Open Economy - International Trade and Finance

Flashcards about open economy - international trade and finance.

What does the current account (CA) record?

Net exports, net income from abroad, and net unilateral transfers.

What does the capital and financial account (CFA) record?

Financial capital transfers and purchases and sales of assets between countries

What is the balance of payments (BOP)?

An accounting system that records a country’s international transactions for a particular time period; it consists of the CA and the CFA.

Any transaction that causes money to flow out of a country is a what to its BOP account?

A debit.

Any transaction that causes money to flow into a country is a what to its BOP account?

A credit.

In terms of credits and debits, how does a country's BOP balance?

The sum of all credit entries should match the sum of all debit entries (CA+CFA=0).

What is the exchange rate?

The price of one currency in terms of another.

If one currency becomes more valuable in terms of the other, it is said to do what?

Appreciate.

If one currency becomes less valuable in terms of the other, it is said to do what?

Depreciate.

What does the demand for a currency in a foreign exchange market arise from?

The demand for the country’s goods, services, and financial assets and shows the inverse relationship between the exchange rate and the quantity demanded of a currency.

What does the supply of a currency in a foreign exchange market arise from?

Making payments in other currencies and shows the positive relationship between the exchange rate and the quantity supplied of a currency.

In the foreign exchange market, equilibrium is achieved when?

The exchange rate is such that the quantities demanded and supplied of the currency are equal.

What changes the equilibrium exchange rate?

Factors that shift the demand for a currency (such as the demand for that country’s goods, services, or assets) and the supply of a currency (such as tariffs or quotas on the other country’s goods and services).

What can fiscal policy influence?

Aggregate demand, real output, the price level, and exchange rates.

What can monetary policy influence?

Aggregate demand, real output, the price level, and interest rates, and thereby affect exchange rates.

Factors that cause a currency to appreciate cause what to happen?

That country’s exports to decrease and its imports to increase, resulting in decreased net exports.

Factors that cause a currency to depreciate cause what to happen?

That country’s exports to increase and its imports to decrease, resulting in increased net exports.

In an open economy, how do differences in real interest rates across countries affect financial capital flows?

Financial capital will flow toward the country with the relatively higher interest rate.

What will domestic interest rates affect?

Net capital inflows.

In the context of international financial transactions, what is international trade?

Purchasing or selling currently produced goods or services across an international border.

What are international asset transactions?

The transfer of property rights to either real or financial assets between the citizens of one country and the citizens of another country.

What is an accounting statement that sums all the financial transactions that take place between its residents and the rest of the world?

A nation’s balance of payments.

What does the current account consist of?

Net exports, net income from abroad, and net unilateral transfers.

What does the capital and financial account consist of?

Financial capital transfers and purchases and sales of assets between countries.

How do changes in the capital and financial account impact the market for loanable funds?

A surplus increases the supply of loanable funds; a deficit decreases the supply of loanable funds.

Why must the current account and the capital and financial account sum to zero?

People can only trade one of two things with each other: currently produced goods and services or preexisting assets.

If there is a current account deficit, what must exist to supply the needed foreign currency?

A capital and financial account surplus.

Where are currencies traded?

Currencies are traded in foreign exchange markets.

What is the exchange rate?

The equilibrium price at which currencies are traded.

When Americans buy foreign goods or financial assets, U.S. dollars are supplied in the foreign exchange market and what else?

The foreign currency is demanded.

When foreigners buy U.S. goods or financial assets, the foreign currency is supplied in foreign exchange markets and what else?

The U.S. dollar is demanded.

What is the appreciation of a currency?

An increase in the exchange rate for a currency.

What is the depreciation of a currency?

A decrease in the exchange rate for a currency.

When a country's currency appreciates, what happens?

It is more expensive for foreigners to buy the country's exports and it is cheaper for the country to buy imports.

When a country's currency depreciates, what happens?

It is cheaper for foreigners to buy the country's exports and it is more expensive for the country to buy imports.

What are the four demand shifters in the foreign exchange markets?

Tastes and preferences, income, relative inflation rates, and relative interest rates.

How does an increase in real income in the United States affect the United States current account balance?

Increased imports.

How does an increase in Japan's government budget deficit affect the supply of euros?

