Chapter 15 Flashcards
Balance of payment
Record that summarizes all international transactions of a country with the rest of the world during a certain period
Credit in components of the balance of payment
Money comes into Canada (exports of goods/services)
Debit in components of the balance of payment
Money that goes out of Canada (imports of goods/services)
Trade Balance
Exports of goods - imports of good
Net Transfers
Inflow of transfers - outflow of transfers (eg. a grant or an aid)
Unilateral Transfers
Transfers that flow in one direction, we take and don’t give back, or give and do not give back,. a gift.
Net Investments income
The inflow of investment income(credit) - the outflow of investment income(debit) (eg. profits and interests). Both are recorded in current account, not capital.
Current Account
is a record of the net exports of goods and services and net transfers and net investment income
Capital account
Records flow of capital like investment and borrowing “loans”. Talking about the investment itself, (eg. me opening a restaurant in China is and outflow of capital in Canada)
Types of investment
Direct: Making a project
Indirect: Investing in the stock market, portfolio investment.
Both are recorded in the capital account.
Capital inflows
Recorded in the credit side
Capital outflows
Recorded in the debit side
International reserve ‘settlement; account
Holdings of gold and foreign currencies and foreign assets held by our central bank. This account is used to settle ‘balance’ the other two accounts so the balance of payment has to be zero=balanced.
Exchange Rate
Price(cost) of 1 foreign currency. How many CD$ to buy 1 unit of foreign currency
If the exchange rate increases
CD$ depreciates versus the other currency, CD$ becomes weaker. Canadian goods and services are now cheaper than foreign goods and our net exports increase.
Fixed (peged) Exchange rate system
Mainly used in developing countries exchange rate is determined by the central bank which uses his reserves of foreign currency to keep the exchange rate fixed.
If there is a shortage of foreign currency in the market the exchange rate goes up, so to prevent this the central bank will sell foreign currency into the market.
If there is a surplus of foreign currency the central bank will buy this surplus and add it to its reserves to prevent the exchange rate from decreasing.
Pure Floating(flexing)
the exchange rate is determined freely by the Demand and supply market. No intervention from central bank
Impure floating
The exchange rate is flexible as long as it is within a certain range “limits”. However the central bank will intervene once the exchange rate gets out of the limits.
Depreciation
currency becomes weaker on its own with no intervention from the central bank. This occurs due to market forces (demand and supply). It happens under a flexible exchange rate system like in Canada
Depreciation
currency becomes weaker on its own with no intervention from the central bank. This occurs due to market forces (demand and supply). It happens under a flexible exchange rate system like in Canada
Devaluation
Currency becomes weaker. This happens internationally by the central bank. This happens under a Fixed exchange rate system.
Appreciation
Currency becomes stronger due to the market forces
Revaluation
The central bank strengthens the currency internationally.
Fixed Exchange Rate Systems Benefits and Costs
Benefit: Less exchange rate fluctuation (Risk) which encourages trades and investments and this helps keep inflation low.
Cost: The country will not have an independent monetary policy it has to follow the monetary policy of the country that its change rate is tired to. –> Country becomes a follower
Pure Floating exchange rate system benefits and costs
Benefits: The country will have an independent monetary policy
Cost: Higher uncertainty and exchange rate risk. Negatively affects trade and investment.
Pure Floating exchange rate system benefits and costs
Benefits: The country will have an independent monetary policy
Cost: Higher uncertainty and exchange rate risk. Negatively affects trade and investment.
Balance the balance of payment
The balance of payment has to equal zero. This automatically happens under Floating exchange rate and the central bank has to balance it using its reserves under a Fixed exchange rate system
Balance the balance of payment
The balance of payment has to equal zero. This automatically happens under Floating exchange rate and the central bank has to balance it using its reserves under a Fixed exchange rate system
Derived Demand
The demand for foreign currency is a Derived demand. We demand foreign currency because we will use it to import or invest abroad. The supply of foreign currency reflects our exports to others. We export our goods and services to others to get their currency in return
Our national income (Factors affecting demand on foreign currency)
If our GDP increases we are now rich and our imports will increase causing our demand on foreign currency in Canada to increase
Our tariffs (Factors affecting demand on foreign currency)
If our tariffs increase then the imported items are now more expensive causing our imports to decrease because our demand on foreign currency in Canada has decreased.
if our tastes are in favor of foreign goods (Factors affecting demand on foreign currency)
Our imports will increase and our demand on foreign currency in Canada will also increase
Relative inflation rate (Factors affecting demand on foreign currency)
If our inflation rate increases compared to other countries, our goods and services are now more expensive so our consumers will prefer to import cheaper foreign goods causing our demand on foreign currency to increase.
Relative interest rate (Factors affecting demand on foreign currency)
If the foreign interest rate Is higher than the domestic interest rate then our bonds and savings accounts are now less attractive since they offer a lower return. Many of our people will prefer to save or invest in other countries and our demand for foreign currency will increase.
Expectations (Factors affecting demand on foreign currency)
If we expect the foreign currency to appreciate in the future then we will buy more of it now since we can sell it tomorrow at a higher price and our demand for foreign currency increases.
Foreign income (Factors affecting supply of foreign currency)
If foreign income increases then foreigners are now rich and they will buy more of our goods and services and our exports will increase so our foreign currency in Canada will increase
Foreign tariff (Factors affecting supply of foreign currency)
If our foreign tariff decreases then our foreigners will buy more of our goods and services since they are now paying less tariffs. This will cause our exports to increase and foreign currency in Canada to rise.
Expectations (Factors affecting supply of foreign currency)
If we expect the foreign currency to depreciate in the future then the people in Canada will get rid of their foreign currency so foreign currency in Canada will increase.
Relative interest rate (Factors affecting supply of foreign currency)
If our interest rate increases relative to other countries then foreigners will prefer to save their money in Canada or buy Canadian bonds to benefit from this higher return. This will cause foreigners to convert their currency into Canadian dollar and foreign currency in Canada will increase
Relative inflation rate (Factors affecting supply of foreign currency)
If our inflation is less than in other countries then Canadians’ goods and services are cheaper and foreigners will buy more of our goods and services. They will convert their currency into Canadian $ to buy our goods and foreign currency in Canada will increase.
In the graph, all 3 scenarios show what in common.
In the 3 cases, the price of foreign currency always increases and this will depreciate our currency.
