Isues in economics today 6th by guell chapter18

Chapter 18
International
Finance
and
Exchange
Rates
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Chapter Outline
• International Financial
Transactions
• Foreign Exchange Markets
• Alternative Foreign Exchange
Systems
• Determinants of Exchange Rates

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Balance of Payments
• Balance of Payments: the accounting system
for how money moves between countries to
facilitate the purchase of goods, services,

financial instruments, and physical investments.
• Current Account: The portion of the Balance
of Payments accounting that represents that
impacts of trade, short-term investment
payments, and American payments of foreign
taxes, foreign payments of American taxes, and
the net transfer of private money.
• The Capital Account represents the changes in
holding of longer term financial and physical
assets by citizens of one country in another
country.
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Balance of Payments United States, 2009
($ millions)
Major
Accounting
Item

Sub Accounting
Item

Sub Acct
component

Current
Account

Balance of Trade
Balance of Shortterm Investment
Income

Component
Amount

Sub Acct Balance

Balance

Exports

1,834

-496

-470

Imports

2,329

Income to the
US

662

Payments from
the US

499

Net Transfers (taxes, private payments)
Capital
Account

Change in the
Ownership of
Assets

-137

US owned
assets abroad

1,025

Foreign owned
assets in the
US

1,245

Financial Derivatives Net
Statistical Discrepancy & Net Derivatives

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163

470

15
235

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Current Account Mirrors
the Balance of Trade

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Foreign Purchases of US Assets &
US Purchases of Foreign Assets

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Trade Requires Currency
• Trade between countries is beneficial.
• International trade requires that the
currency of the trading partners be
exchanged.
• The market where people come to
trade currencies is called the foreign
exchange market.
• E.g. the production and export of a radio
can require several currency
transactions.

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Foreign Exchange Markets
• The demand for a currency (say

the dollar) is also the supply of
the other currency (say the yen).
• The supply for a currency (say
the dollar) is also the demand of
the other currency (say the yen).

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Modeling Foreign Exchange
Price of Yuan in
U.S.
dollars

equilibrium
exchange
rate

A curve which represents
the willingness of those
who have Yuan to trade
them for U.S. dollars

A curve which represents the
willingness of those who have

Yuan to trade them for U.S.
dollars

Quantity of Yuan
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Various Exchange Rates
Amount of Currency
needed to get $1

Amount of US Dollars
needed to get one unit of
the Currency

0.621892

1.608

Canadian Dollar

.976125

1.02446

Chinese Yuan

6.55997

.15244

Euro

.708466

1.4115

Hong Kong Dollar

7.79454

.128295

Japanese Yen

81.169

.01232

Mexican Peso

11.951

.083675

Russian Ruble

28.3149

.0353171

South Korean Won

1112.24

.000899087

Foreign Currency
British Pound

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Various Exchange Rates

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Alternative Foreign Exchange Systems
• Floating exchange rate system: a system
whereby markets determine the value of a
currency relative to all other currencies.
• Fixed exchange rate system : a system
whereby a government sets the value of a
currency relative to all other currencies and
uses its reserve of foreign currencies or gold to
maintain the exchange rate.
• Gold standard: one means by which a country
can execute a fixed exchange rate.
• Managed Float exchange rate system: a
system whereby governments decide the range
of exchange rates they will allow the market to
create, and act only when either the top end or
the bottom end of that range is breached.

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Fixed Exchange Rates
Price of

Yuan in
Dollars

S1
S2

ERfixed

D2
D1
Yuan*
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Yuan

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Managed Float
Price of
Yuan in
Dollars

S1
S2

ERceiling

ERtarget
ERfloor
D2
D1
Yuan*
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Yuan

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Determinants of Exchange Rates
• Desire to hold one currency or
another to
• Facilitate trade
• Facilitate the purchase of financial
assets

• Interest Rates
• Projected Inflation Rates

• Relative safety of the currency
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