Foreign Exchange Market Activities

Unit 2

microeconomics

studies the world’s scarce productive resources through the perspective of individual firms and consumers 

macroeconomics

studies how economies’ overall levels of employment, production, and growth are determined

4 aspects of life (macro)

1. unemployment 

2. saving 

3. trade imbalances 

4. money and price level

Gross National Product

value of all final goods and services produced by a country’s factors of production, sold on the market in a given period of time

NIPA (National Income and Production Accounting)

double-entry system similar to how firms account for transactions (each entered as debit and credit so sum is zero)

Balance of Payments (BOP)

trade accounting

factors of BOP

• products and services

• assets and reserves

• incomes and payments

BOP groups

1. current accounts

2. capital and financial accounts

3. statistical discrepancy

Current Account

“tangible” portion of trade

Current Account 5 components

1. exports of goods and services from U.S.

2. income received by US citizens

3. imports of goods/services to U.S.

4. income paid abroad to U.S. citizens abroad

5. secondary income receipts/payments

secondary income

unilateral transfers, grants, donations

GDP

Y = C + I + G + NX

what does NX equal

CA (current accounts)

consumption (C)

portion of GNP purchased by private households to fulfill current wants

Investment (I)

part of output used by private firms to produce future output

Government purchases (G)

any goods/services purchased by federal, state, local governments

Gross National Product (GNP)

value of all final goods and services produced by a country’s factors of production and sold on the market in a given time period

National Income

income earned in a period by factors of production

Gross Domestic Product (GDP)

measures volume of production within a country’s borders 

GNP

GNP = GDP + net receipts of factor income from the rest of the world

Adjustments to GNP definition

• GNP doesn’t take economic loss into account

• country’s income may include unrequited gifts from residents

National Income Equation

GNP - depreciation + net unilateral transfers

net national product

GNP - depreciation

Fundamental Identity for Closed Economies

Y = C+I+G

Y

GNP

C

Consumption

G

Government purchases

National Income Identity for Open Economies

Y = C+I+G+EX-IM

CA

EX - IM

CA deficit 

imports exceed exports 

CA surplus

Exports exceed imports

National Saving

portion of output that is not devoted to consumption or government purchases (investment for closed economy)

Closed economy saving

S = I

Open economy saving

S = I + CA 

private saving (S^P)

part of the disposable income saved rather than consumed

disposable income

Y - net taxes collected from households

government saving (S^G)

disposable income of the government saved rather than consumed

government income

T

government consumption

G

S^G

T - G

Forms of private saving

1. investment in domestic capital (I)

2. purchases of wealth from foreigners (CA) 

3. purchases of domestic government’s newly issued debt (G-T)

Positive CA

credits > debit

asset

any one of the forms in which people hold wealth

Financial Account of BOP

records all international purchases and sales of financial assets 

BOP balance

debits - credits (difference between country’s purchases and sales of foreign assets)

Capital Account

records transfers of wealth between countries stemming from nonmarket activities/acquisition of nonproduced, nonfinancial, intangible assets

Fundamental BOP Identity

CA + KA = Financial Account balance

statistical discrepancy

unrecorded or misrecorded transactions; difference between net financial flows and the sum of recorded CA & KA 

central bank

institution responsible for managing money supply

official international reserves

foreign assets held by central banks as a cushion against national economic misfortune

official foreign exchange intervention

when central banks buy or sell international reserves in private asset markets to affect macroeconomic conditions in their economies, interjecting money into the economy or withdrawing it from circulation

official settlements balance/balance of payments

level of net central bank financial flows