Download Balance of Payments

38
The Balance of Payments, Exchange Rates,
and Trade Deficits
McGraw-Hill/Irwin
Copyright © 2012 by The McGraw-Hill Companies, Inc. All rights reserved.
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 exchange
LO1
38-2
Balance of Payments
• Sum of international financial
•
LO2
transactions
Current account
• Balance on goods and services
• Net investment income
• Net transfers
• Balance on current account
38-3
Balance of Payments
• Capital and financial account
• Capital account
• Financial account
• Balance of payments accounts sum
•
•
LO2
to zero
Current account deficits generate
asset transfers to foreigners
Official reserves
38-4
Balance of Payments
LO2
38-5
Official Reserves
• Foreign currencies, certain reserves
•
•
LO2
with the IMF, and stocks of gold
Owned by government or central
bank
Used as balancing mechanism in
balance of payments
38-6
U.S. Trade Balances
LO2
38-7
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 depreciates
LO3
38-8
Flexible Exchange Rates
The Market for Foreign Currency
(Pounds)
P
Dollar Price of 1 Pound
S1
$3
$2
Dollar
Depreciates
(Pound
Appreciates)
Exchange
Rate: $2 = £1
Dollar
Appreciates
(Pound
Depreciates)
$1
D1
0
Q1
Q
Quantity of Pounds
LO3
38-9
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 on assets
• Speculation
LO3
38-10
Flexible Exchange Rates
The Market for Foreign Currency
(Pounds)
P
Dollar Price of 1 Pound
S1
c
$3
a
x
Exchange
Rate:
$3 = £1
Balance
Of Payments
Deficit
$2
b D
2
Exchange
Rate:
$2 = £1
$1
D1
0
Q1
Q2
Q
Quantity of Pounds
LO3
38-11
Flexible Exchange Rates
• Eliminate balance of payments
•
LO4
deficit or surplus
Disadvantages of flexible exchange
rates
• Volatility
• Uncertainty and diminished trade
• Terms-of-trade changes
• Instability
38-12
Flexible Exchange Rates
LO4
38-13
Fixed Exchange Rates
• Government intervention
• Use of reserves
• Trade policies
• Exchange controls and rationing
• Distorted trade
• Favoritism
• Restricted choice
• Black markets
• Macroeconomic adjustments
LO4
38-14
The Managed Float
• Gold standard 1879-1934
• Fixed exchange rate system
• Bretton Woods 1944-1971
• Fixed exchange rate system
•
LO4
indirectly tied to gold
Managed float 1971-present
38-15
The Managed Float
• Dependence on foreign exchange
•
•
•
LO4
markets
Occasional intervention
In support of managed float
Concerns with managed float
38-16
U.S. Trade Deficit
• Large and persistent
• Causes of trade deficits
• High U.S. growth (relatively)
• China
• Price of oil
• Low U.S. saving rate
• Implications of trade deficits
• Increased current consumption
• Increased indebtedness
LO5
38-17
Billions of Dollars
U.S. Trade Deficits
0
-50
-100
-150
-200
-250
-300
-350
-400
-450
-500
-550
-600
-650
-700
-750
-800
-850
-900
Goods and Services
Balance of
Trade
Goods
Billions of Dollars
2001
2003
2004
2005
2006
2007
2008
2009
0
-50
-100
-150
-200
-250
-300
-350
-400
-450
-500
-550
-600
-650
-700
-750
-800
-850
-900
Balance
on Current
Account
2001
LO5
2002
2002
2003
2004
2005
2006
2007
2008
2009
38-18
Speculation in Currency Markets
• Positive or negative influence?
• Contributes to currency market
•
•
•
•
•
LO5
fluctuations
Self-fulfilling expectations
Smoothing short-term fluctuations
Absorbing risk
Futures market at work
Positive role played overall
38-19