Week 5:Exchange rates and balance of Payments

With an open economy what 3 things are possbile to decided whether to do local or abroad( WTI)

Work,Trade, invest

What is inflation simply put,what causes it to rise and to go down and whats the link to unemployment

• Inflation is simply the rise in the general level of prices over time, caused mainly by too much demand (demand-pull) or rising costs of production (cost-push), and it falls when demand weakens or costs ease

• its link to unemployment is captured by the Phillips Curve, which shows that when unemployment is low, wages and prices tend to rise, while high unemployment usually keeps inflation down.

• When unemployment is low, firms struggle to find enough workers, so they compete by offering higher wages to attract and keep staff. As wages rise, workers have more income to spend, which increases demand for goods and services.

Is too low inflation good or bad

Yes, a low and stable inflation rate is generally good because it preserves purchasing power, reduces uncertainty, and supports investment and job creation — but if inflation is too low or negative (deflation), it can signal weak demand, discourage spending, and trap economies in stagnation.

What are the objectives of policy authorities

• Stability

• Currency

• Growth

• Maintain price stability and this means

  low and stable inflation

• Currency is not excessively volatile

• Allow balanced and sustainable growth because this stabilizes local industries

What questions do we ask for each category

Define:

• Exchange rate

• Foreign currency

• Foreign exchange market

• The rate at which currencies are exchanged is denoted as the Exchange Rate. The price of one currency in terms of another

• The money or legal tender of another country is denoted as the foreign currency

• The foreign exchange market is the market in which the currency of one country is exchanged for the currency of another country.

For e.g., in the current foreign exchange market, R16.02 are exchanged for 1 U.S. dollar, i.e. R16.02/$

What’s an international currency and what can it interchangebly be called and why

• The first point:The currency isn’t just used inside its home country, but also by people, businesses, and governments outside that country to trade, invest, or settle payments across borders. For example, the US dollar is issued in America, but it’s widely used by non-Americans in global trade, finance, and reserves.

In context of exchange rates define

• Appreciation

• Depreciation

• Appreciation: When a currency increases in value relative to another (and the other currency depreciates). Thus, the appreciating currency is exchanged for more units relative to the other weaker currency.

• Depreciation: When a currency decreases in value relative to another (and the other currency appreciates). Thus, the depreciating currency requires more of its units relative to the stronger currency

In context of exchange rates,what two ways can it be quoted

• Direct quote: Shows how much local currency is needed for 1 unit of foreign currency. Need R16 for 1 dollar

• Indirect quote: Shows how much foreign currency is needed for 1 unit of local currency. 1 dollar for R16

This shows the changes of exchange rates, appreaciation and depreciation

Which quote do we normally work with

In the foreign exchange market:

• What is demand defined by (Hint: dollars)

• What are the 4 sources of demand

  • Importers

  • Investors

  • Assets

  • Tourism

• 3rd point explained: They are selling to South Africans (or other buyers in South Africa) who purchase those assets. The demand for dollars arises because the American investors now need to convert their rand proceeds into dollars.

The demand curve is downward sloping:

• When US goods are cheaper what does it mean for South Africans and demand for American products

• what do South Africans want to take advantage of

In the market for USA dollars what is:

• Definition of supply in this context

• What are the 3 sources of supply

  • Exports

  • Shares and assets

  • Tourists

I=Basically saying demand for Rands from American pov,which supplies us (SA) with foreign currency (their dollars)

Price axis has changed, it is now “the price of Rands

quoted in dollars”. Indirect quote.

“How many dollars are needed to purchase one Rand

• This is known as the market for?

• Give n example of how we would know if the rend weakened

• Why does the quantity demanded for ____ increase

• Give an example of Rand becoming stronger

• When rand strengthens, the quantity ____of

  Rands increases. Why?

• Shows a + relationship between what two items

• Rand supply increases when the Rand strengthens because South Africans find foreign goods and assets cheaper. To buy those foreign items, they must exchange more Rand for foreign currency, so they supply more Rand into the forex market.

• The positive relationship (upward-sloping supply curve) means: as the Rand’s value rises (each Rand buys more dollars), South Africans are more willing to trade Rand for foreign currency, so the quantity of Rand supplied increases.

When SA rand becomes more expensive it _____ against a _____

What causes outward shift in terms of dollars

give an example,lets say USA wins the BID to host 2026 Fifa world cup

Does this cause US dollar to appreciate or depreciate

What causes the inward shift of supply

Give an example,lets say foreigners stop buying SA goods due to oil spill messing up goods in containers

Does this cause US dollar to appreciate or depreciate

• Less supply of dollars → dollars become scarcer.

• When something is scarce, its price rises. In the forex market, the “price” of the dollar is the exchange rate (R/$).

• So, if fewer dollars are offered (supply curve shifts left), buyers must bid more rand per dollar to get them.

• That higher exchange rate means the dollar appreciates (stronger relative to the rand).

👉 The positive relationship is just the law of supply and demand applied to currency: scarcity pushes value up.

How is each thing illustrated

Does the rend and dollar appreciate/depreciate in each case

Is the exchange rate fixed

• Supply of dollars increases → Rand appreciates, Dollar depreciates.
  Why? More dollars are being offered in the forex market (e.g., US firms buying SA minerals). With extra dollar supply, dollars become cheaper relative to rand. That means each rand can buy more dollars → rand strengthens.

• Supply of dollars decreases → Rand depreciates, Dollar appreciates.
  Why? Fewer dollars are available (e.g., US citizens stop investing in SA). Dollars become scarcer, so their value rises. Now each rand buys fewer dollars → rand weakens.

• In the foreign exchange market, the exchange rate is determined by supply and demand, not fixed.

  • If more dollars are supplied (say, US firms bring in dollars to buy SA minerals), then dollars are more abundant relative to rand.

