Balance of Payments and Exchange Rates

Flashcards based on Lecture 7 about Balance of Payments and Exchange Rates

What are the two directions recorded in the Balance of Payments (BOP)?

Credits (money coming in) and Debits (money going out)

What are the main components of the Balance of Payments?

Current account (CA), Financial account (FA), Net change in official international reserves (OR), and Statistical discrepancy

If a country saves less than it invests domestically, will it have a current account surplus or deficit?

Deficit

What does the Net International Investment Position (NIIP) represent?

The stock of international assets minus liabilities

What does it mean if a country's NIIP is positive?

The country is a net creditor to the world.

What is an exchange rate (E)?

The price of some foreign currency expressed in terms of a home currency.

If the US exchange rate against the euro rises (E$/e ↑), is the dollar appreciating or depreciating?

Depreciating

What is an effective exchange rate (EER)?

A weighted average of multiple exchange rates with different countries, where the weights are the share of trade going to each of those countries.

In the short run, when a currency depreciates, what happens to the quantity of exports?

Exports increase (home goods become cheaper for foreigners).

What is the foreign exchange market?

A market that globally trades trillions of dollars per day in currency.

What is a spot contract in the context of foreign exchange transactions?

A contract for the immediate exchange of one currency for another between two parties.

What is arbitrage in the context of foreign exchange?

Buying something for cheap and selling it for more, i.e., exploiting price differences in different markets.

What is the covered interest parity (CIP) condition?

A no-arbitrage condition where the dollar return on the dollar deposit equals the dollar return on the euro deposit, with exchange rate risk covered by a forward contract.

What is the uncovered interest parity (UIP) condition?

A no-arbitrage condition where the dollar return on dollar deposits equals the expected dollar return on euro deposits, without using a forward contract.