Chapter Seventeen Flashcards Preview

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Flashcards in Chapter Seventeen Deck (31):
1

Explain balance of payment accounts

A country's balance of payments accounts records it international trading borrowing and lending. Current account records goods and services to other countries exports minus payments for goods and services bought from other countries imports plus the net amount of interest and transfers received from and paid to other countries

2

Explain capital and financial accounts, reserve assets accounts and Australian official reserves

Capital and financial account: records foreign investment in Australia minus Australian investment abroad.

Reserve assets account records the change in Australia's official reserves

Australian official reserves: are the governments holding of foreign currency

3

Explain personal analogy

A persons current account records the income from supplying the services of factors of production and the expenditures of goods and services. An example in 2015 Joanne worked an earned an income of 25000 and had investments that paid an interest of $1000. Her income is analogous to a country's export while her 1000 of interest is analogous to a country's interest from foreigners. Joanne spent 18,000 buying goods and services to consume and bought an apartment which cost her $60,000. Joanne total expenditure was $78.000. Her expenditure is analogous to a country's imports. Her current account balance was $26,000 - $78000 so a deficit of $52000. To pay the deficit, Joanne borrowed fifty thousand from the bank and used two thousand that she had in her bank account. Joanne borrowing is analogous to a country borrowing from the rest of the world. The change I. Her bank account is analogous to the change in the country's official reserves.

4

Explain net borrowers and lender

Net borrower: is a country that is borrowing more from the rest of world than it is lending to the rest of the world

Net lender: is a country that is lending more to the rest of the world than it is borrowing from the rest of the world

5

Explain debtor and creditor nations

Debtor nation: is a country that during its entire history has borrowed more from the rest of the world than it has lent to it. A debtor nation has a stock of outstanding debt to the rest of the world that exceeds the stock of its own claims on the rest of the world.

Creditor nation: is a country that has invested more in the rest of the world than other countries have invested in it.

6

Explain flows and stock

Borrowing and lending are flows while debts are stocks eg amounts owned at a point of time. The flow of borrowing and lending changes the stock of debt.

7

Explain how to define the current account balance CAB

The largest items in the current account are exports and imports. So net exports are the main component of the current account. We can define the current account balance CAB as CAB = NX + net interest and transfer from abroad. Net interest and transfer from abroad are small and don't fluctuate much so to study the current account balance we look at what determines net exports.

8

Explain net exports

Private sector balance is saving minus investment

Government sector balance is equal to net taxes minus government expenditure on goods and services

9

Explain the foreign exchange market

Is the market in which the currency of one country is exchanged for the currency of another. The foreign exchange market is made up of importers and exporters banks and specialist dealers who buy and sell currencies.

10

Explain the foreign exchange rate

Is the price at which one currency exchanges for another. For example in May 2015, 1 Australian dollar bought 79 U.S. Cents. The exchange rate was 79 U.S. Cents per Australian dollar. We can also expres the exchange rate in terms of Australian dollars per U.S. Dollar which in May 2015 was 1.27 U.S. Dollars per Australian dollar.

11

Explain currency appreciation and depreciation.

Appreciation: is the rise in the value of one currency in terms of another currency. For exmae when the Australian dollar rose from 50 U.S. Cents in 2001 to 76 cents in 2014 the Australian dollar appreciated

Depreciation: is the fall in the value of one currency in terms of another currency. For example when the Australian dollar fell from 104 U.S. Cent in 2014 to 73 U.S. Cents in 2015 the Australian dollar depreciated.

It changes because the foreign exchange rate is a price and like all prices, demand and supply in the foreign exchange market determine its value.

12

Explain demand in the foreign exchange market

The quantity of Australian dollars demanded in the reign exchange market is the amount that traders plan to buy during a given period at a given exchange rate. The quantity of Australian dollars demanded depends on the exchange rate, interest rates in Australia and other countries and the expected future exchange rate.

13

Explain the law of demand in foreign exchange

Other things remaining the same, the higher the exchange rate, the smaller is the quantity of Australian dollars demanded. The exchange rate influences the quantity of Australian dollars demanded for two reasons: exports effect and expects profit effect

14

Explain exports effect

The larger the value of Australian exports, the larger is the quantity of Australian dollars demanded on the foreign exchange market. The lower the exchange rate, the cheaper are Australian made goods and services to people in the rest of the world, the more Australian exports and the greater is the quantity of Australian dollars demanded to pay for them.

15

Define expected profit effect

The larger the expected profit from holding Australian dollars, the greater is the quantity of Australian dollars demanded in the foreign echange market. But the expected profit depends on the exchange rate. The lower the exchange rate, other things remaining the same, the larger is the expected profit from holding Australian dollars and the greater is the quantity of Australian dollars demanded

16

What causes changes in the demand for Australian dollars

A change in any influence (other than the exchange rate) on the quantity of Australian dollars that people plan to buy in foreign exchange market changes the demand for Australian dollars and shifts the demand curve for Australian dollars. These influences are interest rates in Australia and other countries. Expected future exchange rates.

