Copyright ©2001, South-Western College Publishing Contemporary Economics: An Applications Approach By Robert J. Carbaugh 1st Edition Chapter 17: International Finance

Carbaugh, Chap US balance of payments, 1998 Balance of Payments Current account$ bill. Merchandise trade balance Merchandise exports Merchandise imports Services balance+78.8 Investment income, net-22.5 Unilateral transfers, net-41.9 Balance on current account Capital account US capital inflow US capital outflow Statistical discrepancy-25.2 Balance on capital account233.5 Source: US Dept. of Commerce, Survey of Current Business, April 1999

Carbaugh, Chap US balance of payments ($ bill.) Balance of Payments MerchandiseServicesNet investmentNet unilateralCurrent account Yeartrade balancebalanceincometransfersbalance Source: US Dept. of Commerce, Survey of Current Business, various issues

Carbaugh, Chap Effects of a stronger or weaker dollar Exchange Rates Disadvantages 1. US consumers face higher prices on foreign goods. 2. Higher prices on foreign goods contribute to higher inflation in the US 3. US consumers find traveling abroad more costly. 4. It is more difficult for US firms and investors to expand into foreign markets. Strengthening (appreciating) dollar Advantages 1. US consumers see lower prices on foreign goods. 2. Lower prices on foreign goods help keep US inflation low. 3. US consumers benefit when they travel to foreign countries. 4. US investors can purchase foreign stocks and bonds at "lower" prices. Disadvantages 1. US exporting firms find it harder to compete in foreign markets 2. US firms in import-competing markets find it harder to compete with cheaper foreign goods. 3. Foreign tourists find it more expensive to visit the United States 4. It is more difficult for foreign investors to provide capital to the United States. Weakening (depreciating) dollar Advantages 1. US exporting firms find it easier to sell goods in foreign markets 2. Import-competing firms in the US can make higher profits 3. More foreign tourists can afford to visit the US 4. US capital markets become more attractive to foreign investors.

Carbaugh, Chap Exchange rate determination Exchange Rates (a) Foreign exchange market equilibrium Dollars per Pound E D0D0 S0S0 Depreciation Appreciation

Carbaugh, Chap (c) Adjusting to an increase in supply Dollars per Pound E G D0D0 S0S0 S1S1 Exchange rate determination (cont'd) Exchange Rates (b) Adjusting to an increase in demand Dollars per Pound E F D0D0 S0S0 D1D1

Carbaugh, Chap Exchange rate systems, 1999 Exchange Rates Source: IMF, International Financial Statistics, March 1999 Number Exchange rate regimeof countries Fixed exchange rates: currency tied to US dollar21 French franc15 Other currency30 Managed floating exchange rates48 Freely floating exchange rates51 Other16 181

Carbaugh, Chap Exchange rate stability and managed floating exchange rates Exchange Rates Dollars per Pound D0D0 S0S0 D1D1 S1S1