International

examples of credits

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

examples of debits

->merchandise imports, ->transportation and travel expenditures, ->income paid on the investments of foreigners, ->gifts to foreign residents, ->overseas investment by U.S. residents

Managed Floating Rates

1. A nation can alter the degree to which it intervenes in the foreign exchange market -> Reason: concern with erratic fluctuations in exchange rates creating disorderly markets 2.) Leaning against the wind -> intervening to reduce short-term fluctuations in exchange rates without attempting to adhere to any particular rate over the long term -> Q: when should the bank use expansionary/contractionary monetary policy? 3.) Under the managed floating rates some nations choose target Exchange Rates and intervene to support them. -> intended to reflect long-term economic forces that underlie exchange rate movements

Balance of International Indebtedness

1. At a particular moment, a nation will have a fixed stock of assets and liabilities against the rest of the world. -> balance of international indebtedness summarizes this situation 2.) Record of the international position of the U.S. at a particular time -> indicates the accumulated value of U.S. owned assets abroad as opposed to foreign owned assets in the U.S. -> Net creditor: accumulated value of U.S. owned assets abroad exceeds value of foreign owned assets in U.S. -> Net debtor: the reverse

Is the dollar too strong for its own good?

1. The dollar has surged against the euro- and most other global currencies for that matter- this year. 2.) the main reason? Economic conditions in the U.S. are better than Europe and Japan. 3.) as a result, the federal Reserve is likely to soon hike interest rates... -> Q: What do you think will happen to the Exchange rate if we expect an increase in interest rates. source CNN

Meaning of current account deficit/surplus

1. if the current account registers a deficit (debits outweigh credits) the capital/financial account must register a surplus or net capital/financial inflow (credits outweigh debits). Conversely if the current account registers a surplus, the capital and financial account must register a deficit or net capital/financial outflow. 2. In like manner, when a nation experiences a current account deficit, its expenditures for foreign goods and services are greater than the income received from the international sales of its own goods and services, after making allowances for investment income flows and gifts to and from foreigners. how do u finance the current account deficit? u sell assets and borrow, in other words, a nations current account deficit (debits outweigh credits) is offset by a net financial inflow (credits outweigh debits) in its capital and financial account. 2.) Current account balance synonymous with net foreign investment in national income acctg. ->Ca deficit (net borrowing)= (G-T)+(I-S) - (G-T) government deficit I= private investment S= Private Saving 3.) Capital and financial flows can initiate changes in the CA ->capital inflows keep dollar stronger than it would be, boosting imports and suppressing exports, thus leading to a current account deficit. 4.) is a current account deficit a problem? 5.) do current account deficits cost american jobs? 6.) Can the U.S. continue to run current account deficits indefinitely?

Types of FOREX Transactions

1.) A spot transaction -> outright purchase or sale of currency now -> greatest risk of exchange rate fluctuations -> payments actually made two days later 2.) forward transactions -> receiving/paying an amount of foreign currency on a date in the future -> fixed exchange rate ->protects against unfavorable movements in the exchange rate 3.) Currency swaps -> conversion of one currency at one point in time -> reconvert it back to the original currency in the future -> Rates of both exchanges are agreed to in advance -> involves a single transaction

Currency crisis (speculative attack)

1.) A weak currency experiences heavy selling pressure -> some reasons: sizable losses in foreign reserves held by country's central bank -> depreciating exchange rates in forward market 2.) currency crisis can decrease growth of GDP by 6% or more 3.) Crisis ends when selling pressure drops 4.) Crisis ending in devaluations: currency crash 5.) What are some sources of currency crises? ->

Current Account Balance

1.) CA= EX-IM -> deficit means: a country imports more than it exports -> only possible if country borrows the difference from foreigners -> CA balance equals the change in its net foreign wealth 2.) CA= Y- (C+I+G) -> deficit means: national income is less than domestic residents total spending -> importing present consumption and exporting future consumption. 3.) CA=S-I -> deficit means: national savings are less than national investment -> CA balance is synonymous with net foreign investment. CA balance is not entirely in the hands of the home nation. -> another example of intertemporal trade. 4.) CA= (T-G)+(S^P-I) -> Deficit means: budget deficits and imbalances between private savings and investment. -> decreasing the CA deficit requires either decreases in the government's budget deficit or increases in private savings relative to investment.

