Chapter 38: The Balance of Payments, Exchange Rates, and Trade Deficits

The Balance of Payments, Exchange Rates, and Trade DeficitsMcGraw-Hill/Irwin Copyright © 2012 by The McGraw-Hill Companies, Inc. All rights reserved.International TransactionsInternational tradeBuy/sell current goods or servicesImports and exportsInternational asset transactionsBuy/sell real or financial assetsBuy stockSell your house to a foreignerRequires currency exchangeLO138-*Balance of PaymentsSum of international financial transactionsCurrent accountBalance on goods and servicesNet investment incomeNet transfersBalance on current account LO238-*Balance of PaymentsCapital and financial accountCapital accountFinancial accountBalance of payments accounts sum to zeroCurrent account deficits generate asset transfers to foreignersOfficial reservesLO238-*Balance of PaymentsLO238-*Official ReservesForeign currencies, certain reserves with the IMF, and stocks of goldOwned by government or central bankUsed as balancing mechanism in balance of paymentsLO238-*Flexible Exchange RatesDemand for poundsSupply of poundsMarket equilibriumIncrease in dollar price of poundsDollar depreciatesPound appreciates Decrease in dollar price of poundsDollar appreciatesPound depreciatesLO338-*Q0Dollar Price of 1 PoundQuantity of PoundsPFlexible Exchange RatesThe Market for Foreign Currency (Pounds)D1S1DollarAppreciates(PoundDepreciates)DollarDepreciates(PoundAppreciates)ExchangeRate: $2 = £1$2$3$1Q1LO338-*Flexible Exchange RatesDeterminants of exchange ratesFactors that shift demand/supplyChanges in tastesRelative income changesRelative price-level changesPurchasing-power-parity theoryRelative interest ratesRelative expected returns on assetsSpeculationLO338-*Q0Dollar Price of 1 PoundQuantity of PoundsPFlexible Exchange RatesThe Market for Foreign Currency(Pounds)D1S1ExchangeRate: $2 = £1$2$3$1Q1D2ExchangeRate: $3 = £1BalanceOf PaymentsDeficitQ2xabcLO338-*Flexible Exchange RatesEliminate balance of payments deficit or surplusDisadvantages of flexible exchange ratesVolatility Uncertainty and diminished tradeTerms-of-trade changesInstabilityLO438-*Fixed Exchange RatesGovernment interventionUse of reservesTrade policiesExchange controls and rationingDistorted tradeFavoritismRestricted choiceBlack marketsMacroeconomic adjustmentsLO438-*The Managed FloatGold standard: 1879-1934Fixed exchange rate systemBretton Woods: 1944-1971Fixed exchange rate system indirectly tied to goldManaged float: 1971-presentLO438-*The Managed FloatDependence on foreign exchange marketsOccasional interventionIn support of managed floatConcerns with managed floatLO438-*U.S. Trade DeficitLarge and persistentCauses of trade deficitsHigh U.S. growth (relatively)ChinaPrice of oilLow U.S. saving rateImplications of trade deficitsIncreased current consumptionIncreased indebtednessLO538-*