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EC140 - Intro to Macroeconomics > Chp25 - The Exchange Rate and the Balance of Payments > Flashcards

Chp25 - The Exchange Rate and the Balance of Payments Flashcards

1
Q

Foreign Currency

A
  • the money of other countries regardless of whether that money is in the form of notes, coins, or bank deposits
  • purchased on the foreign exchange market
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2
Q

Foreign Exchange Market

A
  • where currency of one country is exchange for currency of another country
  • made up of thousands of people; foreign exchange brokers
  • A competitive market; demand and supply determine price
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3
Q

Exchange Rate

A
  • price of one currency in terms of another; price determined by the market
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4
Q

Factors influencing Demand in Foreign Exchange Market

A
  • The Exchange Rate
  • World Demand for Canadian Exports
  • Interest Rates in Canada and Other Countries
  • The Expected Future Exchange Rate
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5
Q

The Law Demand for Foreign Exchange

A
  • the higher the exchange rate = the smaller the quantity of Canadian dollars demanded
  • The Exchange Rate influences quantity demand for two reasons: Exports Effect & Expected Profits Effect
  • Exports Effect: the larger the value of Canadian exports, the larger is the quantity of Canadian dollars demanded
    • low exchange rate = more dollar demand
  • Expected Profit Effect: larger the expected profit from holding CDN dollars, the greater demand for CDN dollars
    • low exchange rate = greater expected profit = greater demand
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6
Q

Demand Curve for Canadian Dollars

A
  • D Curve (negative)

- rise in exchange rate = lower dollar demand; move up along the curve (and vice versa)

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7
Q

Factors Influencing Supply in the Foreign Exchange Market

A
  • The Exchange Rate
  • Canadian Demand for Imports
  • Interest Rates in Canada and other Countries
  • The Expected Future Exchange Rate
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8
Q

The Law of Supply in Foreign Exchange

A
  • higher exchange rate = greater dollar supplied
  • exchange rate influences quantity of dollars supplied for two reasons: Imports Effect, Expected Profit Effect
  • Imports Effect: larger value of imports = larger quantity of dollars supplied
    • higher exchange rate = lower prices for foreign goods = greater imports = greater supply of CDN dollars
  • Expected Profit Effect: higher exchange rate = larger expected profit from selling CDN dollars = greater dollars supplied
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9
Q

Supply Curve for Canadian Dollars

A
  • S Curve (positive)

- rise in exchange rate = increased dollars supplied; movement up on the S curve (and vice versa)

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10
Q

Equilibrium Exchange Rate

A
  • forces of supply and demand constantly pull foreign exchange market towards equilibrium
  • gap above equilibrium is surplus and below is deficit
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11
Q

Causes of Change in Demand for CDN Dollars

A
  • World demand for CDN exports
  • CDN interest rate relative to foreign interest rate
    • CDN rate - foreign rate = CDN Interest Rate Differential
    • larger the differential = greater demand for dollars
  • The Expected Future Exchange Rate
    • higher expected exchange = more demand
  • Increase in Demand causes a rightward shift in the D curve
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12
Q

Causes for Change in Supply for CDN Dollars

A
  • Canadian Demand for Imports
  • Canadian Interest Rate Relative to Foreign Interest Rate
    • smaller differential = smaller supply
  • The Expected Future Exchange Rate
    • fall in expected exchange rate = increased supply
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13
Q

Changes in Exchange Rate

A
  • Demand for dollar increases & supply does not change = rise in exchange rate (and vice versa)
  • supply of dollar increases & supply does not change = fall in exchange rate (and vice versa)
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14
Q

Fundamental Influences on Exchange Rate

A
  • World Demand for CDN Exports, CDN demand for imports, CDN interest rate relative to foreign
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15
Q

Arbitrage

A
  • practice of buying in one market and selling for a high price in another related market

Interest Rate Parity: equal rates of return
- funds move to get the highest expected return

Purchasing Power Parity: equal value of money
- where the price of the same product is the same in respective currencies

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16
Q

Nominal v. Real Exchange Rate

A
  • Nominal: the amount of one money that another money buys

- Real: the relative price of CDN produced goods to foreign ones

17
Q

The Real Exchange Rate

A
  • RER = (E - P)/P*
    • E = Exchange Rate
    • P = CDN Price Level
    • P* = Foreign Price Level
  • In the Short Run
    • Real Changes with Nominal
  • In the Long Run
    • Real does not change with Nominal
    • Supply/Demand determine market prices
    • quantity of money determines price level
18
Q

Exchange Rate Policy

A
  • Three possible policies

Flexible Exchange Rate
- determined by supply/demand with no direct intervention of stat

Fixed Exchange Rate
- Exchange rate is pegged by state; action is taken by central bank to ensure exchange rate stays at decided level (buying/selling of own currency)

Crawling Peg
- exchange rate that follows a path set by state

19
Q

Balance of Payments Accounts

A
  • records and country’s international trading, borrowing, and lending in three accounts

Current Account: equals the sum of exports - imports, net interest income, net transfers

Capital and Financial Account: records foreign investment in Canada minus Canadian investment abroad

Official Settlements Account: records change in Canadian official reserves (gov holdings of foreign currency)
- increase in holdings = account negative (vice versa)

  • Sum of the balances of these three accounts should always be negative
20
Q

Net Borrower/Lender

A
  • state that is borrowing more than lending: Borrower

- state that is lending more than borrowing: Lender

21
Q

Debtor v. Creditor Nation

A
  • Debtor: nation that his historically borrowed more than it has lent
  • Creditor: nation that has historically lent more than it has borrowed
22
Q

Current Account Balance

A

CAB = NX + Net Interest Income + Net Transfers

23
Q

Net Exports

A
  • determined by gov. budget, private saving, and investment
    • exports minus imports

Gov Sector Balance: Net Taxes - Gov Expenditure

Private Sector Balance: Saving minus Investment

Net Exports = Gov Balance + Private Balance

EC140 - Intro to Macroeconomics (9 decks)

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