Twin deficit hypothesis: Evidence

1.) Captures U.S. experience in 1980's and new century -> we had large CA deficits and large fiscal deficits 2.) Does not capture US experience in 1990s -> we had large CA deficits and federal budget surplus 3.) Empirical evidence: 1.) fiscal policy and savings, and 2.) the current account balances to fiscal policy changes. -> private savings decline when fiscal policy loosen -> decrease in national savings is matched by a drop in the CA ->Effects are too weak for deficit reduction in the US to play a central role in correcting the nations CA imbalances

Currency Manipulation

1.) Currency manipulation -> the purchase or sale of a currency on the exchange market by the fiscal or monetary authority in order to influence its value -> many countries sought depreciation or non-appreciation of their currencies to strengthen their economies and create jobs 2.) artificially lowering a countrys exchange rate can make its exports cheaper, foster internal growth 3.) Imbalance could spark a currency war- a destabilizing battle where countries compete against one another to get the lowest exchange rate 4.) Q: is the U.S. a currency manipulator? Does motivation matter? -> The US used this policy as seen in Federal Reserves stimulation of the American economy during the Great Recession of 2007-2009.. the primary purpose of the feds policy has been to grow the US economy via an increase in the money supply, a reduction in the interest rate, and increases in investment spending. the policy also has caused the dollars exchange value to depreciate. how? as the fed reduces the domestic interest rate, foreign investment in the US contracts, the demand for the dollar declines, and the dollars exchange value falls. the lower exchange rate is the byproduct of the expansionary monetary policy -> motivation: countries on the receiving end of currency manipulation understandably dont much care abou the underlying motive; all they see is that their currency is appreciating and their exports and economic growth are threatened. the rationale matters. there is more reliance on monetary policy.

Nominal vs. Real Exchange Rates

1.) Exchange-rate index -> weighted average of the exchange rates between the domestic currency and the nations most important trading partners 2.) Nominal exchange-rate index -> average value of the dollar not adjusted for changes in prices levels in the U.S. and its trading partners. it is based on nominal exchange rates that do not reflect changes in price levels in trading partners. 3.) Real exchange-rate index -> Nominal exchange rate adjusted for relative price levels -> RER=NER*(p^f/p^h)

Determining Short Run Exchange Rates

1.) Foreign-exchange market activity dominated by investors in assets 2.) Asset market approach -> investors deciding between domestic and foreign investments: i and ER -> nominal and real interest rates -> future expectations can be self-fulfilling -> diversification, safe havens, and investment flows

Dollarization

1.) Full dollarization: elimination of the domestic currency and its complete replacement with the U.S. dollar -> U.S. virgin Islands, Marshall Islands, Puerto Rico, Guam, Ecuador, other Latin American countries 2.) Benefits of dollarization -> credibility and policy discipline -> avoid the capital outflows that often precede or accompany an embattled currency situation -> decrease in transaction costs ->lower rate of inflation -> tied to inflation rate of the issuing country ->Greater openness -> balance of payments crises are minimized

statistical discrepancy: errors and omissions

1.) Fundamental identity: -> current account + financial account + capital account = 0 2.) Data collection process for balance of payments figures imperfect. 3.)Government statisticians base figures partly on information collected and partly on estimates. 4.)When statisticians sum credits and debits, rarely match. 5.)Since debits must equal credits insert a residual to make them equal.

Inter-war Gold Exchange standard (1925-1936

1.) Governments effectively suspended the gold standard during WWI and financed their military spending and reconstruction by printing money -> several countries experienced hyperinflation (see germany example below) 2.) the fleeting return to Gold -> the US returned to gold in 1919, others followed. -> smaller countries could hold large country currencies as reserves. -> Britain followed in 1925 by pegging the pound to gold at pre-war prices. -prices were to high -to return to prewar levels, Bank of England was forced to follow contractionary monetary policy. - Resulted in stagnation in the 1920s - Great Depression eventually led Britain to leave gold in 1931 3.) international economic disintegration -> as depression continued many countries renounced the gold standard and allowed their currencies to float -> countries that clung to the gold standard without devaluing suffered the most. -> most countries resolved the choice between external and internal balance by curtailing their trading links. - the elimination of gains from trade contributed to the slow recovery from depression 4.) all countries would have been better off with freer trade and cooperation -> this realization inspired the Bretton Woods agreement.

Bretton Woods (1945-1971)

1.) In july 1944 representatives of 44 countries signed the Articles of Agreement of the International Monetary Fund. -> hope was to foster full employment and price stability while allowing individual countries to attain external balance with restrictions on international trade -> called for fixed exchange rates against US dollar and an unvarying dollar price of gold 2.) other terms of the Agreement -> formation of IMF and World Bank -> Resolved the trilemma by allowing restrictions on capital -> created convertible currencies 3.) links among countries interest rates tightened and the system was gradually coming undone -> balance of payments crises became frequent and violent during the 1960's and 1970s

Currency Crises: East Asian Currencies

1.) July, 1997, Thai abandoned the baht's peg to USD; 2.) October, 1997, baht depreciated by 60% against the USD 3.) triggered a wave of speculation against other Southeast Asian currencies -> Indonesian rupiah-depreciated 47% -> Malaysia ringgit-depreciated 35% -> Philippines peso-depreciated 34% -> South Korean- depreciated 16% -> Why is China not here?

