Chapter 19 Flashcards
Balance of payments accounts
A summary of the country’s transactions with other countries
Factor income
The income countries pay for the use of factors of prodution owned by residents of other countries
ex. interest paid on loans from overseas; profits of foreign-owned corporations; disneyland paris profits, wages of an American engineer who works temporarily on a construction site in Dubai are counted in the second column
International transfers
Funds sent by residents of one country to residents of another
ex. remittances that immigrants, such as mexican born workers employed in U.s., send to their families in their country of origin
Most of sales involved in Official asset sales and purchases involved _____________________
the accmumulation of foreign exchange reserves by the central bank of China and oil-exporting countries
Purchase of Ford Motor Company’s Volvo brand by the Chinese company Greely Automobile
Private sales and purchases of assets: payments from foreigners
Purchases of European stocks by U.S. investors
Private sales and purchases of assets: payments to foreigners
The balance of payments accounts distinguish between _______________________
transactions that don’t create liabilities and those that do
Balance of payments on current account; current account
Its balance of payments on goods and services plus net international transfer payments and factor income
Balance of payments on goods and services
The difference between its exports and its imports during a given period
*most important part of the current account
Merchandise trade balance
or
“trade balance”
The difference between a country’s exports and imports of goods
*doesn’t include services
**used because data on international trade in services aren’t as accurate as data on trade in physical goods, and they are also slower to arrive
The current account consists of international transactions that _____________
don’t create liabilities
Balance of payments on financial account
or
“financial account”
or
“capital account”
The difference between its sales of assets to foreigners and its purchases of assets from foreigners during a given period
*international transactions that do create future liabilities are included here
Financial account surplus:
the value of the assets it sold to foreigners was more than the value of the assets it bought from foreigners
current account deficit
the amount it paid to foreigners for goods, services, factors, and transfers was more than the amount it received
Current and financial account formula
Current account (CA) + Financial Account (FA) = 0
CA = -FA
Gross national product
includes international factor income
Why do economists use GDP rather than a broader measure?
- original purpose of national acounts was to track production rather than income
- Data on international factor income and transfer payments are generally considered somewhat unreliable
Circular flow diagram equation
Positive entries on current account - Negative entries on current account + Positive entries on financial account - Negative entries on financial account = 0
Financial account measures what?
measures a country’s net sales of assets to foreigners
A country’s financial account is a measure of _______________
capital inflows
Capital inflows
Foreign savings that are available to finance domestic investment spending
Direct foreign investment
When companies build factories or acquire other productive assets abroad
exchange rates
The relative values of different national currencies
Capital tends to flow from ________________________
slowly growing to rapidly growing economies
Government budget deficits ____________________
reduce overall national savings, can lead to capital inflows
net capital flows
The excess of inflows into a country over outflows, or vice versa
Why aren’t out capital flows the same as previous ones?
Migration restrictions
Political risks
A country that receives net capital inflows must run a ______________
matching current account deficit
A country that generates net capital outflows must run a ________________
matching current account surplus
Foreign exchange market
Where currencies are traded
Exchange rates
The prices at which currencies trade
Appreciates
When a currency becomes more valuable in terms of other currencies
Depreciates
When a currency becomes less valable in terms of other currencies
Value of 1 euro goes from $1 to $1.25
Means that the value of US$1 went from 1 euro to 0.80 euro (1/1.25)
Euro appreciated and U.S. dollar depreciated
If exchange rate is 1.25 euros = $1
French hotel room is 20% cheaper
1.25/1
If exchange rate is 0.80 euros = US$1
French hotel room is 25% more expensive than American hotel room
1/.80
When a country’s currency appreciates (becomes more valuable) _________________
exports fall and imports rise
When a country’s currency depreciates (becomes less valuable) __________________
exports rise and imports fall
The quantity of U.S. dollars demanded falls as the number of _____________________
euros needed to buy a U.S. dollar rises
The quantity of U.S. dollars demanded rises as the number of ___________________
euros needed bo buy a U.S. dollar falls
Why supply curve is upward
The more euros required to buy a U.S. dollar, the more ____________________
dollars Americans will supply
Equilibrium exchange rate
The exchange rate at which the quantity of a currency demanded in the foreign exchange market is equal to the quantity supplied
If the demand for U.S. dollars increases (shifts to right)
Equiplibrium number of euro per U.S. dollar rises - dollar apreciates against the euro
Balance of payments on current account falls
Balance of payments on financial account rises
Any change in the U.S. balance of payments on financial account generates ___________________________
an equal and opposite reaction in the balance of payments on current account
Real exchange rates
Exchange rates adjusted for international differences in aggregate price levels
The exchange rate unadjusted for aggregate price levels are sometimes called________________
nominal exchange rate
Real exchange rate =
Mexican pesos per U.S. dollar x (Price level us / price level mexico)
The current account responds only to changes in _______________________
the real exchange rate, not the nominal exchange rate
A country’s products become cheaper to foreigners only when that country’s currency _______________
depreciations in real terms
A country’s products become more expensive to foreigners only when the currency ______________
appreciates in real terms
Purchasing power parity
The purchasing power parity between two countries’ currencies is the nominal exchange rate at which a given basket of goods and services would cost the same amount in each country
When the nominal exchange rate is ____________ thepurchasing power parity, the basket is cheaper in that country
above
What does the nominal exchange rate determine?
