Chapter 32 EXCHANGE RATES, BALANCE OF PAYMENTS, AND INTERNATIONAL DEBT Gottheil — Principles of...
-
Upload
ciera-fleming -
Category
Documents
-
view
227 -
download
0
Transcript of Chapter 32 EXCHANGE RATES, BALANCE OF PAYMENTS, AND INTERNATIONAL DEBT Gottheil — Principles of...
Chapter 32Chapter 32
EXCHANGE RATES, BALANCE EXCHANGE RATES, BALANCE OF PAYMENTS, AND OF PAYMENTS, AND INTERNATIONAL DEBTINTERNATIONAL DEBT
Gottheil — Principles of Economics, 7e© 2013 Cengage Learning1
Economic PrinciplesEconomic Principles
© 2013 Cengage Learning Gottheil — Principles of Economics, 7e2
Exchange rates
Foreign exchange markets
Appreciation and depreciation of currencies
Floating and fixed exchange rates
Economic PrinciplesEconomic Principles
© 2013 Cengage Learning Gottheil — Principles of Economics, 7e3
Arbitrage
Devaluation
Balance of payments
International debt and debt service
The Foreign Exchange Market: The The Foreign Exchange Market: The Buying and Selling of CurrenciesBuying and Selling of Currencies
© 2013 Cengage Learning Gottheil — Principles of Economics, 7e4
Foreign exchange market
• A market in which currencies of different nations are bought and sold.
The Foreign Exchange Market: The The Foreign Exchange Market: The Buying and Selling of CurrenciesBuying and Selling of Currencies
© 2013 Cengage Learning Gottheil — Principles of Economics, 7e5
Exchange rate
• The number of units of foreign currency that can be purchased with one unit of domestic currency.
The Foreign Exchange Market: The The Foreign Exchange Market: The Buying and Selling of CurrenciesBuying and Selling of Currencies
© 2013 Cengage Learning Gottheil — Principles of Economics, 7e6
1. Suppose that a kite costs 40 yaps, and the exchange rate is 10 yaps to the dollar. What is the dollar price of the kite?
• 40 yaps/10 = 4 dollars
© 2013 Cengage Learning Gottheil — Principles of Economics, 7e7
EXHIBIT 1 FOREIGN EXCHANGE MARKET
Exhibit 1: Foreign Exchange MarketExhibit 1: Foreign Exchange Market
© 2013 Cengage Learning Gottheil — Principles of Economics, 7e8
At $2 per yap, is the foreign exchange market in Exhibit 1 in equilibrium, or is there an excess demand or excess supply of yaps?• Since the equilibrium price is $3 per
yap, at $2 per yap there would be an excess demand for yaps.
Exhibit 1: Foreign Exchange MarketExhibit 1: Foreign Exchange Market
© 2013 Cengage Learning Gottheil — Principles of Economics, 7e9
At $4 per yap, is the foreign exchange market in Exhibit 1 in equilibrium, or is there an excess demand or excess supply of yaps?• Since the equilibrium price is $3 per
yap, at $4 per yap there would be an excess supply of yaps.
The Foreign Exchange Market:The Foreign Exchange Market:The Buying and Selling of CurrenciesThe Buying and Selling of Currencies
© 2013 Cengage Learning Gottheil — Principles of Economics, 7e10
• When the price of a foreign currency declines, the quantity of that foreign currency demanded increases.
2. Why is the demand curve for foreign currency downward-sloping?
The Foreign Exchange Market:The Foreign Exchange Market:The Buying and Selling of CurrenciesThe Buying and Selling of Currencies
© 2013 Cengage Learning Gottheil — Principles of Economics, 7e11
• For example, if a dollar can buy more yaps than before, then a dollar can also buy more yap-priced goods and services than before.
2. Why is the demand curve for foreign currency downward-sloping?
The Foreign Exchange Market:The Foreign Exchange Market:The Buying and Selling of CurrenciesThe Buying and Selling of Currencies
© 2013 Cengage Learning Gottheil — Principles of Economics, 7e12
2. Why is the demand curve for foreign currency downward-sloping?
• As a result, Americans wish to exchange dollars for more yaps in order to buy more yap-priced goods, increasing the quantity of yaps demanded in the foreign exchange market.
The Foreign Exchange Market:The Foreign Exchange Market:The Buying and Selling of CurrenciesThe Buying and Selling of Currencies
© 2013 Cengage Learning Gottheil — Principles of Economics, 7e13
• When the price of a foreign currency rises, then the purchasing power of the foreign currency rises when it comes to buying imported goods and services.