Two views: Link between fiscal balance and CA balance

1.) Keynesian View -> fiscal policy is the key ingredient in the twin deficit hypothesis -> see tax cut explanation on twin deficit hypothesis -> a decline in national savings is matched by a rise in the CA deficit 2.) Ricardian View -> tax cuts financed by new public debt leads residents to expect government to raise taxes eventually to repay the new debt -> to prepare, residents save all the cash freed by the tax cut -> consumption, national savings, and CA are unchanged

Bretton Woods

1.) Main difference from gold-exchange standard -> pegged exchange rates became adjustable -> controls were permitted to limit international capital flows -> the IMF was created to monitor national economic policies and extend balance-of-payments financing to at risk countries 2.) Outcome -> some: it was a critical component of the postwar golden age of growth -> others: ease of adjustment was a consequence rather than a cause of buoyant growth.

After 1973

1.) Many fixed Exchange rate systems have nonetheless developed since 1973. -> european monetary system and euro zone. -> China fixes its currency. -> ASEAN countries have considered a fixed exchange rates and policy coordination 2.) No system is right for all countries at all times.

Tariffs

1.) Models -> Monetary Model/Overshooting Model/ Portfolio Balance Model 2.) Economic news fundamentals affect the ER -> Difference between what market participants expect and what they are once their value is announced -> Problem: How do you measure news? 3.) Conclusion: If we look backward or forward, the fundamentals don't seem to explain the ER! -> Today's ER as a forecast works at least as well as any of the economic models 4.) Alternative View: Market sentiment matters -> ER is a result of self-fulfilling prophecy

The European Monetary Union (EMU)

1.) On 01/01/1999, 11 member countries of the EU adopted the Euro. Six more have since joined the euro. 2.) it resulted in a fixed exchange rate between all EMU members. 3.) countries agreed to give up national currencies and to hand over control of their monetary policies to a shared European System of Central Banks (ESCB) 4.) represents an extreme solution to the trilemma 5.) interesting questions -> How and why did Europe set up its single currency? -> Has the Euro been good for the economies of its members? -> How has the euro affected the US? -> What lessons does the experiment carry to other potential currency blocks?

The European Union (flashback)

1.) Persuant to the Treaty of Rome in 1957, European Community became the European Union 2.) Pursuing Economic Integration -> 1957- trade-liberalization -> 1968- free trade area -> 1970- customs union -> 1985- program for becoming a common market -> 1992- elimination of all non tariff trade barriers -> 2002- European Monetary Union (EMU) and single currency (Euro)

Determining Long Run Exchange Rates

1.) Reactions in the foreign-exchange market to changes in four key factors: -> relative price levels -> relative productivity levels -> preferences for domestic or foreign goods -> trade barriers

The Crisis of the Dollar

1.) Spring of 1971: Massive flows from the dollar to deutsche mark 2.) Germany allowed its currency to float 3.) other countries revalued 4.) France and Britain planned to convert dollars to gold 5.) Nixon closed the gold window. 6.) the dollar devalued. there was no reason to doubt that it could happen again. 7.) Early 1973: flight from the dollar led to more countries floating their currency 8.) The Bretton woods international monetary system was no more

After Bretton Woods

1.) The Bretton Woods system collapsed in 1973 because central banks were unwilling to continue to buy over-value dollar assets and to sell under-value foreign currency assets. 2.) Central banks thought they would stop trading in the foreign exchange for a while, and would let exchange rates adjust to supply and demand, and then would re-impose fixed exchange rates soon. 3.) but no new global system of fixed rates was started again.

Is the Euro an optimum Currency Area?

1.) The theory -> predicts that fixed exchange rates are most appropriate for areas closely integrated (trade and factor mobility) -> join if monetary efficiency gain from joining is greater than the economic stability loss from joining -> only when economic integration passes a critical level is it beneficial to join. 2.) the European Union -> does not appear to satisfy all of the criteria for an optimum currency area. -> the level of trade is still not very extensive and labor mobility between and even within EU countries appears more limited. -> these factors have hampered adjustment to the asymmetric shocks -> however, many barriers have been removed and the euro appears to have promoted intra-EU trade

The U.S. Gold Standard

1.) U.S. had bimetallic monetary standard until the civil war 2.) During the civil war it moved to paper currency ("greenback") and a floating exchange rate 3.) Gold standard was adopted in 1879 -> required deflation; 1896 US prices were about 40 percent below that of 1869 -> particularly painful for farmers. Adverse terms of trade trends. -> populist movement surfaced; wanted silver back to increase money supply and increase prices.

