Studied by 0 peopleBalance of Payments Accounts
Measure all international transactions in a year
Include 2 accounts: the Current Account, and the Capital Account
Current Account balance + Capital Account balance =
0
Current Account
Includes:
Net exports
Net investments
Any interest or dividend paid to or from domestic investors
Net transfers
Any aid or grants paid to and from the domestic economy
If the US sent more USD abroad than receiving foreign currency, the balance of the account would be negative
If the US received more foreign currency than sent USD abroad, the balance of the account would be positive
Trade surplus
Country has more exports than imports - got more money than lost
Trade deficit
Country has more imports than exports - lost more money than gained
Capital Account
Includes:
Financial investments
Purchase of foreign and domestic financial assets
Real investments
Purchase of foreign and domestic land and business
If there was more investment in the US than American investments abroad, then the balance of the account would be positive
If there was more American investments abroad than investment in the US, then the balance of the account would be negative
Surplus balance
The balance of the account is positive
Official Reserve Account
The foreign currency the Federal Reserve holds and how it is balanced by the amount of USD sent out
Balance of Payments Deficit
When the current and capital accounts added together are negative because the US sent more dollars out than received foreign currency
When this happens, the Federal Reserve will use some of the foreign currency it holds to balance the account and make it 0
Balance of Payments Surplus
When the current and capital accounts added together are positive because the US received more foreign currency than sent out dollars
When this happens, the Federal Reserve will take the surplus currency and save it as official reserves (foreign currency) until it is needed
Circular Flow of Dollars
Like the circular flow the economy in AP Micro!
The imports/goods the US receives from abroad should be equal to the amount of USD sent out
Essentially, any money sent out would eventually find its way back to its original nation
Exchange Rates
The price at which one international currency can be exchanged for another
Appreciation
Occurs when the value of a country’s currency increases relative to a foreign currency
The country’s currency is stronger in relation to other currencies
Consequences of Appreciation
Overall decrease in net exports
Increases the cost of exports, which can decrease demand for these exports
Decreases the cost of imports, which can increase the demand for these imports
Decrease in net exports decreases AD, decreasing output and increasing unemployment
Depreciation
Occurs when the value of a country’s currency falls relative to a foreign currency
The country’s currency is weaker in relation to other currencies
Consequences of Depreciation
Overall increase in net exports
Decreases the cost of exports, which can increase the demand for these exports
Increases the cost of imports, which can decrease the demand for these imports
Increase in net exports increases AD, increasing output and decreasing unemployment
Gold Standard
Before the Great Depression, many economies were on the gold standard, meaning exchange rates were always fixed
No longer is used in the US
Factors that Change Exchange Rates
Consumer tastes
If Americans have a demand for a foreign good, that will cause the demand for that foreign currency to increase to the right, leading the value of USD to depreciate
If foreigners have a demand for a US good, that will cause the demand for the USD to increase to the right, leading the value of USD to appreciate
Relative income
If one nation’s GDP is increasing and their population’s income is increasing, they will demand more goods and products, including international ones
Say a country was in a recession. Another country in an economic boom would buy products from that country because they have more money to spend, increasing the demand for that country’s currency and appreciating its value
Relative inflation
If a country is experiencing high inflation, they will demand goods from other countries where it is cheaper, increasing demand for other country’s currency
Speculation
Investors will try to make profit by buying currency at low rates and selling them at high rates
Foreign Exchange Demand
The quantity of an international currency that all domestic and foreign currencies are willing and able to purchase at various rates of exchange
About how much one currency is needed for one of this currency
Foreign Exchange Supply
The quantity of an international currency that all domestic and foreign sellers are willing and able to sell at various rates of exchange
About how much currency is gained when selling one of this currency
FOREX Market
The market where foreign currency is bought and sold
FOREX Market Equilibrium
When the quantity supplied of the currency equals the quantity demanded of the currency at a specific exchange rate
FOREX and Monetary Policy
When the money supply increases, interest rates on US assets decrease, making the US a place that is not as ideal to gain profit on investments. Demand for the dollar will fall and the dollar will depreciate.
LONG RUN: A depreciating dollar makes American goods cheaper to foreign consumers, increasing net exports, shifting AD to the right, and the dollar will appreciate again
Expansionary Monetary Policy → Depreciation
When the money supply decreases, interest rates on US assets increase, making the US an ideal place to gain profit on investments. Demand for the dollar will increase and the dollar will appreciate.