3. Why is the supply curve for foreign currency upward-sloping?
The Foreign Exchange Market:The Foreign Exchange Market:The Buying and Selling of CurrenciesThe Buying and Selling of Currencies
© 2013 Cengage Learning Gottheil — Principles of Economics, 7e14
3. Why is the supply curve for foreign currency upward-sloping?
• For example, if it takes more dollars to buy a yap, then it takes fewer yaps to buy a dollar, and so the price of American goods are cheaper for people who use the yap.
The Foreign Exchange Market:The Foreign Exchange Market:The Buying and Selling of CurrenciesThe Buying and Selling of Currencies
© 2013 Cengage Learning Gottheil — Principles of Economics, 7e15
3. Why is the supply curve for foreign currency upward-sloping?
• As a result, people who use yaps wish to exchange more yaps for dollars in order to buy more American goods, increasing the quantity of yaps supplied in the foreign exchange market.
The Foreign Exchange Market:The Foreign Exchange Market:The Buying and Selling of CurrenciesThe Buying and Selling of Currencies
© 2013 Cengage Learning Gottheil — Principles of Economics, 7e16
4. Which of the following will cause an increase in the demand for yaps?
a. Decreasing American incomes
b. Increasing yap-priced interest rates
c. Increasing American interest rates
The Foreign Exchange Market:The Foreign Exchange Market:The Buying and Selling of CurrenciesThe Buying and Selling of Currencies
© 2013 Cengage Learning Gottheil — Principles of Economics, 7e17
a. Decreasing American incomes
b. Increasing yap-priced interest rates
c. Increasing American interest rates
4. Which of the following will cause an increase in the demand for yaps?
© 2013 Cengage Learning Gottheil — Principles of Economics, 7e18
EXHIBIT 2 EFFECT OF AN INCREASE IN THE DEMAND FOR YAPS ON THE DOLLARS-FOR-YAPS RATE OF EXCHANGE
Exhibit 2: Effect of an Increase in the Exhibit 2: Effect of an Increase in the Demand for Yaps on the Dollars-for-Demand for Yaps on the Dollars-for-
Yaps Rate of ExchangeYaps Rate of Exchange
© 2013 Cengage Learning Gottheil — Principles of Economics, 7e19
1. After the increase in demand from D1 to D2, Is there excess supply, excess demand, or equilibrium at an exchange rate of $3 per yap?
• There is excess demand of (70 – 30) = 4,000 yaps.
Exhibit 2: Effect of an Increase in the Exhibit 2: Effect of an Increase in the Demand for Yaps on the Dollars-for-Demand for Yaps on the Dollars-for-
Yaps Rate of ExchangeYaps Rate of Exchange
© 2013 Cengage Learning Gottheil — Principles of Economics, 7e20
2. After the increase in demand from D1 to D2, what is the new equilibrium exchange rate?
• The new equilibrium exchange rate is $5 per yap.
The Foreign Exchange Market: The The Foreign Exchange Market: The Buying and Selling of CurrenciesBuying and Selling of Currencies
© 2013 Cengage Learning Gottheil — Principles of Economics, 7e21
5. Which of the following will cause a decrease in the supply of yaps?
a. Decreasing American tastes for yap-priced goods
b. Decreasing yap-priced interest rates
c. Decreasing yap-priced incomes
The Foreign Exchange Market: The The Foreign Exchange Market: The Buying and Selling of CurrenciesBuying and Selling of Currencies
© 2013 Cengage Learning Gottheil — Principles of Economics, 7e22
5. Which of the following will cause a decrease in the supply of yaps?
a. Decreasing American tastes for yap-priced goods.
b. Decreasing yap-priced interest rates.
c. Decreasing yap-priced incomes.
© 2013 Cengage Learning Gottheil — Principles of Economics, 7e23
EXHIBIT 3 EFFECT OF AN INCREASE IN THE SUPPLY OF YAPS ON THE DOLLARS-FOR-YAPS RATE OF EXCHANGE
Exhibit 3: Effect of an Increase in the Exhibit 3: Effect of an Increase in the Supply of Yaps on the Dollars-for-Supply of Yaps on the Dollars-for-
Yaps Rate of ExchangeYaps Rate of Exchange
© 2013 Cengage Learning Gottheil — Principles of Economics, 7e24
1. After the increase in supply from S1 to S2, is there excess supply, excess demand, or equilibrium at an exchange rate of $3 per yap?
