Unit 9 Flashcards
(22 cards)
Balance of Payments
-Difference between all the money flowing in and out
-An accounting system that records all of a country’s international transactions in a given year
-Money coming in is recorded as a CREDIT (INFLOW)
-Money going out is recorded as a DEBIT (OUTLFOW)
-All international transactions are recorded in either the CURRENT Account or the CAPITAL/FINANCIAL Account
The Current Account
- Trades in Goods + Services (net exports)
- Income earned from abroad
- One-Way Transfers
The Capital/Financial Account
- Purchases of Financial Assets
-flow of funds from international investors
-Foreign Direct Investment = purchases of physical assets
-Purchase of securities, bonds, shares of stock (“foreign financial assets”) = want higher interest rates to buy things like bonds + stocks
CA + CFA = 0
CA = -CFA
This means:
-A current account deficit will be offse tby a financial account surplus
-A current account surplus will be offset by a financial account deficit
Exchange Rates
-The price at which currencies are traded
-Price of one nation’s currency in terms of another’s
-Can be fixed or floating (usually floating –> determined by supply + demand)
Appreciation
-The increase in value of a country’s currency w/ respect to a foreign currency
-One USD buys more of a foreign currency and therefore buys more foreign goods
-The dollar is said to be “stronger”
Depreciation
-The decrease in value of a country’s currency w/ respect to a foreign currency
-One USD buys less of a foreign currency and therefore fewer foreign goods
-The dollar is said to be “weaker”
In the market for USD, foreigners…
DEMAND dollars; are represented on the demand curve; based on foreign demand for U.S. Goods, Services, and Financial Assets
In the market for Yen, Americans
SUPPLY dollars; represented on the supply curve; base don U.S. demand for Foreign Goods, Services, and Foreign Financial Assets
Tariffs
Tax on imports
Quotas
Limit on the quantity of imports
If USD appreciates/depreciates…
-USD appreciates: exports dec b/c foreign currency has less buying power in the U.S., imports inc, net exports dec, AD dec
-USD depreciates: the reverse occurs
Central Banks not only monitor domestic money supply, they also keep their eyes on the exchange rate. In order to influence exchange rates + the value of their currency, central banks hold…
reserves of foreign currencies. In a currency crisis, this gives them the ability to increase the supply of foreign currencies and purchase their own currency (appreciating it)
Current Account Surplus (Financial Account Deficit) Pros and Cons:
-Pros: Export more –> strong export market, Jobs in export sectors
-Cons: Financial investment leaving (the country)
Current Account Deficit (Financial Account Surplus) Pros and Cons:
-Pros: Financial investment, foreign goods
-Cons: Trading deficit
Currency Markets
-Just like a free market for any good, the market for a currency will be determined by supply and demand
-If the rate is above equilibrium, a surplus will push prices down
-If the rate is below equilibrium, a shortage will push prices up
Central Banks and Currency Markets
-Central banks hold foreign currency reserves that they can use to influence the value of their own currency
-To help maintain a strong currency, the central bank can demand their own and sell foreign currency
-To help maintain a weak currency, the central bank can sell their own and demand foreign currency
Why will a current account deficit result in a financial account surplus?
Foreigners who receive payment for our imports will seek a greater return for dollars and buy US financial assets
Why would a country want to operate with a current account deficit and a financial account surplus?
More investment from abroad and greater variety of foreign goods –> capital stock formation and long-term growth
Why would a country want to operate with a financial account deficit and a current account surplus?
Growth in export jobs and strong exporting industry
–> GDP and national income benefits
Quantity Theory of Money
M x V = P x Y
-M = money supply
-V = velocity of money: how many times a dollar is spent in a given year (generally stable)
-P = price level
-Y = real output (relatively stable)
- P x Y = nominal GDP
- M x V = total amount of money spent in the economy
-Both sides represent total value of goods + services produced in an economy!
-Therefore, changes in M are linked with changes in P (since V and Y are relatively stable)
What the quantity theory of money tells us:
-Real output is independent of changes in money supply
-Changes in the money supply can only affect price level and nominal GDP in the long run
-Changes of inflation (price level) are the result of sustained changes in money supply
