Economics Today The Macro View Ch. 33 Exchange Rates and the Balance of Payments

Official reserve assets

1) Foreign currencies 2) Gold 3) Special drawing rights (SDRs)- reserve assets that the International Monetary Fund (IMF) created to be used by countries to settle international payment obligations 4) The reserve position in the IMF 5) Financial assets held by an official agency, such as the U.S. Treasury Department

Market Determinants of exchange rates

1) changes in real interest rates 2) changes in consumer preferences 3) perceptions of economic stability

The following table gives five transactions between U.S. residents and the rest of the world. Complete this table by indicating how each item affects the U.S. balance of payments. Do this by using the letter D to indicate deficit item and S to indicate surplus item. 1. A Central European company sells products to a U.S.​ hobby-store chain. 2. Japanese residents pay a U.S. travel company to arrange hotel​ stays, ground​ transportation, and tours of various U.S.​ cities, including New​ York, Chicago, and Orlando. 3. A Mexican company pays a U.S. accounting firm to audit its income statements. 4. U.S. churches and mosques send relief aid to Pakistan following a major earthquake in that nation. 5. A U.S. microprocessor manufacturer purchases raw materials from a Canadian firm.

1. D 2. S 3. S 4. D 5. D

Bretton Woods And the IMF

1944 the worlds capitalist countries sent representatives to Bretton Woods, New Hampshire to make a new institution- theIMF

The price of peach preserves in the United Kingdom is ​£1. If the exchange rate is​ £1 = ​$2, the price of peach preserves in dollars is ​$___. If the exchange rate changes to​ £1 = ​$3, the price of peach preserves in dollars will _____ and U.S. citizens will want to buy _____. Thus the quantity of British pounds that U.S. citizens demand will be _____.

2 increase; less peach preserves less

Capital Account

A category of balance of payments transactions that measures flow of financial assets.

Current Account

A category of balance payments transactions that measures the exchange of merchandise, the exchange of services, and unilateral transfers.

Depreciation

A decrease in the exchange value of one nation's currency in terms of the currency of another nation.

Hedge

A financial strategy that reduces the chance of suffering losses arising from foreign exchange risk.

Foreign Exchange Market

A market in which households, firms, and governments buy and sell national currencies.

Balance of Payments

A system of accounts that measures transactions of goods, services, income, and financial assets between domestic households, businesses and governments and residents of the rest of the world during a specific time period.

What is the difference between a deficit item and a surplus item in the balance of​ payments? A. A deficit item is when a transaction leads to a payment by a country and a surplus item is when a transaction leads to a receipt by a country. B. A surplus item is when a transaction leads to a payment by a country and a deficit item is when a transaction leads to a receipt by a country. C. A deficit item is when a country exports more than it imports while a surplus item is when a country imports more than it exports. D. A deficit item is when a country imports more than it exports while a surplus item is when a country exports more than it imports.

A. A deficit item is when a transaction leads to a payment by a country and a surplus item is when a transaction leads to a receipt by a country.

Suppose that Argentina decides to fix its exchange rate at 1 Argentinean peso​ = $1. If people in Argentina wish to buy more U.S.​ goods, which of the following is most likely to​ occur? A. The central bank must buy pesos and sell dollars to maintain the fixed rate. B. The central bank will be unable to keep the rate fixed comma and the peso will depreciate. C. The central bank will be unable to keep the rate fixed comma and the peso will appreciate. D. The central bank must sell pesos and buy dollars to maintain the fixed rate.

A. The central bank must buy pesos and sell dollars to maintain the fixed rate.

Suppose that signs of an improvement in the Japanese economy lead international investors to resume lending to the Japanese government and businesses.​ Policymakers, however, are worried about how this will influence the yen. This event would cause A. an increase in the demand for the​ yen, and the yen would appreciate. B. a decrease in the demand for the​ yen, and the yen would depreciate. C. an increase in the supply of the​ yen, and the yen would appreciate. D. a decrease in the supply of the​ yen, and the yen would depreciate. If the central​ bank, the Bank of​ Japan, wants to keep the value of the yen​ unchanged, then it should A. peg the​ yen's value to gold at the original exchange rate. B. buy more dollars because it is unsure about the future of the Japanese economy. C. buy more​ yen, thereby decreasing its supply and the value of the yen will rise to its original level. D. buy foreign currencies in exchange for the​ yen, thereby increasing its supply and value of the yen will fall to its original level.

A. an increase in the demand for the​ yen, and the yen would appreciate. D. buy foreign currencies in exchange for the​ yen, thereby increasing its supply and value of the yen will fall to its original level.