• There is an excess supply of (50 – 30) = 20,000 yaps.
Exhibit 3: Effect of an Increase in the Exhibit 3: Effect of an Increase in the Supply of Yaps on the Dollars-for-Supply of Yaps on the Dollars-for-
Yaps Rate of ExchangeYaps Rate of Exchange
© 2013 Cengage Learning Gottheil — Principles of Economics, 7e25
2. After the increase in supply from S1 to S2, what is the new equilibrium exchange rate?
• The new equilibrium exchange rate is $2 per yap.
Floating Exchange RatesFloating Exchange Rates
© 2013 Cengage Learning Gottheil — Principles of Economics, 7e26
Floating exchange rate
• An exchange rate determined strictly by the demands and supplies for a nation’s currency.
Floating Exchange RatesFloating Exchange Rates
© 2013 Cengage Learning Gottheil — Principles of Economics, 7e27
Appreciation
• A rise in the price of a nation’s currency relative to foreign currencies.
Floating Exchange RatesFloating Exchange Rates
© 2013 Cengage Learning Gottheil — Principles of Economics, 7e28
Depreciation
• A fall in the price of a nation’s currency relative to foreign currencies.
Floating Exchange RatesFloating Exchange Rates
© 2013 Cengage Learning Gottheil — Principles of Economics, 7e29
1. Complete the sentence:
When journalists say that the dollar has “weakened,” they mean that the dollar has _____ in value.
Floating Exchange RatesFloating Exchange Rates
© 2013 Cengage Learning Gottheil — Principles of Economics, 7e30
1. Complete the sentence:
When journalists say that the dollar has “weakened,” they mean that the dollar has depreciated in value.
Floating Exchange RatesFloating Exchange Rates
© 2013 Cengage Learning Gottheil — Principles of Economics, 7e31
2. If the dollar has appreciated in value relative to the yap, then which of the following is true:
a. The exchange rate has more yaps per dollar than before.
b. The exchange rate has fewer yaps per dollar than before.
Floating Exchange RatesFloating Exchange Rates
© 2013 Cengage Learning Gottheil — Principles of Economics, 7e32
2. If the dollar has appreciated in value relative to the yap, then which of the following is true:
a. The exchange rate has more yaps per dollar than before.
b. The exchange rate has fewer yaps per dollar than before.
Tourists at the MallTourists at the Mall
© 2013 Cengage Learning Gottheil — Principles of Economics, 7e33
Has the U.S. dollar appreciated or depreciated in value relative to the Japanese yen between 1960 and 1996?• Depreciated in value
Tourists at the MallTourists at the Mall
© 2013 Cengage Learning Gottheil — Principles of Economics, 7e34
Has the U.S. dollar appreciated or depreciated in value relative to the Japanese yen between 1960 and 1996?• In 1960 the exchange rate was 358 yen per
dollar. By 1996 there were only 131 yen per dollar.
Floating Exchange RatesFloating Exchange Rates
© 2013 Cengage Learning Gottheil — Principles of Economics, 7e35
Arbitrage
• The practice of buying a foreign currency in one market at a low price and selling it in another at a higher price.
Floating Exchange RatesFloating Exchange Rates
© 2013 Cengage Learning Gottheil — Principles of Economics, 7e36
3. How might floating exchange rates make international trade riskier?
• Suppose that the price of an internationally traded good changes during the time between when a purchase is negotiated and the product is delivered.
Exhibit 4: Trade under Free and Exhibit 4: Trade under Free and Fixed Exchange RatesFixed Exchange Rates
© 2013 Cengage Learning Gottheil — Principles of Economics, 7e37
2. If there is a system of fixed exchange rates, then what happens if the demand for a foreign currency increases?
• Since the exchange rate cannot change, an increase in demand will create excess demand for the foreign currency.
Exhibit 4: Trade under Free and Exhibit 4: Trade under Free and Fixed Exchange RatesFixed Exchange Rates
© 2013 Cengage Learning Gottheil — Principles of Economics, 7e38
• The yap government will need to exchange some of its own yaps for dollars on the foreign exchange market.
3. If there is excess demand for yaps under a system of fixed exchange rates, what will the yap government need to do to eliminate the excess demand for the yap?
