econ ch. 25

Ex: exchange rate = 100 yen per dollar, Canada only sells computer chips at a price of $150, Japan only produces ipods at 5000 yen

(100X150)/ 5000 = 3 ipods per chip

There are three balance of payments accounts:

- 1. Current account - 2. Capital and financial account - 3. Official settlements account

The quantity of Canadian dollars that traders plan to sell in the foreign exchange market during a given period depends on 4 things

- 1. The exchange rate - 2. Canadian demand for imports - 3. Interest rates in Canada and other countries - 4. The expected future exchange rate

Where is the Exchange Rate? In the short run, a fall in the nominal exchange rate lowers the real exchange rate, which makes our imports more costly and our exports more competitive. So in the short run, fall in the nominal exchange rate decreases the current account deficit. But in the long run, a change in the nominal exchange rate leaves the real exchange rate unchanged. So in the long run, the nominal exchange rate plays no role in influencing the current account balance.

...

The quantity of Canadian dollars that traders plan to buy in the foreign exchange market during a given period depends on 4 things

1) exchange rate 2) world demand for exports 3) interest rates in other Countries 4)expected future exchange rate

net borrower=

A country that is borrowing more from the rest of the world than it is lending to it is called a net borrower.

net lender

A country that is lending more to the rest of the world than it is borrowing from it is called a net lender.

what is a country's balance of payments accounts

A country's balance of payments accounts records its international trading, borrowing, and lending.

crawling peg?

A crawling peg is an exchange rate that follows a path determined by a decision of the government or the central bank and is achieved by active intervention in the market.

how is crawling peg like fixed and not like it

A crawling peg works like a fixed exchange rate except that the target value changes. This target can be weekly daily monthly etc

creditor nation=

A creditor nation is a country that has invested more in the rest of the world than other countries have invested in it.

A currency is worth..

A currency is worth the value of goods and services that it will buy.

a debtor nation=

A debtor nation is a country that during its entire history has borrowed more from the rest of the world than it has lent to it. It has a stock of outstanding debt to the rest of the world that exceeds the stock of its own claims on the rest of the world.

currency depreciation=

A fall in the value of one currency in terms of another currency is called currency depreciation.

fixed exchange rate

A fixed exchange rate policy is one that pegs the exchange rate at a value decided by the government or central bank and is achieved by direct intervention in the foreign exchange market to block unregulated forces of demand and supply.

Flexible?

A flexible exchange rate policy is one that permits the exchange rate to be determined by demand and supply with no direct intervention in the foreign exchange market by the central bank.

currency appreciation=

A rise in value of one currency in terms of another currency is called currency appreciation.

when is being a net borrower a problem and when not a problem

Being a net borrower is not a problem provided the borrowed funds are used to finance capital accumulation that increases income. Being a net borrower is a problem if the borrowed funds are used to finance consumption.

which countries operate under flexible?

Canada operates under this, foreign exchange market is under this

what shifts Canadian supply

Canadian demand for imports Canadian interest rates relative to the foreign interest rate The expected future exchange rate

example of country using it

China

What determines price of currency

Demand and supply determine the price

what are the 3 exchange rate policies

Flexible exchange rate Fixed exchange rate Crawling peg

what is foreign currency

Foreign bank notes, coins, and bank deposits

example of countries with fixed

Hong Kong still has this policy, China used to, world economy did until 1970's

airplane costs 8 million Canadian. I live in Europe. Am I going to demand more or less Canadian dollars if the exchange rate is .75 EU: 1 CA or .60 EU: 1 CA?

If an airplane cost 8 million Canadian, and the exchange rate is 75 euro cents for every Canadian dollar than KLM will need to pay 6 million euros to buy an airplane from regional jets. This is to high for KLM. If the exchange rate is 60 cents for everyone dollar they will only need to pay 4.5 million, this is much cheaper

If demand for Canadian dollars increases and supply does not change, the exchange rate _____. If demand for Canadian dollars decreases and supply does not change, the exchange rate ___. If supply of Canadian dollars increases and demand does not change, the exchange rate _____. If supply of Canadian dollars decreases and demand does not change, the exchange rate ___.

If demand for Canadian dollars increases and supply does not change, the exchange rate rises. If demand for Canadian dollars decreases and supply does not change, the exchange rate falls. If supply of Canadian dollars increases and demand does not change, the exchange rate falls. If supply of Canadian dollars decreases and demand does not change, the exchange rate rises.

example of fixed exchange rate. Suppose that the target is 90 US cents per Canadian dollar. What would bank of Canada do if demand for Canadian dollars increases, decreases

If the demand for Canadian dollars increases, the Bank sells Canadian dollars to increase supply If demand for Canadian dollars decreases, the Bank of Canada buys Canadian dollars to decrease supply.