The crisis of the dollar

1.) US sought to contain pressures using capital controls -> Eisenhower: Executive order prohibiting US citizens from holding gold abroad -> Kennedy: Prohibited US citizens from collecting gold coins ->treasury: issued foreign currency denominated bonds -> congress: tax on American purchases of foreign securities -> restraints on Bank lending abroad 2.) Dealing with the cause required reforming the international system in a way that diminished the dollar's reserve-currency role -> Something the US was unwilling to contemplate 3.) bolstering this situation was international cooperation -> Americas ultimate threat was to play bull in the china shop -> foreign governments supported the dollar because it was the linchpin of the Bretton Woods System -> There was also no consensus on how that system might be reformed or replaced 4.) But there were limits to how far foreign governments and central banks would go -> by absorbing dollars rather than forcing the US to devalue, foreign central banks allowed their inflation rates to rise -> Limits: Germany would not let inflation rates much in excess of 3 percent

Is China a Currency Manipulator?

1.) US: China manipulates the Yuan -> Yuan: significantly undervalued as to dollar -> Huge trade surplus with the United States -> Large accumulation of dollar reserves 2.) No connection between the Yuan and the health of U.S. manufacturing -> transition away from manufacturing in the U.S. is a long-run trend -> technology is the main driver 3.) China: its purpose is to promote economic stability and maintain a stable value against the dollar. as long as this fixed rate is credible, it serves an an effective monetary anchor for China's internal price level. 4.) Does the US benefit from this? it yields positive results for the U.S. Economy. China has maintained large investments in U.S. debt that helps keep U.S. interest rates low, allowing American firms to make investments that would be unattractive at a higher cost of borrowing. Such investments increase the amount of capital available and increase the size of the economy. an undervalued yuan also promotes a lower inflation rate in the US.

What determines the Exchange Rate

1.) We believe: Exchange rates (ERs) are affected by market fundamental economic forces (economic variables: M^s, i, Y, NX) 2.) If we can forecast fundamentals we should be able to forecast ERs -> ERs don't seem to be affected by fundamentals -> best forecast is whatever happens today 3.) Findings -> ER seem to be influenced by market sentiment rather than fundamentals -> May forecast direction but not the timing.

Twin Deficit Hypothesis

1.) We've seen declines in both the current account and fiscal balances. 2. CA: T-G plus S^P-I -> Eg. cutting taxes increases in fiscal deficit -> domestic residence use income to boost consumption -> national savings declines ->Since CA= (T-G) + (S^P-I) investment falls unless we borrow from abroad -> Thus, fiscal deficits should be accompanied by a wider CA deficit

The great recession

1.) What led to the collapse? -> Housing prices and subprime mortgage market in the US - average US home appreciated 1.4% a year from 1970 to 2000 - 7.6% a year from 2000 to mid-2006 - 11% a year from mid-2005 to mid-2006 -Their value dropped 30%-35% peak to trough -> this occurred because of very low interest rates and unprecedented levels of liquidity 2.) the Great Recession (2008-2009) -> Frightened consumers and businesses -> as a response they have retrenched -> usual recovery tools use by government (Monetary and fiscal stimuli) were relatively ineffective

The great trade collapse

1.) What we know -> the Great Trade Collapse was extremely severe and steep by historical standards -> trade fell more dramatically than GDP around the world -> this trade collapse was much more highly synchronized around the world 2.) what caused the great trade collapse? -> fall in aggregate demand explains half of the decline in imports -> difficult to measure the impact of trade finance -> changes in barriers to trade did not play a role -> other causes of the great recession difficult to measure

Exchange Rate Overshooting

1.) When exchange-rate short-term response to a change in market fundamentals is greater than its long-term response. -> helps explain why exchange rates depreciate or appreciate so sharply from day to day. -> volatility of exchange rates is intensified by exchange rate overshooting 2.) Explained by -> tendency of elasticities to be smaller in the short term than in the long term. -> exchange rates tend to be more flexible than many other prices.

Interesting questions

1.) Why the EU? -> to enhance Europes power in international affairs -> to make Europe a unified market -> to make Europe politically stable and peaceful. 2.) Why the Euro? -> unified market -> political stability -> the belief that German influence under the EMS would be moderated. -> Elimination of the possibility of devaluations/revaluations.

