International Trade and Exchange Rates Outline Balance of payments (BOP) accounting How open is the U.S. economy? Description of international trade Exchange rates—how are they determined? Exchange rates and the price of imported and exported goods.

þBOP accounting is the recording of transactions between domestic and foreign economic agents. þAny transaction that results in a receipt of money by domestic agents from abroad is recorded as a credit in the BOP accounts. þAny transaction that entails the payment of money by domestic units to foreigners is recorded as a debit in the BOP accounts. þThe current account records foreign transactions involving merchandise and services. þThe capital account records foreign transactions involving financial assets and land. Balance of payments accounting

Current Account (in billions) 1. Merchandise exports Merchandise imports Trade balance (1 + 2) Service exports Service imports Goods and services balance ( ) Net unilateral transfers Current account balance (6 + 7) Source: Department of Commerce

Capital Account (in billions) 9. Outflow of U.S. capital Inflow of foreign capital Capital account balance ( ) Net change in U.S. official assets abroad-33.3 TOTAL ( ) 0.0 Source: Department of Commerce

An index of openness This is a simple measure of the relative importance of the foreign sector Let O denote the index of openness X is exports M is imports GDP is gross domestic product Thus, we have:

Imports + Exports as a Percent of U.S. GDP, percent

The U.S. trade deficit ballooned to $ billion in 1999—a $107 billion increase from 1998.

In billions of current dollars

Source: The Economist Current Account balance of selected industrialized nations, August 1998 to August 1999

Nation Exports as percent of World Total United States12.4 Germany9.6 Japan7.5 France5.3 Britain4.8 Canada4.2 Italy4.1 Netherlands3.6 Hong Kong3.5 China3.3 Source: The Economist Top Exporters in 1999

An exchange rate is the price of one national currency expressed in terms of another national currency. For example, the dollar price of the British pound is $ meaning it takes $1.71 to buy 1 pound

Exchange rates are determined by the supply and demand of foreign exchange DM per $ $’s0 S D D’ Why do agents want to swap marks for dollars? To buy American-made goods. To hold stocks in U.S. companies or other dollar- denominated assets. To speculate on future exchange rate movements In this case, the mark depreciates against the dollar

Currency Cross Rates New York Trading, August1, 2000 Source: Wall Street Journal

10/11/992/28/007/17/00 Dollars per Euro Euro in free fall

Firms and individuals demand marks to buy German- made goods, to hold mark-denominated financial assets, or to profit from what they hope will be an increase in the international value of the mark. $ per DM DMs D S S’  Dollar appreciates against the mark

Let the dollar price of the mark = $0.59--i.e., it costs 59 cents to purchase 1 mark in the market for foreign exchange. Let the mark price of a Krups espresso maker = 100 marks Question: What is the dollar price of the Krups espresso maker? $ price = (.59)(100) = $59.00

Effect of an appreciating dollar on the price of imported goods What if the dollar should appreciate, or gain value, against the mark? Let the dollar price of the mark decrease to $0.55. Question:What is the dollar price of the Krups espresso maker? $ price = (.55)(100) = $55.00

Let the mark price of the dollar = 1.69 marks--i.e., its cost 1.69 marks to buy a dollar in the foreign exchange market. Let the dollar price of the Microsoft Windows 98 = $ Question:What is the mark price of Windows 98? Mark price = (1.69)(189.00) = marks Exchange rates and the prices of exported goods and services

Effect of a depreciating mark on the price of Windows 98 Let the mark price of the dollar increase to 1.82 marks. Question:What is the mark price of Windows 98? Mark price = (1.82)(189.00) = marks