Download A Primer on the International Connection

A Primer on the International
Connection:
Exchange Rates,
the Balance of Payments, &
Macroeconomic Adjustments
Have you ever been abroad and
experienced a dramatic change in
exchange rates?
• WSJ hyperlink
Tricks to reading exchange rates:
• The price of the dollar in pesos is read as:
•
9.5 pesos/$US or 1$=9.5 pesos
• If it takes more pesos to buy a dollar, the dollar has gone
up in price.
• The price of the peso in dollars is read as:
• .105 $/peso or 1 peso= 10 1/2 cents U.S.
•
If it costs less in dollars to buy a peso, the
peso's price has fallen (depreciated)
Tricks to reading a balance of
payments table:
• All sorts of property and rights to property
cross borders, so there are many possible
balances that can be calculated depending
on what kind of property you include.
• Which way does the money flow? The
general accounting principle is an
inpayment counts as a plus (+), an
outpayment as a minus (-).
Examples of Commonly Used
Balances:
• Balance on Goods (only includes flows of physical
commodities- Should Exports be a plus or a minus?
Imports? Why?)
• Balance on Goods and Services (includes physical
commodities and provision of services) Where
would U.S. tourism abroad show up on the U.S.
balance of payments table? How would it count, as a
plus or a minus? Foreign travel in the U.S.??
Current Account Balance= Balance on Goods and
Services+ Earnings Balance+ Gifts Balance
• Balance on Current Account- is a country overspending
or underspending its budget for the current period?
• If a household overspends its current income for one year,
what are some ways it can finance that deficit?
• What happens to a country's external wealth position
when it runs a current account deficit? A surplus?
• Result:A country that runs a current account surplus raises
its net international wealth position by transferring capital
abroad. So the current account is balanced by a
corresponding minus on the capital account.
A plus on the current account is balanced by a
corresponding minus on the capital account.
• Balance on the Capital Account- (includes movements in
(+) and out (-) of financial capital (bank accounts and
loans), portfolio investments (stocks, bonds), and direct
investment.
• How does an increase in foreigners holdings of U.S.
treasury securities show up, as a plus or a minus on the
capital account? Where would interest payments on that
debt show up??
• How do foreign purchases of U.S. stocks show up? Where
would dividend earnings on their holdings show up? How
do U.S. purchases of foreign stocks show up? Sales?
Connection between the Balance of Payments and the
Foreign Exchange
Market for a Country's Currency
•
Price of peso
Supply of pesos-outpayments
$/peso
.15
.10
.05
Demand for pesos-Mexican
inpayments
FX Market for Pesos
Try forecasting what will happen to the price
of the peso if:
• The price of oil rises on the world market
• Interest rates in Mexico rise
• Portfolio Investors hear a rumor that the
Mexican government will be overthrown
First Approximation Macro- Effects
of an orderly depreciation of the peso, assuming Mexican Xports rise and Imports
fall. The trade balance improves (X-M)rises.
•
•
•
•
A Keynesian Perspective – Which way will Aggregate Demand Move? Under
what conditions will there be real economic growth? Inflation? Show on a
macro S & D diagram.
A Quantity Theory Perspective- how does the improvement of the trade
balance influence the Quantity of Money held by the non-bank public in
Mexico? Show the effects using the Quantity Equation and an aggregate
demand and supply diagram.
A Marxist Perspective- what happens to the rate of profit in Mexican export
industries? Industries that compete with imports? Show the impact of the rise
in the rate of profit on an aggregate demand and supply diagram.
Alternative Scenario:
• What would happen if portfolio investors
expect a further depreciation of the peso, an
internal financial crisis or an internal
meltdown of another sort?
• Will the first approximation results happen?
Work through this alternative scenario from
the three perspectives.
Keynesian First Approximation when X-M rises
Supply
Price Level
D3
D1
D2
Real GDP (D or y)
Quantity Theory First Approximation
Xports up, Mports down causes Money Supply to Grow
M*V=P*y
Supply- based on Say’s Law
Price
Level
D (after the Ms rises and
people spend excess cash
balances)
Demand- Before
Real GDP (y or D)
Marxist Theory First Approximation- the rise in export
earnings and lowering of competition with imports causes the
rate of profit inside the country to rise, demand moves to the
right as investors increase purchases of inputs, then supply
moves to the right as extra value added yields output increase
S
Price
S’
Level
D
D’
Real GDP (y or D)
Second Approximation- Capital Flight from fear of future instability
Quantity
Theory
Keynes
P
S
D2
y
Marx
S
P
P
D
D’
D1
y
I collapses
Money Supply
Collapses
S’ S
D’
y
Capital Investment
Collapses
D