But expectations about the exchange rate are driven by deeper forces. the 2 forces are

Interest rate parity Purchasing power parity

Interest rate parity means equal interest rates when ______ ____ ___ are taken into account

Interest rate parity means equal interest rates when exchange rate changes are taken into account.

does fixed exchange rate require lots or little intervention

LOTS

If Canadian official reserves increase, the official settlements account is ____. This is like the same as investing in another country

NEGATIVE

NX=

NX = (T - G) + (S - I)

Net exports is equal to

Net exports is equal to the sum of government sector balance and private sector balance: NX = (T - G) + (S - I)

Government sector balance was - $56 billion Private sector balance was $25 billion NX=

Net exports were - $31 billion

Can this intervention be sustained over long periods of time

Persistent intervention on one side of the foreign exchange market cannot be sustained.

In the short run, the equation determines ___

RER

So in the long run, E is determined ....

So in the long run, E is determined by RER and the price levels. E = RER x (P*/P)

do factors that influence demand for Canadian dollars also influence the supply of US, Yen etc.

So the factors that influence the demand for Canadian dollars also influence the supply of U.S. dollars, E.U. euros, U.K. pounds, and Japanese yen. And the factors that influence the demand for another country's money also influence the supply of Canadian dollars.

The exchange rate changes when it is expected to change. T or F

TRUE

The other two items are much smaller and don't fluctuate much. T OR F

TRUE

does Bank of Canada still somewhat intervine in flexible though

The Bank of Canada does somewhat intervine though by increasing interest rate (increasing demand for dollars, decreasing supply) and visa versa

Canadian interest rate differential.

The Canadian interest rate minus the foreign interest rate is called the Canadian interest rate differential.

what is capital and financial account

The capital and financial account records foreign investment in Canada minus Canadian investment abroad. Also includes statistical discrepancy

what is the current balance account

The current account balance (CAB) is CAB = NX + Net interest income + Net transfers

what is the current account?

The current account records receipts from exports of goods and services sold abroad, payments for imports of goods and services from abroad, net interest paid abroad, and net transfers (such as foreign aid payments).

current accounts balance=

The current accounts balance = exports − imports + net interest income + net transfers.

what us the real exchange rate formula

The equation that links the nominal exchange rate (E) and real exchange rate (RER) is RER = (E x P)/P*) where P is the Canadian price level and P* is the Japanese price level.

foreign exchange market

The foreign exchange market is the market in which the currency of one country is exchanged for the currency of another.

what is government sector balance?

The government sector surplus or deficit is equal to net taxes, T, minus government expenditure on goods and services G.

what is the whole idea behind a crawling peg

The idea behind a crawling peg is to avoid wild swings in the exchange rate that might happen if expectations became volatile and to avoid the problem of running out of reserves, which can happen with a fixed exchange rate.

what is the private sector balance

The private sector surplus or deficit is saving, S, minus investment, I.

what is the real exchange rate?

The real exchange rate is the relative price of Canadian-produced goods and services to foreign-produced goods and services.

The return on a currency is the...

The return on a currency is the interest rate on that currency plus the expected rate of appreciation over a given period.

The exchange rate responds instantly to news about changes in the variables that influence demand and supply in the foreign exchange market.

True

largest debtor nation

USA

We get foreign currency in the...

We get foreign currency in the foreign exchange market.

When people who are holding one money want to exchange it for Canadian dollars, they...

When people who are holding one money want to exchange it for Canadian dollars, they demand Canadian dollars and they supply that other country's money.

interest rate parity

When the rates of returns on two currencies are equal, interest rate parity prevails.

what is purchasing power parity?

When two quantities of money can buy the same quantity of goods and services, the situation is called purchasing power parity, which means equal value of money.

is the foreign exchange market a competitive market?

With many traders and no restrictions, the foreign exchange market is a competitive market.

Suppose that the Bank of Japan is considering raising the interest rate next week. What does this cause

With this news, currency traders expect the demand for yen to increase and the demand for dollars to decrease—they expect the Canadian dollar to depreciate.

what shifts the demand for Canadian dollars

World demand for Canadian exports Canadian interest rate relative to the foreign interest rate The expected future exchange rate

The sum of the balances of the three accounts always equals ...

ZERO

when demand shifts out dollar appreciates or depreciates

appreciates, other countries supply to buy CDN dollars depreciates

A rise in the Japanese price level P* brings an ___ of the Canadian dollar in the long run. A rise in the Canadian price level P brings a ____ of the Canadian dollar in the long run.

appreciation, depreciation

But to benefit from a yen appreciation, yen must be bought and dollars must be sold before or after the exchange rate changes.

before. To transact before the exchange rate changes means transacting right away, as soon as the news is received.

In 2009 and 2010, Canada was a net ___, but between 1999 and 2009, Canada was a net ___.

borrower, lender

People sell Canadian dollars so they can

buy foreign goods and services such as exports, bonds, stocks, real estate, etc.