A world recession

1.) Why was the great recession global? -> the liquidity and low interest rates from common in many countries -> the financial system was devastated -> low demand from the developed world affect many developing countries 2.) this was a financial crisis -> financial recessions more prolonged - value of assets fall - margin calls are triggered, forcing sale of assets - further depresses their value - in turn discourages spending and lending -> the credit freeze brought the financial system to the brink of collapse

Foreign exchange market

1.) a typical international transaction requires two purchases 2.) foreign exchange market -> organizations buy and sell foreign currencies -> largest and most liquid market in the world -> dominated by U.S. dollar, Euro, Japanese yen, British pound 3.) Banks typically engage in 3 types of foreign exchange transactions: spot, forward, swap

arguments in favor/against fixed exchange rate system

1.) argument in favor of fixed rates -> clarity of exchange rate target -> automatic rule for the conduct of monetary policy -> keeps inflation under control 2.) arguments against fixed exchange rates. -> loss of independent monetary policy -> vulnerable to speculative attacks

Floating Exchange Rates

1.) currency prices established daily in the foreign-exchange market 2.) Argument in favor of floating rates -> simplicity -> continuous adjustment in the balance of payments -> partially insulate the home economy from external forces -> nations have greater freedom to pursue policies that promote domestic balance 3) arguments against floating exchange rates -> disorderly exchange markets can disrupt trade and investment patterns -> inflationary bias -> encourage reckless financial policies on part of government

Disadvantages of Dollarization

1.) disadvantages -> country must be treated like one of 50 states -> no Lender of last resort -> No seigniorage from its monetary system -> Cannot print more domestic currency to finance budget deficits and will have to exercise caution in spending

Issues

1.) dollar as a reserve currency -> not a problem as long there was no question about the convertibility into gold -> once reserves loomed large relative to gold reserves, the commitment was in doubt -> US monetary liabilities first exceeded US gold reserves in 1960 2. Special drawing rights -> need to substitute a new reserve asset for the US dollar -> this was favored by week-currency countries and opposed by strong-currency counterparts 3.) Declining controls and rising rigidity -> with the restoration of current account convertibility, capital controls became more difficult. - it was easier to over-or under-invoice trade and to spirit funds abroad -> growth of multinational corporations -> controls on banking transactions in Europe were relaxed - controls at US border less effective with a pool of dollars already existed offshore. 4.) inflexibility of exchange rate under this system of "managed flexibility" -> problem intensified with the growth of capital mobility -> governments had to make even stronger statements and commit to even more draconian steps

Exchange rates and the great recession?

1.) in a recession -> the economic environment deteriorates and interest rates drop, making the country less attractive to foreigners. We would expect a fall in the value of the currency. -> Since prices are sticky in the short run, the first effect tends to dominate. 2.) during the great recession -> global in nature; most countries were a mess -> all major economies had low interest rates -> capital flows drove foreign exchange rates -> what was the safest country?

How the system worked

1.) in the Bretton Woods System -> retention of capital controls was essential -> commitment to growth and full employment were integral to the postwar social contract. -> deflationary central bank policies that had redressed payments deficits under the gold standard were no longer acceptable politically 2.) the role of the U.S. dollar -> given the US dominant role in international trade and gold hoard, countries began to accumulate dollars -> The US could run deficits as long as countries desired dollars - it could also raise interest rates - or by exercising inadequate restraint - the system was dependent on the dollar of liquidity

Macroeconomic Policy Goals

1.) internal balance -> full employment of country resources -> Domestic price level stability - unexpected inflation redistributes income between creditors and debtors -governments must prevent large output fluctuations and control money supply 2.) external balance -> current account neither in deficit/surplus - problem with excessive CA deficits -problem with excessive CA surpluses -> not necessary zero current account -> Fear: you or your partner won't be able to replay foreign debts in the future

Currency board

1.) monetary authority that issues notes and coins convertible into foreign anchor currency at a fixed exchange rate 2.) can operate in place of a central bank or as a parallel issuer alongside an existing central bank -> sole function: to exchange its notes and coins for the anchor at a fixed rate -> the government can finance its spending only by taxing or borrowing 3.) What happens when anchor currency flows in? flows out? -> flows in: , the board will issue more domestic currency and interest rates fall; -> flows out: interest rates rise. the government sits back and watches, even if interest rates skyrocket and recession ensues 4.) Whats the advantage? disadvantage? ->advantage: making a nations currency and exchange rate regimes more rule bound and predictable, placing an upper bound on the nations base money supply, arresting any tendencies in an economy toward inflation, forcing the government to restrict its borrowing to what foreign and domestic lenders are willing to lend it at market interest rates, engendering confidence in the soundness of the nations money, assuring citizens and foreign investors that the domestic currency can always be exchanged for some other strong currency, creating confidence and promoting trade, investment, and economic growth. -> disadvantage: most common objection is that a currency board prevents a country from pursuing a discretionary monetary policy and thus reduces its economic independence. it is sometimes said that a currency board system is susceptible to financial panics because it lacks a lender of last resort. another objection is that a currency board system creates a colonial relation with the anchor currency.