The price of imports and exports
Movements in the exchange rate can have major effects in countries were exports and imports are large percentages of GDP by__________________________
affecting aggregate output and aggregate price level
Exchange rate regime
A rule governing policy toward the exchange rate
Fixed exchange rate
When the government keeps the exchange rate against some other currency at or near a particular target
Floating exchange rate
When the government lets market forces determine the exchange rate
Exchange market intervention
Government purchases or sales of currency in the foreign exchange market
Foreign exchange reserves
Stocks of foreign currency that governments maintain to buy their own currency on the foreign exchange market
For governments to keep the value of their currency down through market intervention they must __________________
buy foreign assets
Foreign exchange controls
Liscensing systems that limit the right of individuals to buy foreign currency
3 ways to support a currency
- “soak up” the surplus of genos by buying its own currency in the foreign exchange market
- shift supply and demand by changing monetary policy (increasing interest rates)
- Reducing the supply of currency to the foreign exchange market - foreign exchange controls –>increases the value of a country’s currency
To keep the geno from rising above $1.50, the Genovian government can _________________________
sell genos and buy U.S. dollars.
How to keep exchange rate below equilibrium?
- Selling domestic currency and acquiring US dollars, which it can add to its foreign exchange reserves
- Reduce interest rates to increase the supply of genos and reduce the demand
- Impose foreign exchange controls that limit the ability of foreigners to buy genos
*all reduce the value of the geno and keep it below equilibrium
Additional benefit to adopting a fixed exchange rate: by committing itself to a fixed rate, a country is also committing itself not to _________________________
engage in inflationary policies
Costs to fixing the exchange rates
- a country must keep large quantities of foreign currency on hand - low return investment
- if they use monetary policy, they must divert from other goals such as stabilizing the economy
- foreign exchange controls distort incentives for importing and exporting goods and services
- create substantial costs in terms of red tape and corruption
A country that lets its currency float _________________________________________
leaves monetary policy available for macroeconomic stabilization but creates uncertainty for business
Fixing the exchange rate ________________________
eliminates the uncertainty but means giving up monetary policies and/or adoipting exchange controls
currency crises
Episodes in which widespread expectations of imminent devaluations led to large but temporary capital flows
What countries did not adopt the euro?
Britain
Sweden
Devaluation
A reduction in the value of a currency that is set under a fixed eschange rate regime
*A devaluation is a depreciation that is due to a revisioin in a fixed exchange rate
depreciation
a downward move in currency
Revaluation
An increase in the value of a currency that is set under a fixed exchange rate regime
Devaluation causes:
Makes domestic goods cheaper => higher exports
Makes foreign gods more expensive => reduces imports
*increases the balance of payments on current account
Revaluation causes:
Makes domestic goods more expensive => reduces exports
Makes foreign goods cheaper => increases imports
*reduces the balance of payments on current account
Devaluation increases ________________
aggregate demand
can be used to reduce a recessionary gap
Revaluation reduces ______________
aggregate demand
*can be used to reduce or eliminate an inflationary gap
Devaluations and revaluations serve two purposes under fixed exchange rates:
- Can be used to eliminate shortages or surpluses in the foreign exchange rate
- Can be used as tools of macroeconomic policy
A reduction in the interest rate’s effect on the foreign exchange market graph
Shift supply to the right => genovians invest more abroad, buying more U.S. dollars and selling more genos
Shift demand to the left => foreigners invest less in Genovia, reducing their demand for genos
A recession leads to a ________________________ and an expansion leads to a ____________________
fall in imports; rise in imports
One of the virtues of a floating exchange rate
Is that they help insulate countries from recessions originating abroad