17

explain interest rates in Aus and other countries as a influence

Australian interest rate differential is the Australian interest rate minus the foreign interest rate. Other things remaining the same, the larger the Australian interest rate differential, the greater is the demand for Australian assets and the greater is the demand for Australian dollars on the foreign exchange market.

18

Explain the expected future exchange rate as an influence

Other things remaining the same, the higher the expected future exchange rate, the greater is the demand for Australian dollars. The higher the expected future exchange rate, the larger is the expected profit from holding Australian dollars so the larger is the quantity of Australian dollars that people plan to buy on the foreign exchange market.

19

Explain supply in the foreign exchange market

The quantity of Australian dollars supplied in the foreign exchange market is the amount that traders plan to sell during a given time period at a given exchange rate. The quantity of Australian dollars supplied depends on many factors, but the main ones are: the exchange rate, interest rate in Australian and other countries and the expected future exchange rate.

20

Explain the law of supply of foreign exchange

Traders supply Australian dollars in foreign exchange market when they buy other currencies. Other things remaining the same, the higher the exchange rate the greater is the quantity of Australian dollars supped in the foreign exchange market. The exchange rate influences the quantity of Australian dollars supplied for two reasons: imports effect and expects profit effect.

21

Explain imports effect

The higher the value of Australian imports, the larger is the quantity of foreign currency demanded to pay for these imports. When Australian importers buy foreign currency, they supply Australian dollars.

Other things remaining the same, the higher the exchange rate, the cheaper are foreigner made goods and services to Australians. So the more Australia imports, the greater is the quantity of Australian dollars supplied in the foreign exchange market.

22

Explained the expected profit effect

The larger the expected profit from holding a foreign currency, the greater is the quantity of that currency demanded. So the greater is the quantity of Australian dollars supplied in the foreign exchange market. The expected profit depends on the exchange rate. The higher the exchange rate, the larger is the expected profit from selling Australian dollars and so the greater is the quantity of Australian dollars supplied in the foreign exchange market.

23

What causes change in the supply of Australian dollars

A change in any influence (other than the current exchange rate) on the quantity of Australian dollars that people plan to sell in the foreign exchange market changes the supply of Australian dollars and shifts the supply curve for Australian dollars. These influences are interest rates in Australia and other countries and expects future exchange rates.

24

Explain interest rates in other countries and Australia as a supply influence

The larger the Australian interest rate differential, the smaller is the demanded for foreign assets, so the smaller is the supply of Australian dollars on the foreign exchange market.

25

Explain the expected future exchange rate as a supply influenced

Other things remaining the same, the higher the expected future exchange rate, the smaller is the expected profit from selling Australia dollars today so the smaller is the supply of Australian dollars in the foreign exchange market today.

26

Explain market equilibrium

Demand and supply in the foreign exchange market determines the exchange rate. If the exchange rate is too low, there is shortage of Australian dollars. If the exchange rate is too high, there is a surplus of Australian dollars. At the equilibrium exchange rate, there is neither a shortage nor a surplus of Australian dollars.

27

Explain why exchange rates are volatile

Sometimes the Australian dollar appreciates and at other times it depreciates but the quantity of Australian dollars traded each day barely changes. The main reason behind this is that demand and supply are not independent in foreign exchange market. The shocks that change the demand for a currency also change its supply. Because demand and supply change in opposite direction, price changes are large and quantity changes are small.

28

Explain exchange rate expectations

The answer is new information about the deeper forces that influence the value of money. There are two such forces: purchasing power parity and interest rate parity

29

Explain purchasing power parity

Purchasing power parity: means equal value of money - a situation in which money buys the same amount of goods and services in different currencies

30

Explain interest rate parity

Interest rate parity means equal interest rates - a situation in which the interest rate in one currency equals the interest rate in another currency when exchange rate changes are taken in account.

31

Explain the link between monetary policy and the exchange rate

Monetary policy influences the interest rate so the reserve banks actions influence the exchange rate. If the Australian interest rises relative to those in other countries, the value of the Australian dollar rises on the foreign exchange market. If the foreign interest rate rises relative to the Australian interest rate, the value of the Australian dollar falls on the foreign exchange market. So the change rate responds to monetary policy. But the reserve bank can intervene directly in the foreign exchange market to influence the exchange rate. The reverse bank can try to smooth out fluctuations in exchange rate by changing the supply of Australian dollars. The reserve bank changes the supply of Australian dollars on the foreign exchange market by buying or selling Australian dollars.