International and Balance of

Payments Issues in the Macro

Economy

Chapter 15
 Exchange Rates

 The currency exchange rate is how much of

one currency can be exchanged for another, or
the price of one currency in terms of another.

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 Recent Exchange Rates
R (UNITS OF FOREIGN 1/R ($ PER UNIT OF
CURRENCY
CURRENCY PER $) FOREIGN CURRENCY)
January 2005 January 2006 January 2005 January 2006
Euro (E) 0.76 0.82 1.31 1.21
Japanese yen (¥)
($/100¥) 103 115 0.97 0.87
Trade-weighted $
($/100 units) 109 110 0.92 0.91
January 2007 January 2008 January 2007 January 2008
Euro (E) 0.77 0.68 1.30 1.47
Japanese yen (¥)
($/100¥) 120 108 0.83 0.93
Trade-weighted $
($/100 units) 108 98 0.93 1.02
3 Source: Federal Reserve Statistical Release, Copyright © 2010 Pearson Education, Inc.
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 Currency Appreciation and
Depreciation

 When a currency  When a currency

appreciates in value, depreciates in value,
that currency can be that currency can be
exchanged for more exchanged for fewer
units of another units of another
currency or, the currency or the value
value of R increases. of R decreases.

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 Effect of Dollar Appreciation and Depreciation
on U.S. Exports and Imports

DOM. Jan 05: Jan 06: EFFECT ON EXPORTS (X)

R = ¥/$
PRICE R = 103 R = 115 AND IMPORTS (M)
Exports:
Computers
$10,000 ¥1.03 m. ¥1.15 m. X decreases
Imports:
Jap. Cars
¥2.0 m. ≈ $19,400 ≈ $17,400 M increases

Jan 07: Jan 08:

R = 120 R = 108
Exports:
Computers
$10,000 ¥1.2 m. ¥1.08 m. X increases
Imports:
Jap. Cars
¥2.0 m. ≈ $16,700 ≈ $18,500 M decreases

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 Balance of trade

 The relationship between a country’s export

and import spending, which can be positive if
there is a trade surplus (exports exceed
imports) or negative if there is a trade deficit
(imports exceed exports).

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 Determinants of U.S. Net Exports
(X – M)

Relation to U.S. Net

Determinant
Exports
Negative – higher U.S. income,
Income in the U.S.
lower U.S. net exports
Positive – higher income in the
Income in the rest of the world rest of the world, higher U.S. net
exports
Negative – higher exchange
Exchange rate
rates, lower U.S. net exports

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 Equilibrium in the Open Economy

U.S. Balance of Trade U.S. Capital Flows

Capital outflow from U.S. to

trade surplus (X - M) > 0)
rest of the world

Capital inflow from the rest

trade deficit (X – M) < 0
of the world to the U.S.

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 U.S. International Transactions in
2007

 A comprehensive measure of all economic

activity between a country and the rest of the
world.

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 The Current Account

 A measure of the current flows of goods,

services, investment income, and unilateral
transfers between a country and the rest of the
world.

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 U.S. Balance of Payments, 2007
(billion $)
CURRENT ACCOUNT TRANSACTIONS
Exports of goods and services $ 1,628
Imports of goods and services -2,337
Trade balance $-709
Receipts on U.S. assets abroad 782
Payments on foreign assets in United States -708
Net investment income 74
Unilateral transfers -104
Current account balance $-739

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 The Financial Account

 A measure of the change in the stock of real

assets (buildings, property, etc.) and financial
assets (bank deposits, securities, etc.) held by
a country’s residents in foreign countries and
by foreigners in the given country.

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 U.S. Balance of Payments, 2007
(billion $)
FINANCIAL ACCOUNT TRANSACTIONS

Change in U.S. holdings of foreign assets (ko) -1,206

Change in foreign holdings of U.S. assets (ki) 1,864

Statistical discrepancy 81

Net Capital Flows to United States $ 739

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 Revenue or T-Account

 An accounting statement that shows expense-

generating items on the left-hand or debit side
and income-generating items on the right-hand
or credit side.