A problem associated with flexible exchange rates is A. foreign exchange risk. B. hedging. C. the inability for an economy to compete against foreign substitutes. D. government control over the exchange rate.

A. foreign exchange risk.

The purchase of U.S. financial assets by a foreign central bank is recorded in A. the official settlements balance. B. the capital account. C. the current account. D.both the current account and the capital account.

A. the official settlements balance.

If a family unit is spending more than its current income, the family unit must be doing one of the following: 1) reducing its money holdings or selling stocks, bonds, or other assets. 2) Borrowing 3) receiving gifts from friend or relatives

Accounting Identities

Balance of payments

All international trade and financial transactions taking place between a given nation and the rest of the world.

International Monetary Fund

An agency founded to administer an international foreign exchange system and to lend to member countries that had balance of payments problems. The IMF now functions as a lender of last resort for national governments.

Appreciation

An increase in the exchange value of one nation's currency in terms of the currency of another nation.

Consider the diagram to the​ right, which depicts the market for the​ baht, the currency of Thailand issued by that​ nation's central​ bank, the Bank of​ Thailand, and answer the following questions. Consider the following two​ events: ​A) An increase in foreign purchases of Thai export goods. ​B) A decrease in foreign purchases of financial services provided by Thai banks. Which one of these events could have generated the decrease in the demand for the​ baht? ___ ​(Enter a letter​ 'A' or ​'B'.​) Following the decrease in the demand for the​ baht, the baht has _____ in relation to the U.S. dollar. Suppose that the Bank of Thailand desires to push the equilibrium exchange rate back to a value of​ $0.27 per baht. Which of the following actions by the Bank of Thailand would likely succeed in causing the demand for baht to rise back to its original​ level? _____ .

B depreciated Raising interest rates.

In the table to the​ right, what is the equilibrium exchange rate between the South African rand and U.S.​ dollars? A. 0.10 B. 0.20 C. 0.25 D. 0.30 What is the situation when the dollar price of the South African rand is at 0.15? A. There is a surplus of 0.6 trillion U.S. dollars. B. There is a shortage of 8 trillion rand demanded. C. There is a surplus of 4 trillion rand. D. There is a shortage of 0.6 trillion rand.

B. 0.20 A. There is a surplus of 0.6 trillion U.S. dollars.

Which of the following statements is consistent with both the gold standard and the Bretton Woods​ agreement? A. Increases in the money supply do not cause inflation. B. Active monetary policy could not be pursued by a single economy. C. Exchange rate risk was a serious problem under both exchange rate systems. D. Each exchange rate system was based on flexible exchange rates.

B. Active monetary policy could not be pursued by a single economy.

The current exchange rate is​ $1= euro1. Suppose that Americans prefer to buy domestic products rather than European products. What would be expected to happen to the value of the dollar and the value of the​ euro? A. The dollar will depreciate comma and the euro will appreciate. B. The dollar will appreciate comma and the euro will depreciate. C. The dollar will​ appreciate, and the euro will appreciate. D. The dollar will​ depreciate, and the euro will depreciate

B. The dollar will appreciate comma and the euro will depreciate.

The range of permitted exchange rate fluctuations between upper and lower bounds is referred to as the A. flexability range. B. target zone. C. exchange zone. D. gold points. Nations manage their​ currency's exchange rate within this target zone by A. buying and selling corporate bonds. B. open market operations. C. buying and selling foreign exchange. D. buying and selling of government securities.

B. target zone. C. buying and selling foreign exchange.

The purchase of U.S financial assets by a foreign citizen is recorded in A. the current account. B.the capital account. C. the official settlements balance. D. both the current account and the capital account.

B.the capital account.

How are flexible exchange rates​ determined? A. The exchange rate is determined where the quantity of exports demanded is equal to the quantity supplied of exports. B. The exchange rate is determined where the quantity of exports demanded is equal to the quantity supplied of imports. C. The exchange rate is determined where the quantity of a currency demanded is equal to the quantity supplied of the currency. D. The exchange rate is determined where the current account is equal to the capital account.

C. The exchange rate is determined where the quantity of a currency demanded is equal to the quantity supplied of the currency.

Under a gold​ standard, if the sum of a​ nation's current account and capital account is negative​, A. gold would flow into the country comma reducing the domestic money supply and the price level. B. gold would flow out of the country comma increasing the domestic money supply and the price level. C. gold would flow out of the country comma reducing the domestic money supply and the price level. D. gold would flow into the country comma increasing the domestic money supply and the price level.

C. gold would flow out of the country comma reducing the domestic money supply and the price level.

Balance of goods and services/trade balance

Compares exports and imports of both goods and services.