Exhibit 4: Trade under Free and Exhibit 4: Trade under Free and Fixed Exchange RatesFixed Exchange Rates
© 2013 Cengage Learning Gottheil — Principles of Economics, 7e39
• This will increase the supply of yaps on the foreign exchange market and eliminate the excess demand.
3. If there is excess demand for yaps under a system of fixed exchange rates, what will the yap government need to do to eliminate the excess demand for the yap?
Exhibit 4: Trade under Free and Exhibit 4: Trade under Free and Fixed Exchange RatesFixed Exchange Rates
© 2013 Cengage Learning Gottheil — Principles of Economics, 7e40
• In order for the yap government to do this, it must have sufficient stock of yaps to exchange for dollars.
3. If there is excess demand for yaps under a system of fixed exchange rates, what will the yap government need to do to eliminate the excess demand for the yap?
Exhibit 4: Trade Under Free and Exhibit 4: Trade Under Free and Fixed Exchange RatesFixed Exchange Rates
© 2013 Cengage Learning Gottheil — Principles of Economics, 7e41
4. Continuing the yap example, what might the yap government be forced to do if it did not have a sufficient quantity of yaps on reserve to eliminate the excess demand?
• The yap government might be forced to borrow yaps from another country, or even agree to increase the exchange rate ($ per yap).
Floating Exchange RatesFloating Exchange Rates
© 2013 Cengage Learning Gottheil — Principles of Economics, 7e42
Foreign exchange reserves
• The stock of foreign currencies a government holds.
Floating Exchange RatesFloating Exchange Rates
© 2013 Cengage Learning Gottheil — Principles of Economics, 7e43
Devaluation
• Government policy that lowers the nation’s exchange rate; its currency instantly is worth less in the foreign exchange market.
Floating Exchange RatesFloating Exchange Rates
© 2013 Cengage Learning Gottheil — Principles of Economics, 7e44
4. In which of the following would a country most likely be forced into a devaluation of its currency:
a. The excess supply of its currency in the foreign exchange market exceeds its foreign exchange reserves.
b. The excess demand for its currency in the foreign exchange market exceeds its foreign exchange reserves.
Floating Exchange RatesFloating Exchange Rates
© 2013 Cengage Learning Gottheil — Principles of Economics, 7e45
4. In which of the following would a country most likely be forced into a devaluation of its currency:
a. The excess supply of its currency in the foreign exchange market exceeds its foreign exchange reserves.
b. The excess demand for its currency in the foreign exchange market exceeds its foreign exchange reserves.
Floating Exchange RatesFloating Exchange Rates
© 2013 Cengage Learning Gottheil — Principles of Economics, 7e46
Import controls
• Tariffs and quotas used by government to limit a nation’s imports.
Floating Exchange RatesFloating Exchange Rates
© 2013 Cengage Learning Gottheil — Principles of Economics, 7e47
Exchange controls
• A system in which government, as the sole depository of foreign currencies, exercises complete control over how these currencies can be used.
Floating Exchange RatesFloating Exchange Rates
© 2013 Cengage Learning Gottheil — Principles of Economics, 7e48
International Monetary Fund (IMF)
• An international organization formed to make loans of foreign currencies to countries facing balance of payments problems.
Balance of PaymentsBalance of Payments
© 2013 Cengage Learning Gottheil — Principles of Economics, 7e49
Balance of payments
• An itemized account of a nation’s foreign economic transactions.
Balance of PaymentsBalance of Payments
© 2013 Cengage Learning Gottheil — Principles of Economics, 7e50
Balance on current account
• A category that itemizes a nation’s imports and exports of goods and services, income receipts and payments on investment, and unilateral transfers.
© 2013 Cengage Learning Gottheil — Principles of Economics, 7e51
EXHIBIT 5 THE U.S. BALANCE OF PAYMENTS ACCOUNT: 2010 ($ billions)
Source: Survey of Current Business (Washington, D.C.: U.S. Department of Commerce, June 2011).
Exhibit 5: The U.S. Balance of Exhibit 5: The U.S. Balance of Payments Account: 2010Payments Account: 2010
© 2013 Cengage Learning Gottheil — Principles of Economics, 7e52
In which of the following categories of the U.S. balance of payments did the U.S. run a surplus in 2010?a. Balance of trade
b. Balance on current account
c. Balance on capital account
Exhibit 5: The U.S. Balance of Exhibit 5: The U.S. Balance of Payments Account: 2010Payments Account: 2010
© 2013 Cengage Learning Gottheil — Principles of Economics, 7e53
In which of the following categories of the U.S. balance of payments did the U.S. run a surplus in 2010?a. Balance of trade
b. Balance on current account
c. Balance on capital account
© 2013 Cengage Learning Gottheil — Principles of Economics, 7e54
EXHIBIT 6 U.S. BALANCE OF TRADE: 1960–2007
Source: U.S. Census Bureau, Foreign Trade Statistics.
