2. Eco 200 – Principles of Macroeconomics Chapter 7: Foreign Exchange Markets and the Balance of Payments

3. Foreign exchange market Foreign exchange = money denominated in foreign currency

4. Foreign exchange market Foreign exchange = money denominated in foreign currency Foreign exchange market = global market in which currencies are exchanged for each other

5. Foreign exchange market Foreign exchange = money denominated in foreign currency Foreign exchange market = global market in which currencies are exchanged for each other Most foreign exchange transactions involve the purchase and sale of bank deposits

6. Exchange rate Exchange rate = price of one currency in terms of another

7. Exchange rate Exchange rate = price of one currency in terms of another Reciprocal exchange rates – If $1 is worth ½ of a British pound, each British pound is worth 2 dollars.

8. Exchange rate Exchange rate = price of one currency in terms of another Reciprocal exchange rates – If $1 is worth ½ of a British pound, each British pound is worth 2 dollars. Domestic currency price = foreign currency price x exchange rate

9. Appreciation and depreciation If the domestic currency appreciates, Imports become less expensive Imports rise Exports become more expensive in the rest of the world. Exports decline

10. Appreciation and depreciation If the domestic currency appreciates, Imports become less expensive Imports rise Exports become more expensive in the rest of the world. Exports decline If the domestic currency depreciates, Imports become more expensive Imports decline Exports become less expensive in the rest of the world. Exports rise

11. Balance of payments Double-entry bookkeeping Two sides to each transaction Dollar value of money flowing into the country must equal the dollar value of the money flowing out (two sides of the same transaction)

12. Balance of payments Double-entry bookkeeping Two sides to each transaction Dollar value of money flowing into the country must equal the dollar value of the money flowing out (two sides of the same transaction) Credits activities that brings payments into the country

13. Balance of payments Double-entry bookkeeping Two sides to each transaction Dollar value of money flowing into the country must equal the dollar value of the money flowing out (two sides of the same transaction) Credits activities that brings payments into the country Debits activities that involve payments to the rest of the world

14. Current and financial accounts Current account = trade in goods and services

15. Current and financial accounts Current account = trade in goods and services Financial account = trade in financial assets

16. Current and financial accounts Current account = trade in goods and services Financial account = trade in financial assets Net balance on current account + net balance on financial account + statistical discrepancy = 0 (overall balance of payments = 0)

17. Current account Merchandise – trade in goods

18. Current account Merchandise – trade in goods Services – trade in services

19. Current account Merchandise – trade in goods Services – trade in services Income = payment for labor and capital services (interest and dividend payments)

20. Current account Merchandise – trade in goods Services – trade in services Income = payment for labor and capital services (interest and dividend payments) Unilateral transfers – payments for which no goods or services are provided in return

21. Current account

22. Balance of payment accounts – 2000 (in millions) AccountCreditDebitNet balance Merchandise$183,728$289,566-$105,838 Services$71,309$51,647$19,662 Income$79,749$83,949-$4,200 Unilateral transfers-$11,925 Current Account-$102,301 Financial Account$215,008$143,283$71,725 Statistical discrepancy-$30,410 Overall BOP $0