LONG RUN: An appreciating dollar makes American goods more expensive to foreign consumers, decreasing net exports, shifting AD to the left, and the dollar will depreciate again
Contractionary Monetary Policy → Appreciation
Determinants of Supply and Demand in the FOREX Market
Foreign Tastes
Less consumers/tourists are attracted to visiting a country, decreasing the demand for its currency, depreciating
More consumers/tourists are attracted to visiting a country, increasing the demand for its currency, appreciating
Trade Prices
Price of exports increase, causing the demand for US goods (and its currency) to decrease, depreciating
Price of exports decrease, causing the demand for US goods (and its currency) to increase, appreciating
Income Levels
A foreign country’s general income decreases, decreasing demand for international goods (and their currencies), depreciating
A foreign country’s general income increases, increasing demand for international goods (and their currencies), appreciating
Real Interest Rates
A foreign country’s interest rates are lower than interest rates in the US, the demand for that country’s currency will decrease, depreciating
A foreign country’s interest rates are higher than interest rates in the US, the demand for that country’s currency will increase, appreciating
Fiscal Policy and Exchange Rates
Expansionary Fiscal Policy
AD increases, increasing RGDP and PL, making US goods more expensive and other countries will not buy as much, leading a decrease in demand for the USD, depreciating
Expansionary Fiscal Policy → Depreciation
Contractionary Fiscal Policy
AD decreases, decreasing RGDP and PL, making US goods less expensive and other countries will buy more, leading an increase in demand for the USD, appreciating
Contractionary Fiscal Policy → Appreciation
Monetary Policy and Exchange Rates
Expansionary Monetary Policy
Increase in money supply lowers the interest rate, increasing investment spending which increases AD, raising the PL, making exports more expensive, decreasing demand for the USD, depreciating
Expansionary Monetary Policy → Depreciation
Contractionary Monetary Policy
Decrease in money supply raises the interest rate, decreasing investment spending which decreases AD, lowering the PL, making exports less expensive, increasing demand for the USD, appreciating
Contractionary Monetary Policy → Appreciation
Trade Barriers
Trade barriers protect domestic jobs in a high-wage paying country
Revenue Tariffs
Taxes imposed on goods that were not produced domestically
No domestic jobs to protect, but instead to raise government revenue
Protective Tariffs
Taxes imposed on goods that are produced domestically
Protect domestic jobs that produce the goods being imported from another country
Economic Effects of Tariffs
Consumers pay higher prices while consuming less products
Consumer surplus is lost
Domestic producers increase productivity and output
Imports decline
The government makes revenue off of tariffs
Inefficiency - we are not working a market equilibrium
Import Quota
Sets a maximum amount of goods that can be imported
The government does NOT make revenue from this, but this has a similar effect to tariffs
Interest Rates and the Loanable Funds Market
When interest rates are high in the US, assets are more attractive to foreign investors, so more funds are injected into the economy due to foreign investors purchasing domestic assets
Higher interest rates → more loanable funds
When interest rates are low in the US, assets are less attractive to foreign investors, so less funds are injected into the economy due to foreign investors not purchasing domestic assets
Also, domestic investors will seek to invest elsewhere, leading to a decrease in funds available in the US
Lower interest rates → less loanable funds
Capital Flow
The movement of money for the purpose of investment, trade, or business production
Inbound Capital Flow
The injection of funds into a domestic economy that occurs through the purchase of domestic assets by foreign investors
Outbound Capital Flow
The extraction of funds from a domestic economy that occurs through the purchase of foreign assets by domestic investors
Interest Rates and Net Exports
Higher interest rates in one country will make it more attractive to foreign investors to invest there, leading to appreciation of its currency, making exports more expensive and less foreign consumers will buy domestic products, decreasing net exports
Higher interest rates → decrease in net exports
Lower interest rates in one country will make it less attractive to foreign investors to invest there, leading to depreciation of its currency, making exports less expensive and more foreign consumers will buy domestic products, increasing net exports
Lower interest rates → increase in net exports
Central Banks and Changing Domestic Interest Rates
Adjusting the interest rates they charge on loans
Raising interest rates on loans → higher interest rates domestically
Lowering interest rates on loans → lower interest rates domestically
Adjusting the interest rates they charge on deposits
Raising interest rates on deposits → higher interest rates domestically
Less will spend, more will save
Lowering interest rates on deposits → lower interest rates domestically
Note
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