UNIT 8 VOCABULARY: THE OPEN ECONOMY: INTERNATIONAL TRADE AND FINANCE Flashcards
Balance of Payments Accounts:
Definition: A record of all economic transactions between residents of one country and the rest of the world over a specific period. It includes the current account, financial account, and capital account.
Example: If a country exports goods and receives foreign investment, both transactions are recorded in its balance of payments accounts.
Current Account:
Definition: A component of the balance of payments that records a country’s transactions involving goods, services, income, and current transfers. It includes trade balance (exports minus imports), net income from abroad, and net current transfers.
Example: If a country exports more goods than it imports, it has a trade surplus in the current account.
Financial Account:
Definition: A component of the balance of payments that records transactions involving financial assets and liabilities. This includes foreign direct investment, portfolio investment, and changes in reserve assets.
Example: If foreign investors purchase stocks and bonds from a country, these transactions are recorded in the financial account.
Foreign Exchange Market:
Definition: A global marketplace where currencies are traded. It determines the exchange rates between different currencies.
Example: Banks and financial institutions trade currencies in the foreign exchange market to facilitate international trade and investment.
Exchange Rates:
Definition: The price at which one currency can be exchanged for another. It determines how much of one currency you can get for a unit of another currency.
Example: If the exchange rate between the U.S. dollar and the euro is 1.2, one U.S. dollar can be exchanged for 1.2 euros.
Appreciation:
Definition: An increase in the value of one currency relative to another currency. This means that the currency can buy more of the other currency.
Example: If the U.S. dollar appreciates against the euro, it means that one U.S. dollar can buy more euros than before.
Depreciation:
Definition: A decrease in the value of one currency relative to another currency. This means that the currency buys less of the other currency.
Example: If the Japanese yen depreciates against the U.S. dollar, it means that one yen buys fewer U.S. dollars than before.
Equilibrium Exchange Rate:
Definition: The exchange rate at which the quantity of a currency demanded equals the quantity supplied in the foreign exchange market. It represents a balance where there is no pressure for the rate to change.
Example: If the market-clearing exchange rate between the British pound and the U.S. dollar is 1.4, this is the equilibrium exchange rate where supply and demand for pounds and dollars are balanced.
Real Exchange Rate:
Definition: The nominal exchange rate adjusted for differences in price levels between two countries. It reflects the relative purchasing power of currencies.
Example: If the nominal exchange rate is 1.2 and the price level in the U.S. is higher than in the Eurozone, the real exchange rate adjusts to reflect this price difference.
Purchasing Power Parity (PPP):
Definition: A theory that states that in the long run, exchange rates should adjust so that identical goods or services cost the same amount in different countries when priced in a common currency.
Example: If a hamburger costs $5 in the U.S. and €4 in Germany, PPP suggests that the exchange rate should adjust so that $5 = €4, which implies an exchange rate of 1.25 dollars per euro.
Exchange Rate Regime:
Definition: The system or policy a country uses to manage its currency’s value relative to other currencies. It includes fixed, floating, or managed exchange rate systems.
Example: A country might choose a floating exchange rate regime where the currency’s value is determined by market forces, or a fixed exchange rate regime where the currency is pegged to another currency.
Fixed Exchange Rate:
Definition: A system where a country’s currency value is pegged or tied to another major currency or a basket of currencies. The central bank maintains this fixed rate through interventions.
Example: If a country pegs its currency to the U.S. dollar at a rate of 1:1, it means the currency’s value remains stable relative to the dollar.
Floating Exchange Rate:
Definition: A system where the value of a country’s currency is determined by supply and demand in the foreign exchange market. The currency value fluctuates freely based on market conditions.
Example: In a floating exchange rate system, if there is high demand for the Australian dollar, its value will rise relative to other currencies.
Exchange Market Intervention:
Definition: Actions taken by a central bank or government to influence the value of their currency by buying or selling currencies in the foreign exchange market.
Example: To prevent its currency from depreciating, a central bank might buy its own currency in the foreign exchange market to increase its value.
Foreign Exchange Reserves:
Definition: The stock of foreign currencies held by a central bank. These reserves are used to influence the exchange rate and to settle international transactions.
Example: A country may hold reserves of U.S. dollars, euros, and other major currencies to manage its own currency’s value.