  • When something is abundant, its price falls

What type of quote is this

What’s happening with the shifts

what are the axis titles

(*NOTE in exam/tests must show the equilibrium points)

What are 3 main examples that cause changes in demand for rand and explain them

-Exports

-Interest

-Exchange rate

(Honorable mentions: Demand for SA goods,services and tourism)

What are 2 main changes in supply of the rand and explain them

-imports

-Interest

Complete the flow chart

Current account basics → It records trade in goods, services, income, and transfers between South Africa and the rest of the world. So if net exports imporve CA improves same goes for NE worsening

• Improved current account (depreciation) is good for export industries and balance of payments, but it risks higher inflation.

• Lower domestic prices (appreciation) is good for consumers and inflation control, but it can hurt exporters and worsen the current account.

What 3 things could happen if the rand weakens

-Inflation

-___ exports

-Oil

why do more exports lead to countries prices rising therefore inflation

• When the Rand depreciates, South African exports become cheaper abroad, so foreign buyers demand more SA goods.

• To meet this higher demand, local firms produce more, which often pushes up domestic costs (wages, raw materials, transport).

• At the same time, imports become expensive, so South Africans rely more on local goods. This extra demand for local products adds further pressure on prices.

• The combined effect — higher demand + higher costs — leads to domestic price increases, i.e. inflation.

What are the 3 properties of Flexible exchange rates

• Determined by

• No direct ___ intervention

• Indirect influence

Name 3 countries besides SA that has flexible exchange rates

Do all countries have flexible exchange rates?

No,floating,pegged and hybrid system

-Peggeed refers to when a currency value is tied to anpther major currency (Denmarks pegs its currency(Danish krone) to the euro

What are the 3 Advantages of a flexible exchange rate and what are the 3 disadvantages to a flexible exchange rate and explain asseblief

• Automatic

• International liquidity

• Domestic policy

• Speculation

• Uncertainty for…

• Lack of discipline

• In point 2 (Maintaining the Peg),they mean demand for the domestic currency (the one being pegged).

• EXAMPLE

• Suppose South Africa pegs the Rand to the US dollar at R10 = $1.

  • If foreigners suddenly want more Rand (to buy SA exports or invest in SA assets), the demand for Rand rises.

  • Normally, this extra demand would push the Rand’s value up (say to R8 = $1).

  • To stop that appreciation and keep the peg at R10 = $1, the SA Reserve Bank sells Rand (TO WHOEVER needs it in the forex market to buy SA goods and services) and buys dollars. By increasing Rand supply, it balances demand and holds the exchange rate steady.

What are the 6 Advantages of fixed Exchange rates

• Discipline

• Speculation

• Boosts

• Investment

• Stability & ___

• Inflation

Difference between monetary and fiscal policy

Monetary policy is how a country’s central bank (like the Reserve Bank) manages money supply and interest rates to control inflation, stabilize the currency, and support growth, while fiscal policy is how the government uses taxation and public spending to influence demand, employment, and overall economic activity; in short, monetary policy works through credit and money, fiscal policy works through taxes and budgets.

👉 Shortcut cue: Monetary policy = central bank, interest rates, money supply; Fiscal policy = government, taxes, spending.

What are the disadvantages of fixed exchange rate

• Dependency

• Limited —- policy

• Vulnerability to ____

• ____ imbalances

  
  

EXPLANATION OF TRADE IMBALANCES:

• If the pegged country’s currency is overvalued (too strong compared to its true market value), its exports become expensive and fall, while imports become cheap and rise.

• This imbalance means the pegged country is buying more from abroad than it sells — leading to a trade deficit in its own current account.

• The anchor/reference country (like the US if the peg is to the dollar) isn’t directly affected in this way; the imbalance shows up in the pegging country’s trade flows.

👉 In short: the deficit belongs to the pegging country, because its strong currency hurts exports and boosts imports, worsening its own current account.

Fixed exchange rates come with limited monetary policy,what does that mean??

• What do countries prioritize

• when Currency under depreciation pressure what does Central bank do

• Currency appreciating, what does central bank do

• What’s the trade-off

• bank may lower interest rates. Lower returns discourage foreign inflows, reducing demand for the domestic currency and preventing it from becoming too strong. Why is being too strong a problem?

  • he central bank uses interest rates mainly to stabilize the exchange rate, even if that conflicts with domestic goals like controlling inflation or boosting growth.

• What’s a hybrid system

• How does it work

  • Buy & sell currency to maintain

  • Interventions are____

• What is its purpose

  • Reduce(speculative attacks)

  • Maintain competitiveness in ___

• How are fluctuating exchange rates managed

• How does the central bank avoid this and make equilibrium unchanged

• Central bank intervenes when needed to influence the currency’s value in line with _______

• Why does CB depreciate the currency

  • balance

  • reduce risk of (2)

  • Shift economy

• Why may CB appreciate the currency

  • Curb ___

  • Lower the cost of ___

Deflationary recession

• When the central bank raises interest rates to defend the currency, borrowing becomes expensive.

• Less borrowing → less spending → demand falls → economy slows → risk of recession with falling prices (deflation).

• Higher D prices,more expensive,less demand etc.

Curb demand‑pull inflation

• If the economy overheats (too much demand pushing prices up), higher interest rates(on loans/credit) reduce spending power.

• Less demand → slower price increases → inflation is curbed.

• What are the two major components of the balance of payments

• Current account & Financial account

Explain whats in each point

What is ‘Balance on current account’

Whats a trade surplus/deficit

What three things does balance on current account measure

What does the financial Account record and track

What are the 4 main components

• D investment

• P investment

• ____ derivatives

• O investments

Is having a current account in deficit a bad thing

Short answer: Yes and No

Why??