Chapter 25. The Balance of Payments, Exchange Rates, and Trade Deficits

The Balance of Payments, Exchange Rates, and Trade DeficitsChapter 25Copyright © 2015 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.International TransactionsInternational tradeBuy/sell current goods or servicesImports and exportsInternational asset transactionsBuy/sell real or financial assetsBuy stockSell your house to a foreignerRequires currency exchangeLO1LO1Balance of PaymentsSum of international financial transactionsCurrent accountBalance on goods and servicesNet investment incomeNet transfersBalance on current account LO2LO2Balance of PaymentsCapital and financial accountCapital accountFinancial accountBalance of payments accounts sum to zeroCurrent account deficits generate asset transfers to foreignersOfficial reservesLO2LO2Official ReservesForeign currencies, certain reserves with the IMF, and stocks of goldOwned by government or central bankUsed as balancing mechanism in balance of paymentsLO2LO2Q0Dollar Price of 1 PoundQuantity of PoundsPFlexible Exchange RatesThe Market for Foreign Currency (Pounds)D1S1DollarAppreciates(PoundDepreciates)DollarDepreciates(PoundAppreciates)ExchangeRate: $2 = £1$2$3$1Q1LO3LO3Flexible Exchange RatesDeterminants of exchange ratesFactors that shift demand/supplyChanges in tastesRelative income changesRelative price-level changesPurchasing-power-parity theoryRelative interest ratesRelative expected returns on assetsSpeculationLO3LO3Q0Dollar Price of 1 PoundQuantity of PoundsPFlexible Exchange RatesThe Market for Foreign Currency(Pounds)D1S1ExchangeRate: $2 = £1$2$3$1Q1D2ExchangeRate: $3 = £1BalanceOf PaymentsDeficitQ2xabcLO3LO3Flexible Exchange RatesEliminate balance of payments deficit or surplusDisadvantages of flexible exchange ratesVolatility Uncertainty and diminished tradeTerms-of-trade changesInstabilityLO4LO3Fixed Exchange RatesGovernment interventionUse of reservesTrade policiesExchange controls and rationingDistorted tradeFavoritismRestricted choiceBlack marketsMacroeconomic adjustmentsLO4LO4The Managed FloatGold standard 1879-1934Fixed exchange rate systemBretton Woods 1944-1971Fixed exchange rate system indirectly tied to goldManaged float 1971-presentLO4LO5The Managed FloatDependence on foreign exchange marketsOccasional interventionIn support of managed floatConcerns with managed floatLO4LO5U.S. Trade DeficitLarge and persistentCauses of trade deficitsHigh U.S. growth (relatively)ChinaPrice of oilLow U.S. saving rateImplications of trade deficitsIncreased current consumptionIncreased indebtednessLO5LO6Speculation in Currency MarketsPositive or negative influence?Contributes to currency market fluctuationsSelf-fulfilling expectations Smoothing short-term fluctuationsAbsorbing riskFutures market at workPositive role played overallLO5