Open economy, int trade + exchange rate - week 10

What is international trade?

Buying and selling goods and services from other countries.

What are imports?

The purchase of goods and services from abroad that leads to an outflow of currency from the UK.

What are exports?

The sale of goods and services to buyers from other countries leading to an inflow of currency to the UK.

What is the balance of payments?

A record of a country's international transactions over a certain period of time presented in the form of double-entry bookkeeping.

What does the balance of payments record?

All transactions between the residents of a country (citizens, firms, and government) and the rest of the world.

What are the parts of the balance of payments?

Current account (CA), capital account (KA), official reserves account (RA), and statistical discrepancy.

What is the current account?

Trade in goods and services + income flows and transfers.

What is the capital account?

Transfer of funds related to the sale of assets and liabilities.

What is the official reserves account?

Gold, foreign currencies, SDRs, reserve positions in the IMF.

What is the statistical discrepancy?

Errors and omissions in the balance of payments.

How can a current account deficit be covered?

By borrowing or attracting investments from abroad.

What happens if there is a combined current account and capital account deficit?

The country has to draw on its reserves, which may cause a crisis of confidence and a 'run on the pound'.

What does the current account include?

Balance of trade (X-M) and net income flows (NI) and net transfers (NT).

What is a current account deficit?

When DR > CR or M > X.

What is a current account surplus?

When CR > DR or X > M.

What is the capital account (KA)?

Transfer of funds related to sale of assets and liabilities.

How does the currency exchange rate affect a country's balance of payments?

It determines the volumes of exports and imports.

What is an exchange rate?

The rate at which one currency can be exchanged for another on the foreign exchange market.

What is an exchange rate index?

A weighted average of exchange rates of main trading partners.

What factors determine exchange rates?

Demand for imports and exports, relative interest rates, changes in relative inflation rates, changes in income levels, relative investment opportunities, speculative sentiments, global trading patterns, etc.

What is appreciation of the exchange rate?

A rise in the value of a currency in relation to other currencies, resulting in each unit of the currency buying more of the other currency.

How does appreciation of the exchange rate affect the trade balance and balance of payments?

Trade balance (exports decrease, imports increase) and balance of payments will worsen.

What is depreciation of the exchange rate?

A fall in the value of a currency in relation to other currencies, resulting in each unit of the currency buying less of the foreign currency.

How does depreciation of the exchange rate affect the trade balance and balance of payments?

Trade balance (exports increase, imports decrease) and balance of payments will improve.

What causes appreciation and depreciation of the exchange rate?

Market forces.

What is devaluation of the currency?

When a government reduces the value of its currency in relation to other currencies.

What is revaluation of the currency?

When a government increases the value of its currency in relation to other currencies.

What is a floating exchange rate regime?

An exchange rate regime where the exchange rate is determined only by the demand and supply of the currency, with no government intervention.

What is a free floating exchange rate?

Exchange rate balances automatically, no changes in reserves needed.

What is a fixed exchange rate regime?

Currency value fixed in relation to an anchor currency.

What are intermediate exchange rate regimes?

Rate influenced by government via central bank.

What is an adjustable peg?

Fixed rate for a period, then re-pegged.

What is managed (dirty) floating?

Occasional interventions to influence exchange rate.

What is a crawling peg?

Frequent readjustments of the peg.

What is an exchange rate band?

Lower and upper limits set for exchange rate.

How does government intervene to reduce short-term fluctuations?

Using reserves, borrowing from abroad, changing interest rates.

How does government maintain a fixed rate of exchange?

Deflation/reflation, supply-side policies, import controls.