International Economy

Exchange Rates

the value of one currency expressed in terms of another

Foreign Exchange Market

where currencies are traded

Floating exchange rates

exchange rates determined by supply and demand in the foreign exchange market without government intervention

Appreciation

an increase in the value of a currency (more buying power)

Depreciation

A decrease in the value of a currency (less buying power)

Shifts that cause appreciation

increase in demand, decrease in supply

Shifts that cause depreciation

decrease in demand, increase in supply

Two-Currency Insight

In a model, demand for one currency shows supply for the other

Actions that appreciate currency

Increased Foreign demand for exports,

Shifters of floating exchange rates

foreign purchases of exported materials, inward investment, outward investment, remittances, speculation

Foreign Direct Investment (FDI)

the investment into 10 or more percent of a foreign business

Portfolio Investment

the foreign purchase of assets such as shares and bonds

Capital Flows

FDI and Portfolio Investment

Do capital flows or trade flows alter exchange rates more?

Capital flows alter exchange rates more than trade flows

Remittances

when people send money to their relatives in other countries

Speculation

buying and selling currencies to profit from future changes in exchange rates

Relative Inflation Rate Properties of X: X < Y

X is more competitive, more internationally demanded, and currency X appreicates

Relative Interest Rate Properties of X: X > Y

X has more appealing financial returns, inward portfolio investment rises, currency X appreicates

Relative Growth Rate Properties of X and Y: X > Y

income in X grows faster, more imports, Y appreciates

Central Bank Intervention

a central bank may enter the market as a buyer or seller in order to influence their currencies’ values

Constraints of Central Bank Intervention

finite reserves, the huge market size doesn’t let the central bank do much, policy tradeoffs, speculators may bet against the government

How does appreciate influence net exports

next exports decrease because foreign nations will find it harder to spend on a stronger currency

What does currency appreciation and depreciation impact?

inflation rates, economic growth, unemployment (based on whether the industry focuses on exports for not)

How does depreciation improve the current account balance

increases exports and reduces imports

Fixed Exchange Rate

when a central bank maintains a currency’s value at a certain level instead of letting market forces influence it

How are fixed exchange rates maintained

buying or selling foreign reserves and making policy changes

Currency Revaluation

when a country increases the value of its currency to be similar to others, increasing imports and reducing inflation

Currency Devaluation

when a country devalues its currency compares to others, increasing exports and inflation

Manages Exchange Rates

When market forces mostly influence exchange rates, but central banks intervene periodically. prevents large economic fluctations

Peg Currency

the central bank sets and maintains the value of a domestic currency relative to another one

Overvalued Currency

the value of a currency is kept higher than its equilibrium level by government or central bank intervention.

Benefits of having an overvalued currency

increases imports

Drawbacks of having an overvalued currency

exports are expensive, domestic producers are worse off, trade deficit

Undervalues Currency

the currency’s value is kept lower than its equilibrium level, making exports cheaper and imports more expensive

Tariffs

taxes on imported goods

Why do nations use tariffs?

to protect domestic producers from comparative disadvantages and gain government revenue

Free Trade

An absence of government intervention in international trade, resulting in no imposing restrictions of any kind on imports and exports.

Trade Protection

When the government intervenes in international trade by imposing restrictions to reduce free imports.

Comparative Advantage

the price of one nation’s good is lower the the world’s price of that good

Who benefits from tariffs

domestic producers, workers, the government

Who loses from tariffs

consumers, people of low income, foreign producers, wellfare