The supply curve for euros shifts to the right and the yen price of the euro decreases.

How will the change in the exchange rate affect aggregate demand in Singapore in the short run?

Increases aggregate demand.

How will the transaction affect the United States current account balance?

Exports are recorded as a credit in the current account.

Which country has a comparative advantage in the production of machines?

Luna has a comparative advantage in

Why does the balance of payments always equal zero?

Because every international transaction has an equal and opposite entry in either the current or capital/financial account.

What causes a country's currency to appreciate or depreciate?

Changes in supply and demand for the currency in the foreign exchange market cause appreciation or depreciation.

How does a change in currency value affect imports and exports?

Appreciation decreases exports and increases imports, while depreciation increases exports and decreases imports.

What three components make up the current account (CA)?

Net exports, net income from abroad, and net unilateral transfers make up the CA.

Why can a country run a CA surplus or deficit?

Because exports, income, and transfers may not equal imports and outflows.

What is the balance of trade, and how is it related to the CA?

The balance of trade is net exports, a major part of the current account.

What does the capital and financial account (CFA) include?

It includes purchases and sales of assets and capital transfers between nations.

Why can the CFA show a surplus or a deficit?

Because financial capital can either flow into or out of the country.

What does a CFA surplus indicate?

It indicates that more financial capital is entering the country than leaving.

What does a CFA deficit indicate?

It means more capital is leaving the country than coming in.

What is the purpose of the balance of payments (BOP)?

To record and track all of a country’s international economic transactions.

Why must the CA and CFA always sum to zero in the BOP?

Because every inflow (credit) must be matched by an outflow (debit), ensuring balance.

What is a credit in the BOP?

A transaction that brings money into the country.

What is a debit in the BOP?

A transaction that sends money out of the country.

What happens when a currency appreciates?

It becomes more expensive relative to other currencies.

What happens when a currency depreciates?

It becomes less expensive relative to other currencies.

Why do exchange rates fluctuate?

Because of changing demand and supply for currencies in global markets.

How does an exchange rate represent the price of a currency?

It shows how much of one currency is needed to buy another.

How do you convert between currencies using an exchange rate?

Multiply or divide by the given rate depending on the direction of conversion.

Why do people demand a foreign currency?

To buy that country’s goods, services, or financial assets.

Why do people supply their currency in the forex market?

To obtain foreign currency for imports or investment.

What kind of relationship exists between exchange rate and currency demand?

An inverse relationship—higher exchange rates lower demand.

What kind of relationship exists between exchange rate and currency supply?

A direct relationship—higher exchange rates increase supply.

What happens when the currency market is in disequilibrium?

There is either a surplus or shortage of a currency.

How does the forex market return to equilibrium?

Changes in exchange rates eliminate shortages or surpluses.

How do changes in demand for a country's goods affect its currency?

Increased demand for goods raises demand for the currency, causing appreciation.

How do trade barriers affect the supply or demand for a currency?

Tariffs or quotas can reduce imports, changing currency supply or demand.

How does fiscal policy impact the exchange rate?

By influencing output and prices, it affects demand for currency through trade and investment.

How does monetary policy affect exchange rates?

It changes interest rates, which alters capital flows and currency demand.

Why do capital flows respond to policy changes?

Because investors seek higher returns, which depend on domestic interest rates and economic stability.

How does a stronger currency affect the trade balance?

It reduces exports and increases imports, worsening the trade balance.

How does a weaker currency affect the trade balance?

It increases exports and reduces imports, improving the trade balance.

Why does appreciation reduce aggregate demand?

Because net exports fall, reducing overall spending in the economy.

Why does depreciation increase aggregate demand?

Because net exports rise, increasing total spending in the economy.

How do real interest rate differences influence investment flows?

Investors move capital to countries with higher real interest rates.

What effect do higher interest rates have on a country’s currency?

They attract capital inflows, increasing demand for the currency.

How does a lower interest rate affect a country’s currency value?

It causes capital to flow out, reducing demand and depreciating the currency.

Why do central banks monitor interest rates in open economies?

Because interest rates impact exchange rates and capital movements.

How do capital flows affect the loanable funds market?

Inflows increase the supply of