analysis-10-20-30-40-50-60-70-250 10 20Japan -85.038-6
  • 7. Flexible Exchange Rates• Demand for pounds• Supply of pounds• Market equilibrium• Increase in dollar price of pounds–Dollar depreciates–Pound appreciates• Decrease in dollar price of pounds–Dollar appreciates–Pound depreciates38-7
  • 8. Q0DollarPriceof1PoundQuantity of PoundsPFlexible Exchange RatesThe Market for Foreign Currency (Pounds)D1S1DollarDepreciates(PoundAppreciates)DollarAppreciates(PoundDepreciates)ExchangeRate: $2 = £1$2$3$1Q138-8
  • 9. 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 onassets–Speculation38-9
  • 10. Q0DollarPriceof1PoundQuantity of PoundsPFlexible Exchange RatesThe Market for Foreign Currency (Pounds)D1S1ExchangeRate:$2 = £1$2$3$1Q1D2ExchangeRate:$3 = £1BalanceOf PaymentsDeficitQ2x abc38-10
  • 11. Flexible Exchange Rates• Eliminate balance of paymentsdeficit or surplus• Disadvantages of flexibleexchange rates–Volatility–Uncertainty and diminished trade–Terms-of-trade changes–Instability38-11
  • 12. Fixed Exchange Rates• Government intervention–Use of reserves• Trade policies• Exchange controls and rationing–Distorted trade–Favoritism–Restricted choice–Black markets• Macroeconomic adjustments 38-12
  • 13. Exchange Rate Systems• Gold standard 1879-1934–Fixed exchange rate system• Bretton Woods 1944-1971–Fixed exchange rate systemindirectly tied to gold• Managed float 1971-present38-13
  • 14. Managed Float• Dependence on foreignexchange markets• Occasional intervention• In support of managed float• Concerns with managedfloat38-14
  • 15. U.S. Trade Deficit• Large and persistent• Causes of trade deficits–High U.S. growth (relatively)–China–Price oil–Low U.S. saving rate• Implications of trade deficits–Increased current consumption–Increased indebtedness 38-15
  • 16. Speculation in Currency Markets• Positive or negative influence?• Contributes to currency marketfluctuations• Self-fulfilling expectations• Smoothing short-termfluctuations• Absorbing risk• Futures market at work• Positive role played overall38-16
  • 17. Key Terms• balance of payments• current account• balance on goods andservices• trade deficit• trade surplus• balance on currentaccount• capital and financialaccount• balance on capital andfinancial• balance-of-paymentsdeficits and surpluses• official reserves• flexible- or floating-exchange-rate system• fixed-exchange-ratesystem• purchasing-power-parity theory• currency interventions• managed floatingexchange rate38-17

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