International Trade and Finance Final

absorption approach

analyzing balance of trade ... national savings must increase relative to domestic investment for a currency devaluation to narrow a trade deficit... depends if economy is wokring at full potential at time of devaluation

Meaning of surplus in a) merch trade balance b) goods and services and c) current?

A merchandise trade surplus suggests that the home country is a net exporter of merchandise. A goods and services surplus suggests that the home country transfers more real resources (goods and services) to other countries than it receives from them. A current account surplus means an excess of exports over imports of goods, services, income, and unilateral transfers.

exchange rate overshooting

An exchange rate is said to overshoot when its short-run response (depreciation/appreciation) to a change in market fundamentals is greater than its long-run response. Exchange rate overshooting occurs because exchange rates tend to be more flexible than other prices

fixed exchange rate

An exchange rate policy under which a government commits itself to keep its currency at or around a specific value in terms of another currency or a commodity, such as gold.

Impact when a currency becomes overvalued in a foreign market

An overvalued currency tends to lead to a balance-of-payments deficit for the home country, while an undervalued currency leads to a balance-of-payments surplus.

Under a fixed exchange system, what automatic adjustments promote payments equilibrium?

Automatic balance-of-payments adjustments consist of changes in domestic prices, interest rates, and income. The impact of money on the balance of payments is also considered an automatic adjustment mechanism.

balance of payments adjustment

Balance-of-payments adjustment concerns the return to payments equilibrium after the initial equilibrium has been disrupted.

How can adjustments in domestic interest rates help promote payment balance?

Changes in interest rates promote balance-of-payments adjustments via their impact on short-term capital movements.

how does currency depreciation affect a nations balance of trade?

Currency devaluation affects a country's trade balance via its impact on relative prices (elasticities approach), spending behavior (absorption approach), and the purchasing power of money balances (monetary approach).

Two accounts

Current and Captial

What is the strategy of speculating in the forward market?

Exchange market speculators deliberately assume foreign exchange risk with the hope of profiting from exchange rate fluctuations over time. Most speculation is conducted in the forward market.

Why are exchange rate quotes consistent?

Exchange-rate quotations throughout the world are brought into harmony via exchange arbitrage.

Why has the goods and services balance sometimes shown a surplus while the merchandise trade balance shows a deficit

If the surplus balance on the service account exceeds the deficit balance on the merchandise (goods) account, the goods and services balance will be in surplus.

Marshall Lener Condition

It suggests that devaluation works best at improving a country's trade balance when demand elasticities are high (i.e., the sum of the domestic demand elasticity for imports plus the foreign demand elasticity for exports exceeds one). Empirical studies suggest that demand elasticities for most countries are quite high.

In a free market, what factors underlie currency exchange values?

Market fundamentals and market expectations. Long run exchange rates are best explained by factors including real income differentials, inflation rate differentials, productivity changes, and the like. In the short run, exchange rates respond to real interest rate differentials, news about market fundamentals, and speculative opinion about future exchange rates.

Official reserve assets for the US

Official reserve assets consist of gold, Special Drawing Rights, reserve positions in the International Monetary Fund, and convertible currencies.

stabilizing vs. destabilizing speculation

Stabilizing speculation refers to the purchase of a foreign currency with the domestic currency when there occurs a fall in the foreign exchange rate. The anticipation is that the exchange rate will soon rise and thus generate a profit. Stabilizing speculation moderates a fall (rise) in the exchange rate. Destabilizing speculation reinforces fluctuations in exchange rates.

J Curve

The J-curve effect implies that due to time lags between the response of goods traded to relative price changes (e.g., recognition lags), currency devaluation will have a more pronounced effect on a country's trade balance over the longer run.

What is the balance of payments?

The balance of payments is a record of the monetary transactions between residents of one country and the rest of the world that occur over the course of a one-year period.

What implications does currency pass through have for a nation whose currency depreciates?

The extent to which changing currency values lead to changes in import and export prices is known as the pass-through relationship. Pass-through is important since buyers have incentives to alter their purchases of foreign goods only to the extent that the prices of these goods change in terms of their domestic currency following a change in the exchange rate.

What is meant by the foreign exchange market?

The foreign exchange market refers to the organizational setting within which individuals, firms, and banks buy and sell foreign currencies. The two largest foreign exchange markets are located in New York and London.

forward vs spot rate

The relation between the spot rate and the forward rate is maintained via the process of covered interest arbitrage.

Gold Standard Era Rules of the Game?

The so-called rules of the game resulted in central bankers agreeing to reinforce and speed up the automatic balance-of-payments adjustment mechanism that existed under the gold standard. In practice, they were not closely adhered to during the gold standard era.

What is meant by the forward market?

The spot market permits the buying and selling of foreign exchange for immediate delivery. Future contracts are made by those who will make or receive foreign exchange payments in the weeks or months ahead.

Why are the supply and demand for foreign exchange considered to be derived schedules?

The supply and demand for foreign exchange is derived from the credit (debit) items on the balance of payments, such as exports or investment flows.

Who are the participants in the foreign exchange market?

Traders and investors often participate in the forward market to protect their expected profits from the risk of exchange rate fluctuations. Speculators also participate in the forward market.

Purchasing power parity theory

a country's currency will depreciate by an amount equal to the excess of domestic inflation over foreign inflation and that a country's exchange rate will appreciate by an amount equal to the excess of foreign inflation over domestic inflation. The theory does not consider the impact of international capital movements, and it suffers from the choice of an appropriate price index used in price calculations.

floating exchange rate

a government permits its currency to be traded on the open market without direct government control or intervention

elasticity approach

depreciation works best when demand elasticities are high

Why does the balance of payments statement balance

each transaction has equal debits and credits

monetary approach

effects that depreciation has on the purchasing power of money

Quantity Theory of Money

hypothesis that the supply of money directly affects the price level over long run

Balance of indebtedness vs. balance of payments

indicates the international investment position of a country at one moment in time. The balance of payments indicates all of the international monetary transactions of a country over a one-year period.

What economic transactions give rise to the receipt of dollars from foreigners?

merchandise exports, transportation-travel receipts, income received from foreign investments abroad, gifts received from foreign residents, aid received from foreign governments, and investments in the U.S. by overseas residents.

Credit vs Debit

payment from foreigner vs payment to foreigner

What factors account for changes in a currency's value in the SHORT run?

relative interest rates and expected changes in exchange rates.

What factors account for changes in a currency's value in the LONG run?

relative productivity levels, relative price levels, preferences for domestic goods and foreign goods, and barriers to trade.

why are international investors especially concerned about real (as opposed to nominal) interest rates?

the real interest rate equals the nominal interest rate minus the inflation rate.