Unit5 Macro Review Foreign Exchange Balance of Payments

Unit-5 Macro Review Foreign Exchange & Balance of Payments

Determinants of Exchange Rates 1. 2. 3. 4. 5. Changes in Consumer Tastes Relative Income Changes Relative Inflation Relative Real Interest Rates Speculation & Investment U. S. Income Rises Demand Imports Market for Foreign Exchange Demand Foreign Currency Dollar Depreciates Foreign Appreciates

Graphing Exchange Rates = Market for Foreign Exchange Euro Price of a dollar Dollars Euros S 1 Dollar Price of a Euro ------- D 1 Q 1 D 2 Qty of Dollars S 2 -------------- 1. 3 $ . 75 Euro ------- S 1 Q 1 D 1 Qty of Euros U. S. Price Level Falls => U. S. goods look “cheap” => Europeans ↑U. S. exports => Demand for dollars ↑ => Dollar appreciates

Balance of Payments • Current Account (NX) If one account is positive the other must Be negative. They generally sum to ZERO! – U. S. Trade Balance – Exports - Imports & Investment Income (bond interest, stock dividends) • Financial Account (formerly called capital account) – Foreign purchase of US assets – U. S. purchase of foreign assets – Assets = Stocks, bonds, factories, land, etc… – Example: Capital Surplus = Capital flows into US

China & Balance of Payments • The USA imports more goods from China than we export to them… • Balance of Payments: China buys U. S. Bonds Capital Account Surplus Imports > Exports Current Account Deficit

Balance of Payments • Current Account (NX) If one is positive the other is negative. They generally sum to ZERO! – U. S. Trade Balance – Exports - Imports & Investment Income (bond interest, stock dividends) • Financial Account (formerly called capital account) – Foreign purchase of US assets – U. S. purchase of foreign assets If both accounts do Not sum to zero, reserves are used to Offset minor difference – Assets = Stocks, bonds, factories, land, etc… – Example: Capital Surplus = Capital flows into US • Official Reserves – Fed holds quantities of foreign currency called reserves – Used to offset discrepancy in current account vs. capital account