Exhibit 6: U.S. Balance of Exhibit 6: U.S. Balance of Trade: 1960–2007Trade: 1960–2007
© 2013 Cengage Learning Gottheil — Principles of Economics, 7e55
Until the mid-1990s, the balance deficit was often less than $100 billion. Note the sharp plunge in the balance of trade from the late 1990s through to 2007, reaching $819 billion by 2007.
Exhibit 6: U.S. Balance of Exhibit 6: U.S. Balance of Trade: 1960–2007Trade: 1960–2007
© 2013 Cengage Learning Gottheil — Principles of Economics, 7e56
That said, what has been the overall trend in the U.S. balance of trade since the mid-1970s?• Since the mid-1970s, the U.S. balance of
trade has been in deficit.
Balance of PaymentsBalance of Payments
© 2013 Cengage Learning Gottheil — Principles of Economics, 7e57
What is an example of an export of services?
• When a U.S. engineering firm provides engineering design services for a project in another country.
Balance of PaymentsBalance of Payments
© 2013 Cengage Learning Gottheil — Principles of Economics, 7e58
Unilateral transfers
• Transfers of currency made by individuals, businesses, or government of one nation to individuals, businesses, or governments in other nations, with no designated return.
Balance of PaymentsBalance of Payments
© 2013 Cengage Learning Gottheil — Principles of Economics, 7e59
Balance on capital account
• A category that itemizes changes in the foreign asset holdings of a nation and that nation’s asset holdings abroad.
What is a Balance of Payments What is a Balance of Payments Problem?Problem?
© 2013 Cengage Learning Gottheil — Principles of Economics, 7e60
Do trade imbalances always create problems?
• No. For example, a country may have a balance of trade deficit because it is importing capital equipment necessary for it to produce valuable exports in the future.
How Deficits on Current How Deficits on Current Account DevelopAccount Develop
© 2013 Cengage Learning Gottheil — Principles of Economics, 7e61
• Foreign purchases of U.S. stocks and bonds increases the demand for U.S. dollars.
If foreigners make huge investments in U.S. stocks and bonds, how might this affect the current account?
How Deficits on Current How Deficits on Current Account DevelopAccount Develop
© 2013 Cengage Learning Gottheil — Principles of Economics, 7e62
• Increased demand for the U.S. dollar increases the value of the dollar relative to other currencies.
If foreigners make huge investments in U.S. stocks and bonds, how might this affect the current account?
How Deficits on Current How Deficits on Current Account DevelopAccount Develop
© 2013 Cengage Learning Gottheil — Principles of Economics, 7e63
If foreigners make huge investments in U.S. stocks and bonds, how might this affect the current account? • A high-valued dollar makes imports cheap for
Americans, but makes American exports expensive for foreigners in other countries.
How Deficits on Current How Deficits on Current Account DevelopAccount Develop
© 2013 Cengage Learning Gottheil — Principles of Economics, 7e64
If foreigners make huge investments in U.S. stocks and bonds, how might this affect the current account? • Consequently imports increase and exports
decline, causing a current account deficit.
International DebtInternational Debt
© 2013 Cengage Learning Gottheil — Principles of Economics, 7e65
International debt
• The total amount of outstanding IOUs a nation is obligated to repay other nations and international organizations.
© 2013 Cengage Learning Gottheil — Principles of Economics, 7e66
EXHIBIT 7 DEBT SERVICE OF SELECTED COUNTRIES, AS A PERCENTAGE OF EXPORTS: 2010
Source: OECD Stat Extracts, July, 2011.
Exhibit 7: Debt Service of Exhibit 7: Debt Service of Selected Countries, as a Selected Countries, as a
Percentage of Exports: 2010Percentage of Exports: 2010
© 2013 Cengage Learning Gottheil — Principles of Economics, 7e67
What causes countries such as Angola to have such high debt service as a percentage of their exports?• The amount of international debt held by these
countries is quite large relative to the value of their exports, making repayment difficult.