Lecture Macroeconomics - Chapter 18: Exchange rates and the balance of payments
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EXCHANGE RATES
AND THE
BALANCE OF PAYMENTS
CHAPTER 18
SLIDES PREPARED BY JUDITH SKUCE, GEORGIAN COLLEGE
© 2002 McGraw-Hill Ryerson Ltd.
Macroeconomics, Chapter 18
1
In this chapter you will learn
What determines the supply of and demand
for a nation’s currency
About a nation’s balance of payments
What a flexible exchange rates system is and
its effects on the domestic economy
What a fixed exchange rates system is and its
effects on the domestic economy
About the history of the world’s international
exchange-rate systems
© 2002 McGraw-Hill Ryerson Ltd.
Macroeconomics, Chapter 18
2
Chapter 18 Topics
Financing International Trade
The Balance of Payments
Flexible Exchange Rates
Fixed Exchange Rates
International Exchange Rate Systems
© 2002 McGraw-Hill Ryerson Ltd.
Macroeconomics, Chapter 18
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Financing International Trade
Assume $2 = £1
1. $300,000 in Canadian telecommunications
equipment purchased by a British buyer for
£150,000
2. £150,000 cheque drawn on British bank to
pay for equipment
3. £150,000 cheque is exchanged for $300,000
at a Canadian bank
4. Canadian bank sends £150,000 cheque to
London bank for future transactions
© 2002 McGraw-Hill Ryerson Ltd.
Macroeconomics, Chapter 18
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Points to Remember
Canadian exports create:
a foreign demand for Canadian $
an increase in the supply of foreign
currency owned by Canadian banks
© 2002 McGraw-Hill Ryerson Ltd.
Macroeconomics, Chapter 18
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Points to Remember
Canadian imports:
create a domestic demand for foreign
currencies
reduce the supplies of foreign
currencies held by Canadian banks
© 2002 McGraw-Hill Ryerson Ltd.
Macroeconomics, Chapter 18
6
Points to Remember
Canadian exports supply the foreign
currencies needed to “pay for” imports
Demand for & supplies of foreign
currencies also arise from transactions
involving services & payment of interest
& dividends on foreign investments
© 2002 McGraw-Hill Ryerson Ltd.
Macroeconomics, Chapter 18
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Chapter 18 Topics
Financing International Trade
The Balance of Payments
Flexible Exchange Rates
Fixed Exchange Rates
International Exchange Rate Systems
© 2002 McGraw-Hill Ryerson Ltd.
Macroeconomics, Chapter 18
8
The Balance of Payments
The Canadian balance of payments
shows the balance between
– all the payments that Canada receives
from foreign countries &
– all the payments which we make to them
© 2002 McGraw-Hill Ryerson Ltd.
Macroeconomics, Chapter 18
9
Current Account
shows the flows resulting from imports
& exports of goods & services
– the trade balance is the net amount of
imports & exports of goods only
– the balance on goods & services
includes services as well
– trade in services, investment income &
transfers are included to get the current
account balance
– normally a deficit
© 2002 McGraw-Hill Ryerson Ltd.
Macroeconomics, Chapter 18
10
The Canadian Balance of Payments
in 2000 (billions of dollars)
Table 18-1
Exports
Imports
Balance
- 363.2
- 62.8
+54.5
- 6.6
Current Account
Merchandise
Services
417.7
56.2
Balance on Goods and Services
+47.9
7. Net Investment Income
balance of trade
8. Net Transfers
- 30.3
+ 1.3
9. Current Account Balance
+18.9
© 2002 McGraw-Hill Ryerson Ltd.
Macroeconomics, Chapter 18
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Capital Account
shows capital inflows & outflows
– purchase or sale of real or financial assets
– official settlements account
© 2002 McGraw-Hill Ryerson Ltd.
Macroeconomics, Chapter 18
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The Canadian Balance of Payments
in 2000 (billions of dollars)
Table 18-1
Balance
Capital Account
10. Capital inflows
11. Capital outflows
12. Capital
account balance
+115.5*
- 132.1*
- 16.6
Official settlements account
13. Official international reserves
balance of payments surplus
Balance of payments
- 2.3
$ 0
*includes one-half of a $2.3 billion statistical discrepancy
© 2002 McGraw-Hill Ryerson Ltd.
Macroeconomics, Chapter 18
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Payments Deficits & Surpluses
A drawing down of official international
reserves measures a nation’s balance
of payments deficit
A building up of official reserves
measures a balance of payments
surplus
© 2002 McGraw-Hill Ryerson Ltd.
Macroeconomics, Chapter 18
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GLOBAL PERSPECTIVE 18.1
Canada's trade balance with selected
nations, 2000
All other
Other OECD
EU
Japan
U.S.
-20
0
20
40
60
80
100
$ billions
© 2002 McGraw-Hill Ryerson Ltd.
Macroeconomics, Chapter 18
15
Chapter 18 Topics
Financing International Trade
The Balance of Payments
Flexible Exchange Rates
Fixed Exchange Rates
International Exchange Rate Systems
© 2002 McGraw-Hill Ryerson Ltd.
Macroeconomics, Chapter 18
16
Flexible Exchange Rates
Rates by which national currencies are
exchanged are determined by demand
& supply
© 2002 McGraw-Hill Ryerson Ltd.
Macroeconomics, Chapter 18
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The Market for Foreign Currency (Pounds)
Figure 18-2
Dollar price of 1 pound
P
D
Quantity of pounds
© 2002 McGraw-Hill Ryerson Ltd.
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Macroeconomics, Chapter 18
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The Market for Foreign Currency (Pounds)
Figure 18-2
P
Dollar price of 1 pound
S
dollar price of
pounds is
determined by
demand & supply
D
Quantity of pounds
© 2002 McGraw-Hill Ryerson Ltd.
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Macroeconomics, Chapter 18
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The Market for Foreign Currency (Pounds)
Figure 18-2
Dollar price of 1 pound
P
S
2
D
Q1
Quantity of pounds
© 2002 McGraw-Hill Ryerson Ltd.
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Macroeconomics, Chapter 18
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The Market for Foreign Currency (Pounds)
Figure 18-2
Dollar price of 1 pound
P
2
S
Pound
appreciates
D
D
Q1
Quantity of pounds
© 2002 McGraw-Hill Ryerson Ltd.
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Macroeconomics, Chapter 18
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The Market for Foreign Currency (Pounds)
Figure 18-2
Dollar price of 1 pound
P
S
Pound
depreciates
2
D
Q1
Quantity of pounds
© 2002 McGraw-Hill Ryerson Ltd.
D
Q
Macroeconomics, Chapter 18
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Determinants of Exchange Rates
Changes in Tastes
Relative Income Changes
Relative Price-Level Changes
– Purchasing Power Parity Theory
Relative Interest Rates
Speculation
© 2002 McGraw-Hill Ryerson Ltd.
Macroeconomics, Chapter 18
23
Advantages of Flexible Rates
automatic adjustment to eventually
eliminate balance of payments deficits
or surpluses
© 2002 McGraw-Hill Ryerson Ltd.
Macroeconomics, Chapter 18
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Adjustments Under Flexible Exchange Rates
Figure 18-3
Dollar price of 1 pound
P
S
suppose
tastes
change
& Canadians
want to buy
more British
automobiles
2
D
Quantity of pounds
© 2002 McGraw-Hill Ryerson Ltd.
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Macroeconomics, Chapter 18
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