foreign currency options

1.) option -> agreement between a holder (buyer) and a writer (seller) -> holder has the right to buy or sell financial instruments at any time through a specified date -> writer (seller) has the obligation to fulfill a transaction -> used by firms (speculators) seeking to hedge against exchange rate risk (to make a profit) 2.) Foreign currency options -> call option= gives the holder the right to buy foreign currency at a specified price -> put option gives the holder the right to sell foreign currency at a specified price. -> strike price= the price at which the option can be exercised (the price at which the foreign currency is bought or sold). 3.) generate substantial premium income=

The Gold Standard, 1870-1914

1.) origins of legal institution -> Britain 1819 -> Later in the 19th century: US, Germany, Japan, Others 2.) External Balance -> primary responsibility of central bank was to fix the exchange rate between its currency and gold -> what does current account balance mean? -> goal was to avoid large gold movements. 3.) Price-Specie-Flow Mechanism (Hume vs. Mercantilists) -> contributed to the simultaneous achievement of balance of payments equilibrium in all countries -> Example: Britain has a CA surplus. Gold flows in, foreign money supply decreases and Britain money supply increases -price changes leads to demand changes. These demand shifts reduce CA surplus 4.) Rules of the game -> CA deficit risk: unable to meet obligations to redeem currency notes -> motivated to sell/buy domestic assets when gold was being lost/accumulated -> frequently violated before 1914 5.) Internal balance -> aim was to limit monetary growth and thus ensure world price stability

The impact of the recession

1.) primary hypotheses for Great Trade collapse -> a decline in aggregate demand for all goods -> difficulties in obtaining trade finance -> rising trade barrier 2.) other hypotheses for great trade collapse -> differences in the composition of trade and domestic output -> global supply chains 3.) G-20 commitments to address international trade -> ensure availability of at least $250 billion to support trade finance -> refrain from raising new barriers to trade -> fiscal expansion would total $5 trillion

The crawling Peg

1.) small, frequent changes in the par value of its currency. -> to correct balance of payments disequilibrium 2.) used by nations with high inflation rates 3.) combines the flexibility of floating rates with the stability usually associated with fixed rates

What determines Exchange Rates

1.) supply and demand schedules of currencies -> market fundamentals (economic variables) -> market expectations (news, expectations) 2.) Factors affecting exchange rates -> short term: transfers of assets -> interim: cyclical factors -> long term: flows of goods, services, and investment capital.

The lessons of Bretton Woods

1.) the inadequacy of the adjustment mechanisms and the very difficulty in operating a system of pegged exchange rates in the presence of highly mobile capital 2.) that the system functioned at all is testimony to the international cooperation that operated in its support 3.) cooperation in support of a system of pegged currencies will be most extensive when it is part of an interlocking web of political and economic bargains. 4.) there were limits to how far Europe and Japan would go.

What factors influence the success of sanctions?

1.) the number of nations imposing sanctions. 2.) the degree to which the target nation has economic and political ties to the imposing nations. 3.) the extent of political opposition in the target nation, and 4.) cultural factors in the target nation. Page 221

Fixed Exchange Rate System

1.) used primarily by small, developing nations 2.) Currencies are anchored to a key currency (par value) -> widely traded on world money markets -> demonstrated relatively stable values over time -> widely accepted as a means of international settlement 3.) to maintain a fixed exchange rate -> set up an exchange rate stabilization fund -> use monetary policy to change the interest rate 4.) if you can't maintain a fixed exchange rate -> devaluation: cause a depreciation of domestic currency -> revaluation:cause an appreciate of domestic currency

Monetary Unions

1.)It's a type of regional trading agreement 2.) An agreement among members of that union to share a common -> currency -> monetary policy -> foreign exchange policy 3.) the ultimate degree of economic union -> economic union (flashback): National, social, taxation and fiscal policies harmonized and administered by supranational institution

Exchange Rate

1.Exchange rate: Price of one currency in terms of another -> Appreciation, Depreciation, Cross exchange rate -> ER=$/franc and ER'=1/ER=franc/$ 2.) Banks: Earning profits in foreign-exchange transactions -> Bid rate- refers to the price that the bank is willing to pay for a unit of foreign currency; -> offer rate= is the price at which the bank is willing to sell a unit of foreign currency -> spread= the difference between the bid and the offer rate is the spread rate and it varies by the size of the transaction and the liquidity of the currencies being traded. 3.) A banks profit -> bid quote< offer quote -> anticipating correctly the future direction of currency movement

Whats our economic sanctions?