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 Revenue or T-Account for 2007
Balance of Payments (billion $)
PAYMENTS RECEIPTS
(IMPORT-TYPE TRANSACTIONS: (EXPORT-TYPE TRANSACTIONS:
DEBIT [-]) CREDIT [+])
Imports of goods & Exports of goods &
$2,337 $1,628
services services
Payments on foreign
Receipts on U.S. assets
assets 708 782
abroad
in United States
Change in foreign holdings
Unilateral transfers 104 1,864
of U.S. assets
Change in U.S. holdings
1,206 Statistical discrepancy 81
of foreign assets
Total $4,355 Total $4,355
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 Demand for Dollars in Foreign
Exchange Market

UNITED STATES
IF JAPAN IF JAPAN
SELLS TO RESULT
PAYS IN $ PAYS IN ¥
JAPAN

In foreign
Japan sells United States
exchange Qd $
¥ to buy $ sells ¥ to buy $
market

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 Supply of Dollars in Foreign
Exchange Market
UNITED STATES IF UNITED IF UNITED
BUYS FROM STATES STATES RESULT
JAPAN PAYS IN $ PAYS IN ¥
In foreign
Japan sells United States
exchange Q s$
$ to buy ¥ sells $ to buy ¥
market

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 Determinants of Currency Supply
and Demand

 Exchange rate
 Relative incomes in two countries
 Relative interest rates in countries

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 Equilibrium in Foreign Exchange
Markets

 Equilibrium in the R = ¥/$

S0
foreign exchange
(dollar) market is
achieved at that A
1
exchange rate where
the quantity demanded
of dollars equals the
quantity supplied of
dollars. D0

100 Q$
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 Flexible exchange rate system

 A system in which currency exchange rates are

determined strictly by the forces of demand for
and supply of the currencies and there is no
intervention by any country’s central bank in
order to influence the level of exchange rates.

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 Fixed exchange rate systems

 A system in which the central banks of various

countries intervene in the foreign exchange
market to maintain or stabilize currency
exchange rates.
– A gold standard is a fixed rate system in which central banks
agree to buy and sell gold to keep exchange rates at a given
level.
– A managed float is a fixed rate system in which central banks
buy and sell foreign currency to maintain exchange rates at a
given level.

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 International Monetary Institutions
 The International Monetary Fund (IMF) is an
international financial organization created at the
Bretton Woods conference in 1944 that helps
coordinate international financial flows and can arrange
short-term loans between countries.
 The World Bank is an international financial
organization created at the Bretton Woods conference
in 1944 that helps developing countries obtain low-
interest loans.

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 Flexible Exchange Rate System
Equilibrium
 An increase in U.S. income, R = ¥/$
S0
all else held constant,
results in an increased S1
supply of dollars in the
foreign exchange market. 1
Under a flexible exchange
rate system, this increased .5
supply of dollars results in a
lower exchange rate or a
depreciation of the dollar. D0

100 125 150 Q$

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 Fixed Exchange Rate System
Equilibrium
 The Federal Reserve R = ¥/$
S0
intervenes to maintain a
S1
fixed exchange rate. In
response to an increased
supply of dollars, the 1
Federal Reserve must
.5
increase the demand for
dollars by selling its D1
reserve assets for D0
dollars.
100 125 150 Q$

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 Policy Examples of International
Economic Issues
 The U.S. Economy, 1995–2000
 The U.S. Economy, 2007–2008
 Effects of the Euro in the Macroeconomic Environment
 Euro Macro Environment Effectson Managerial
Decisions
 Southeast Asia: An Attempt to Maintain Fixed Exchange
Rate
 Macro and Managerial Impact of the Chinese Yuan
Since 2003

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 Effects of Exchange Rate Systems
on Domestic Money Supply

FLEXIBLE FIXED

The domestic money supply automatically adjusts

to eliminate BP disequilibrium (through flows of
gold or currency).
The exchange rate
automatically
adjusts to eliminate BP The Fed sterilizes
disequilibrium (Qs = Qd). (through open market
The Fed does nothing,
operations) and
allowing MS to adjust.
maintains BP
disequilibrium.

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