1. The Balance of
Payments,
Exchange Rates,
and Trade Deficits
Chapter 38
McGraw-Hill/Irwin Copyright Š 2009 by The McGraw-Hill Companies, Inc. All rights reserved.
2. Chapter Objectives
⢠How currencies are exchanged
⢠Balance sheet for recording
international payments
⢠How exchange rates are
determined
⢠Flexible vs. fixed exchange
rates
⢠Causes and consequences of
trade deficits
38-2
3. International Transactions
⢠International trade
âBuy/sell current goods or services
âImports and exports
⢠International asset transactions
âBuy/sell real or financial assets
âBuy stock
âSell your house to a foreigner
⢠Requires currency exchange
38-3
4. Balance of Payments
⢠Sum of international financial
transactions
⢠Current account
âBalance on goods and services
âNet investment income
âNet transfers
âBalance on current account
38-4
5. Balance of Payments
⢠Capital and financial account
âCapital account
âFinancial account
⢠Balance of payments accounts
sum to zero
⢠Current account deficits generate
asset transfers to foreigners
⢠Official reserves
38-5
6. U.S. Trade Balances
Goods and Services, Select Nations, 2007
SurplusDeficit
Australia
Belgium
Canada
China
Germany
Mexico
Netherlands
+10.0
-67.0
-45.3
+9.8
-256.6
-77.3
+14.3
Source: Bureau of Economic Analysis
-10-20-30-40-50-60-70-250 10 20
Japan -85.0
38-6
7. Flexible Exchange Rates
⢠Demand for pounds
⢠Supply of pounds
⢠Market equilibrium
⢠Increase in dollar price of pounds
âDollar depreciates
âPound appreciates
⢠Decrease in dollar price of pounds
âDollar appreciates
âPound depreciates
38-7
8. Q
0
DollarPriceof1Pound
Quantity of Pounds
P
Flexible Exchange Rates
The Market for Foreign Currency (Pounds)
D1
S1
Dollar
Depreciates
(Pound
Appreciates)
Dollar
Appreciates
(Pound
Depreciates)
Exchange
Rate: $2 = ÂŁ1
$2
$3
$1
Q1
38-8
9. Flexible Exchange Rates
⢠Determinants of exchange rates
⢠Factors that shift demand/supply
âChanges in tastes
âRelative income changes
âRelative price-level changes
â˘Purchasing-power-parity theory
âRelative interest rates
âRelative expected returns on
assets
âSpeculation
38-9
10. Q
0
DollarPriceof1Pound
Quantity of Pounds
P
Flexible Exchange Rates
The Market for Foreign Currency (Pounds)
D1
S1
Exchange
Rate:
$2 = ÂŁ1
$2
$3
$1
Q1
D2
Exchange
Rate:
$3 = ÂŁ1
Balance
Of Payments
Deficit
Q2
x a
b
c
38-10
11. Flexible Exchange Rates
⢠Eliminate balance of payments
deficit or surplus
⢠Disadvantages of flexible
exchange rates
âVolatility
âUncertainty and diminished trade
âTerms-of-trade changes
âInstability
38-11
12. Fixed Exchange Rates
⢠Government intervention
âUse of reserves
⢠Trade policies
⢠Exchange controls and rationing
âDistorted trade
âFavoritism
âRestricted choice
âBlack markets
⢠Macroeconomic adjustments 38-12
13. Exchange Rate Systems
⢠Gold standard 1879-1934
âFixed exchange rate system
⢠Bretton Woods 1944-1971
âFixed exchange rate system
indirectly tied to gold
⢠Managed float 1971-present
38-13
14. Managed Float
⢠Dependence on foreign
exchange markets
⢠Occasional intervention
⢠In support of managed float
⢠Concerns with managed
float
38-14
15. U.S. Trade Deficit
⢠Large and persistent
⢠Causes of trade deficits
âHigh U.S. growth (relatively)
âChina
âPrice oil
âLow U.S. saving rate
⢠Implications of trade deficits
âIncreased current consumption
âIncreased indebtedness 38-15
16. Speculation in Currency Markets
⢠Positive or negative influence?
⢠Contributes to currency market
fluctuations
⢠Self-fulfilling expectations
⢠Smoothing short-term
fluctuations
⢠Absorbing risk
⢠Futures market at work
⢠Positive role played overall
38-16
17. Key Terms
⢠balance of payments
⢠current account
⢠balance on goods and
services
⢠trade deficit
⢠trade surplus
⢠balance on current
account
⢠capital and financial
account
⢠balance on capital and
financial
⢠balance-of-payments
deficits and surpluses
⢠official reserves
⢠flexible- or floating-
exchange-rate system
⢠fixed-exchange-rate
system
⢠purchasing-power-
parity theory
⢠currency interventions
⢠managed floating
exchange rate
38-17