2014 Russia: discourage annexation of Crimea 2010 Iran: Discourage nuclear proliferation 1998 Pakistan and India: Discourage nuclear proliferation 1993 Haiti: Improve human rights 1992 Serbia: Terminate civil war in Bosnia-Herzegovina 1990 Iraq: Terminate Iraq's military power takeover of Kuwait 1985 South Africa: Improve Human Rights 1981 Soviet Union: Terminate martial law in Poland 1979 Iran: Release U.S. hostages; settle expropriation claims 1961 Cuba: Improve national security

The capital and financial account

All international purchases or sales of assets. ->Transaction that leads to the home country receiving payment= credit. ->Transaction that leads to the foreign country receiving payment= debit. 1.)the capital account: transfers of wealth between countries. -> capital transfers and acquisition/disposal of certain non financial assets. Generally small in U.S. accounts. 2.) The Financial Account: Purchases or sales of financial assets. ->difference between sales of assets to foreigners and purchases of assets located abroad. ->Examples are direct investment, securities, and bank claims and liabilities.

Do current account deficits cost american jobs?

Although export and import trends raise concerns about U.S. job losses, economists have found that employment statistics do not bear out the relation between a rising current account deficit and lower employment. Why? A current account deficit may hurt employment in particular firms and industries as workers are displaced by increased imports. At the economy wide level, however, the current account deficit is matched by an equal inflow of foreign funds that finances employment sustaining investment spending that would not otherwise occur. Whether dollars flow into the United States to purchase our goods or to purchase our assets, economic activity is promoted. The foreign purchase of American assets can stimulate the U.S. economy just as well as the export of goods and services. When viewed as the net inflow of foreign investment, the current account deficit produces jobs for the economy: both from the direct effects of higher employment in investment oriented industries and from the indirect effects of higher investment spending on economy wide employment. Although this analysis indicates that current account deficits do not cause a net loss of output or jobs in the overall economy, they tend to change the composition of output and employment. evidence suggests that over the past 3 decades, persistent current account deficits have likely caused a reduction in the size of the U.S. manufacturing sector while output and employment in the economy's service sector have increased.

Balance of payments

Definition: a record of the economic transactions between the residents of one country and the rest of the world. It is a double entry accounting system, total debits will always equal total creditsit is grouped into two categories: 1. the current account and 2. the capital and finanacial account which includeds the international purchases and sales of assets.

Double entry accounting

Definition: each transaction involves an exchange of assets and has both a credit and a debit side. -> a credit transaction results in a receipt of a payment from foreigners; recorded with a plus sign (+) -> a debit transaction is one that leads to a payment to foreigners; recorded with a minus sign (-)

Determinants of the dollars Exchange rate in the long run

Factors: U.S. price level, U.S. productivity, U.S. Preferences, U.S. trade barriers 1.) U.S. Price level -> if it increases the depreciation of the dollar. If it decreases the appreciation of the dollar. 2.) U.S. Preferences -> If it increase then an appreciation of the dollar. if it decreases then a depreciation of the dollar. 3.) U.S. preferences -> if an increase then a depreciation of the dollar. If a decrease then a appreciation of the dollars 4.) U.S. trade barriers -> if an increase then an appreciation of the dollar. if a decrease then a depreciation of the dollar.

exchange rate determination

Determined by the market forces of supply and demand. 1. Demand -> Driven by foreigner demand of domestic goods and assets -> corresponds to the debit items on a country balance of payments -> varies inversely with price 2.) supply -> amount of foreign exchange that is offered in the market at various exchange rates, all other factors held constant. -> increases at various exchange rates, all other factors held constant

Can future deficit reductions pla a critical role in eliminating the U.S. current account imbalance with the rest of the world?

Effects are too weak for deficit reduction in the US to play a central role in correcting the nations CA imbalances

Economic Sanctions

Instead of promoting trade, governments may restrict trade for domestic and foreign policy objectives. Economic Sanctions are government mandated limitations placed on customary trade or financial relations among nations

The purpose/objective of economic sanctions

They have been used to protect the domestic economy, reduce nuclear proliferation, set compensation for property expropriated by foreign governments, combat international terrorism, preserve national security, and protect human rights. The nation initiating the economic sanctions, the imposing nation, hopes to impair the economic capabilities of the target nation to such an extent that the target nation will succumb to its objectives.