Which of the following is the definition of a dirty float​? A. A strategy to reduce potential losses from exchange rate risk. B. A range of permitted exchange rates between upper and lower bands, which are defended by the central bank. C. Tying the value of a currency to the value of another currency, while allowing the par value to change. D. Active management of a floating exchange rate by the government.

D. Active management of a floating exchange rate by the government.

Under the gold​ standard, if a country had a balance of payments deficit A. national output and prices would fall discouraging imports and encouraging exports leading to an improvement in the balance of payments. B. interest rates would rise which would attract foreign capital and lead to an improvement in the balance of payments. C. gold would flow out of that country and the domestic money supply would contract. D. All of the above

D. All of the above

The table on the right lists the dollar figures of international transactions of the U.S. figures are in billions of dollars. The current account balance is A. ​$150. B. ​$-50. C. ​$-150. D. ​$-100. The capital account balance is A. ​$-150. B. ​$150. C. ​$-50. D. ​$-100.

D. ​$-100. B. ​$150.

Slope of Demand Curve

Downward sloping

Flexible exchange rates

Exchange rates that are allowed to fluctuate in the open market in response to changes in supply and demand. Sometimes called floating exchange rates.

Surplus Items ( + )

Exports of merchandise Private and governmental gifts from foreigners Foreign usage of domestically operated travel and transportation services Foreign tourists' expenditures in this country Foreign military spending in this country Interest and Dividend receipts from foreign entities Sales of Domestic Assets to foreigners Funds deposited in this country by foreigners Sales of gold to foreigner Sales of domestic currency to foreigners

Current aaccount balance

Goods, services, net investment, net transfers

Disequilibrium

If family expenditures exceed family income and this situation is financed by borrowing, the household may be considered to be in disequilibrium because such a situation cannot continue indefinitely.

Current Account Surplus

If the sum of net exports of goods and services plus net unilateral transfers plus net investment income exceeds zero, a Current Account Surplus is said to Exist

Current Account Deficit

If the sum of net exports of goods and services plus net unilateral transfers plus net investment income is negative then a Current Account Deficit is said to exist. A current account deficit means that we are importing more goods and services that we are exporting. Such a deficit must be paid for by the export if financial assets.

Deficit Items ( - )

Imports of merchandise Private and governmental gifts to foreign residents Use of foreign-operated travel and transportation U.S. tourists expenditures abroad Military spending abroad Interest and dividends paid to foreign individuals and businesses Purchases of foreign assets Funds placed in foreign depository institutions Purchases of gold from foreign residents Purchases of foreign currency.

Capital and financial accounts

Net amount of nations debt forgiveness and sale of real and financial assets to people living abroad less its purchases of real and financial assets from foreigners.

Special Drawing Rights (SDRs)

Reserve assets created by the IMF for countries to use in settling international payment obligations

In the absence of interventions by finance ministries or central banks,

The current account balance and the capital account balance must sum to zero. Stated differently, the current account deficit must equal the capital account surplus when governments or central banks do not engage in foreign exchange interventions. in this situation, any nation experiencing a current account deficit, such as the United States, must also be running a capital account surplus.

Balance of trade

The difference between exports and imports of physical goods.

Par Value

The officially determined value of a currency.

Foreign exchange risk

The possibility that changes in the value of a nation's currency will result in variations in the market value of assets.

Exchange Rate

The price of one nation's currency in terms of the currency of of another country.

Accounting Identities

Values that are equivalent by definition.

The figure to the right shows the market for​ Thailand's currency, the baht. Suppose that​ Thailand's productivity increases relative to productivity in other countries.​ Moreover, assume a floating exchange rate. Using the line drawing tool​, show how the market for the baht is impacted by this event. According to your​ graph, the baht has _____ relative to the U.S. dollar.

appreciated

On​ Wednesday, the exchange rate between the Japanese yen and the U.S. dollar was ​$0.0100 per yen. On​ Thursday, it was ​$0.0121 per yen. It can be concluded that the U.S. dollar has _____ relative to the yen.

depreciated

The figure to the right shows the market for​ Thailand's currency, the baht. Suppose market interest rates on financial assets denominated in baht decline relative to market interest rates on financial assets denominated in other​ nations' currencies.​ Moreover, assume a floating exchange rate. Using the line drawing tool​, show how the market for the baht is impacted by this event. Properly label this line. According to your​ graph, the baht has _____ with respect to the dollar.

depreciated graph B shows Demand1 lower than Demand is an example.

A​ country's current account balance is ​$4365. Assuming that there is no government​ intervention, this means that this country has a current account _____ and a capital account _____. This means that this country is _____ and that it is _____.

surplus; deficit exporting more goods than it is importing; importing money or money equivalents