1. CURRENCY APPRECIATION & DEPRECIATION BALANCE OF PAYMENTS Foreign Exchange Markets

2. US Exports & Imports Exports…  Create a foreign demand for dollars  Makes a supply of foreign currency available to the US Imports…  Create a demand for foreign exchange  Make a supply of dollars available to foreigners

3. Purchasing Power Parity Theory  Exchange rates reflect purchasing powwer of the various countries  If goods in the US cost $1,000 and the same goods in the UK cost L 500 then the exchange rate is $2 = L 1  Doesn’t always work in practice

4. Currency Depreciation v. Appreciation What affects the value of the $  Unemployment rate/jobs  Rate of inflation… change in relative prices  Government stability  Interest rate  National income of ROW/change in relative incomes  Change in taste & preferences

5. Currency Depreciation v. Appreciation  D eterminants of Foreign Exchange (FEX)  S peculation/expectations  T astes & preferences  R elative incomes  I nterest… real rates  P rices/inflation  E conomy… stability/jobs/government

6. Currency Depreciation v. Appreciation Cause: D $ decrease or S $ increase Cause: D $ increase or S $ decrease What happens: $1 = 100 yen $1 = 90 yen What happens: $1 = 100 yen $1 = 110 yen US $ exchanged for less other currency so value has declined US $ exchanged for more other currency so value has increased Called: weak dollarCalled: strong dollar

7. Currency Depreciation v. Appreciation Advantages: US goods cheaper Reduced competition Increase foreign tourism $$/capital more attractive Good for exporter Advantages: Foreign goods less costly Pricing competition Overseas travel cheaper Overseas expansion easier Good for importer Disadvantages: Inflation Foreign goods more costly Overseas travel costs more Overseas expansion more Amount of imports decreases Disadvantages: US goods more expensive US firms must reduce costs Reduced foreign tourism to US Reduced foreign currency into US Amount of exports decreases

8. Currency Exchange  Is a long run issue  In the short run there is a lot of fluctuation  Purchasing Power Parity… value of currency determined by prices  If there is a change in prices in one country, but prices do not change in the other country, the exchange rate will change to achieve PPP

9. Balance of Payments (BoP) Imports v. Exports  Balance of payments is the sum of all transactions between one country and all other countries… between the US and everyone else with whom we trade  Balance of payments has three parts: Current Account Capital Account Official Reserves Account

10. Current Account  Current because it happens now… there is not a future claim or payment  Contains import/export of goods and services  Contains income from stock/dividends  Transfers of money from one person to another… immigrants sending money back home to family  Contains US foreign aid to and from other countries

11. Current Account  Exports… money comes to the US government, businesses or private citizens  Imports… money goes to other countries; includes foreign owned businesses or assets located in the US… the money is going to people of other countries  Trade balance is the sum of imports/exports

12. Capital Account  Capital because it deals with the ownership of assets  Contains real or financial assets such as land, treasury bond, hotel that help to create finished goods and services  Money/interest received from treasury bonds goes to the Current Account

13. Official Reserves Account  Foreign currency held in the Central Bank… held by the Federal Reserve for the US  It is like a savings account used to make up a deficit  Balance of payments must ALWAYS equal zero