is a current account deficit a problem

Relatively high interest rates in U.S.-> Capital inflows for U.S.-> Appreciation of dollars exchange value-> U.S. exports decrease/imports increase-> current account deficit for U.S. if the current account registers a deficit (debits outweigh credits) the capital and financial account must register a surplus or net capital/financial inflow ( credits outweigh debits). contrary to commonly held views, a current account deficit has little to do with foreign trade practices or any inherent inability of a country to sell its goods on the world market. Instead, it is because of underlying macroeconomic conditions at home requiring more imports to meet current domestic demand for goods and services than can be paid for by export sales. in effect, the domestic economy spends more than it produces and this excess of demand is met by a net inflow of foreign goods and services leading to the current account deficit. When a nation realizes a current account deficit, it experiences foreign capital inflows and becomes a net borrower of funds from the rest of the world. All inall this isn't a problem necessarily. Foreign capital inflows increase domestic sources of capital that in turn keep domestic interest rates lower than they would be without foreign capital. the benefit of a current account deficit is the ability to push current spending beyond current production. However the cost is the debt service that must be paid on the associated borrowing from the rest of the world. is it good or bad to incur debt? what matters is if whether the deficit is being used to finance more consumption or more investment. if used exclusively to finance an increase in domestic investment, the burden could be slight because investment spending increases the nations sock of capital and expands the conomys capacity to produce goods and services. the value of this extra ouptut may be sufficient to both pay foreign creditors and also increase domestic spending. in this case because future consuption need not fall below what it otherwise whould have been, there would be no true economic burden. if on the other hand, foreign borrowing is used to finance or increase domestic consumption (private or public) there is noboost given to future productivity. To meet debt service expense, future consumption must be reduced below what it otherwise would have been. such a reduction represents the burden of borrowing. This is not necessarily bad; it all depends on how one values current versus future consumption. Look at page 343

How do economic sanctions achieve their objective?

The imposing nation can levy several types of economic sanctions. Economic sanctions placed against a target country have the effect of forcing it to operate inside its production possibilities curve. Economic sanctions can also result in an inward shift in the target nations production possibilites curve. Look at graph on page 220. Also look at the purpose to answer this question.

Purchasing-Power Parity Theory

The purchasing power parit theor predicts that a countries currenc will depreciate bi an amount equal to the excess of domestic inflation over foreign inflation. the theori also predicts that a countries exchange rate will appreciate bi an amount equal to the excess of foreign inflation over domestic inflation. the theori does not consider the impact of internation capital movements, and it suffers from the choice of an appropriate price index used in the price calculations. 1.) Law of one price -> identical goods should be sold everywhere at the same price -> Assumptions: no transportation costs, no trade barriers, perfect competition -> example: "Big Mac" Index Next slide: 1.) Purchasing-Power-Parity theory -> trade flows= mechanism -> changes in relative national price levels determine changes in exchange rates -> foreign-exchange value of a currency tends to move with the inflation differential 2.) Used to predict long-term exchange rates: S1= S0((Pus1/Pus0)/(Pmoz1/Pmoz0) 3.) Problems -> Exchange-rate movements may be influenced by investment flows -> choosing the appropriate price index to be used in price calculations -> determining equilibrium period to use as a base -> government policy may interfere with the operation of the theory -> appropriate in long run; in short run, it is a poor forecaster

Countries Levy what types of economic sanctions?

Trade sanctions: involve boycotts on imposing nation exports. They may also include quotas on imposing nation imports from the target nation. Financial Sanctions: can entail limitations on official lending or aid.

Credit transaction

a credit transaction results in a receipt of a payment from foreigners; recorded with a plus sign (+)

debit transaction

a debit transaction is one that leads to a payment to foreigners; recorded with a minus sign (-)

Current Account

definition: exports or imports of goods and services. 1.)The montetary value of international flows associated with the following: ->Merchandise trade (exports or imports of goods), ->Services (exports or imports of services), ->Income (Income receipts and payments), ->Unilateral transfers (transfers of good and services (gifts in kind) or financial assets (money gifts)).

Case studies of Economic sanctions: North Korea, Iran, and Cuba

page 221

Can the U.S. continue to run current account deficits indefinitely?

pg. 346-348

relation between the forward rate and spot rate

to profit from relatively high interest rates in the U.K., U.S. investors will->-> Buy pounds with dollars in the spot market->> spot price of the pound rises say, to $2.01 per pound.->> pound moves to a discount in the forward market and the relative gains from investing in UK Treasury bills decrease. To profit from relatively high interest rates in the U.K., U.S. investors will. ->> sell pounds for dollars in the forward market.->> Forward price of pound falls, say, to $1.99 per pound.->> pound moves to a discount in the forward market and the relative gains from investing in UK Treasury bills decrease.