At a given current exchange rate, if the expected future exchange rate for Canadian dollars rises, ... the supply of Canadian dollars ______ and the demand curve for dollars shifts _____.

decrease, leftward

If the Canadian interest differential rises, the supply for Canadian dollars ______ and the supply curve of Canadian dollars shifts _____

decreases, leftward

The quantity of goods and services that one unit of a particular currency will buy ____ from the quantity of goods and services that one unit of another currency will buy.

differs

In the short run, if the nominal exchange rate changes, P and P* do or do not change?

do no change

The exchange rate influences the quantity of Canadian dollars demanded for two reasons:

exports effect and expected profit effect

does interest rate parity happen fast or slow, explain

extremely fast. In Canada interest is 3 percent In Germany interest is 6 percent. We will want to invest in Germany because higher interest rate If we invest 1000 into Germany, we get 60 bucks. Since demand increases and Euro keeps appreciating, we now need to pay 1200. This now gives us 5 percent interest 5 percent is still better than 3 percent so it eventually goes to 1300, 1400 which gives us less and less of a interest. Once it goes to 3 percent it wont make a difference if we invest in Canada or Germany

If I is higher than S, a private sector is

financed by other sectors

The price at which one currency exchanges for another is called

foreign exchange rate.

if government sector balance is positive...

govnt surpluss is lent to other countries

If the exchange rate rises, the _____ is the value of Canadian imports, so the greater is the quantity of Canadian dollars supplied.

greater

The larger the expected profit from holding Canadian dollars, the _____ is the quantity of Canadian dollars demanded today.

greater

The lower today's exchange rate, other things remaining the same, the ___ is the expected profit from buying Canadian dollars and the ____ is the quantity of Canadian dollars demanded today.

greater, greater

For a given expected future Canadian dollar exchange rate, the lower the current exchange rate, the_____ is the expected profit from holding Canadian dollars, and the ______ is the quantity of Canadian dollars supplied on the foreign exchange market.

greater, smaller

Other things remaining the same, the ____ the exchange rate, the greater is the quantity of Canadian dollars supplied in the foreign exchange market.

higher

Mcdonalds example

if exchange rate is 1 pound= 1.57 US, than if u have 3.57 US dollars it can be u a big mac in the UK

if government sector balance is negative?

if negative other sectors must finance it

The exchange rate influences the quantity of Canadian dollars supplied for two reasons:

imports effect and expected profit effect

If the exchange rate falls, the quantity of Canadian dollars demanded in the foreign exchange market _____.

increases

If the Canadian interest differential rises, the demand for Canadian dollars ___, demand shifts __

increases , out

At a given current exchange rate, if the expected future exchange rate for Canadian dollars rises, ... the demand for Canadian dollars _____ and the demand curve for Canadian dollars shifts _____.

increases out

At a given exchange rate, if the Canadian demand for imports increases, the supply of Canadian dollars on the foreign exchange market ____ and the supply curve of Canadian dollars shifts ______.

increases, rightward

At a given exchange rate, if world demand for Canadian exports increases, the demand for Canadian dollars ____.

increases. Shifts outward. This also means another countries supply is going to shift outward to purchase CDN dollars

The larger the value of Canadian exports the _____ is the quantity of Canadian dollars demanded.

larger

The larger the value of Canadian imports, the ____ is the quantity of Canadian dollars supplied on the foreign exchange market.

larger

The higher the exchange rate, the ___ are the prices of foreign-produced goods and services expressed in Canadian dollars.

lower

The lower the exchange rate, the ____ are the prices of Canadian produced goods and services to foreigners and the ___ is the volume of Canadian exports.

lower, greater

change in exchange rate is both demand and supply is movement or change

movement

draw demand curve for Canadian dollars. Exchange rate= movement or shift

movement

The main item in the current account balance is

net exports (NX).

It measures the quantity of ___ ___ of other countries that a unit of Canadian real ____ buys.

real GDP, GDP

Other things remaining the same, the higher the exchange rate, the___ is the quantity of Canadian dollars demanded in the foreign exchange market.

smaller

The Demand for One Money Is the __ of Another Money

supply

Equilibrium depends on bank of Canada and other central banks. If the exchange rate is too high, a _____ of Canadian dollars drives it down. If the exchange rate is too low, a _____ of Canadian dollars drives it up.

surpluss, shortage

does RER change in short run? why or why not

the change in E brings an equivalent change in RER.

The difference between being a borrower/lender nation and being a creditor/debtor nation is

the difference between stocks and flows of financial capital.

expected profit depends on...

the exchange rate today

what is Canadian official reserves

the government's holdings of foreign currency

the ___ the exchange rate,

the greater is the quantity of Canadian Dollars Demanded

In the long run, RER is determined by

the real forces of demand and supply in the markets for goods and services

T or F to buy goods in another country we need the money of that country

true

T or F, the price adjusts every minute, and the market is pulled (quickly) to the equilibrium exchange rate at which there is neither a shortage nor a surplus.

true

exchange rate increases= movement exchange rate decreases= movement..

up, down

A currency is worth _________

what it can earn