Balance of Payments and Exchange Rates
Module Convenor: Luke Buchanan-Hodgman
Contact: [email protected] Office: Keynes D2.12 Contact Hours: Thursday 10-11
Website: https://sites.google.com/site/buchananhodgman
March 31, 2016
Learning Objectives
1. LO1: Examine the data pertaining to world trade.
2. LO2: Analyse what an exchange rate is and why it matters for world trade.
Some Preliminaries
I Foreign Exchange Markets
Markets in which currencies are exchanged. In common parlance, ’exchanging pounds for euros’ for example.
I Balance of Payments (BoP)
Simply, international payments concerning a country. The BoP is separated into the current account and the capital and financial accounts.
When studying open economies (economies which trade with other economies, we must concern ourselves with a treatment of these topics
World Trade: total volume
Trade ’Openness’
openness= ExportsGDP+Imports = X+YM.
Can interpret this as a country’s interdependence on world trade out of output.
What are exchange (FX) rates?
I Currencies are exchanged for one another in the foreign exchange market;
I Effectively we can view this ’rate’ as the price of a unit of one nation’s currency in terms of another nations currency;
Why do we need to use FX markets?
I The buying and selling of goods across international borders requires the selling party to accept foreign currency and exchange it for home currency, or the buying party must first exchange their currency for the currency of the seller to use for purchase (effectively, money orders);
I In either case, the foreign exchange transactions are undertaken.
What determines the value of the exchange rate?
Simply put, the interaction of supply and demand (in foreign exchange markets) determine the exchange rate of a currency. Just as in the case of any other good or service
I Demand-side factors;
↑UK exports (arms), ↑income payments from foreign assets (dividends),↑domestic asset purchases from abroad (capital inflows),↑ currency reserve balances (historically)
I Supply-side factors
Appreciation v. Depreciation
In the UK format, we talk of ’how many units of the foreign currency it takes to purchase one unit of sterling’.
I Currency appreciation (sterling): ’it takes more units of the foreign currency to purchase one unit of sterling’.
$1 =$1 =⇒ $1.50 =$1
I Currency depreciation (sterling): ’it takes fewer units of the foreign currency to purchase one unit of sterling’.
$1 =$1 =⇒ $0.75 =$1
Nominal v Real FX Rates
I Nominal exchange rate: the ’price’ of sterling in terms of a foreign currency unit on the FX markets.
I Real exchange rate: (roughly speaking) how many goods and services in the domestic economy can goods and services in the foreign economy afford you.
UK Exports and FX Rates: how do rates impact flows?
Balance of Payments
The balance of payments consists of two components: the current account and the capital and financial accounts (usually taken together).
I Current Account;
This measures the flow of goods and services, international
payments (domiciled residents paying non-domiciled residents etc), and current transfers (child benefit for EU workers etc)
I Capital & Financial Accounts;
This measures the international movement of assets. In the main, this is made up of debt securities, both governmental and
corporate, equities etc.
Current Account Deficits: should we care?
Current Account Deficits: should we care?
We often hear about largecurrent account deficits in the U.K. A key question is: should we care?
I The answer is a matter of perspective...
1. As a matter of international prestige and power, governments would look favourably upon surpluses.
2. As a matter of well-being, ordinary subjects would look favourably on whichever arrangement yielded to them their highest utility - be that deficit or surplus.
Learning Objectives
1. LO1: Examine the data pertaining to world trade. X
2. LO2: Analyse what an exchange rate is and why it matters for world trade. X
3. LO3: Examine what the balance-of-payments is and what it means to have a deficit or surplus X
