Class Notes (839,482)
Canada (511,363)
Economics (1,511)
EC140 (417)
Ken Jackson (249)
Lecture 20

EC140 Lecture 20: Ch 34- Exchange Rates

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Ken Jackson

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Ch. 34 – Exchange Rates  A country has an existing stock of debt, a modest government budget deficit, and has Y > Y*. What is true? - Structural deficit > actual deficit > primary budget deficit  A credit entry in the Canadian balance of payments occurs when: - A transaction involves money  A fall in the Canadian dollar price of foreign currency is referred to as: - An appreciation of the Cdn dollar Balance of Payments  Records transactions between Canada and the rest of the world  Buying and selling of goods, services and assets Payment to Canada recorded as a credit (positive)  Payment from Canada recorded as a debit (negative)  Payment to Canada recorded as a credit  Two main categories - the current account and the capital account Current Account  Deals with trade in goods or services, and net investment income earned on foreign assets  Trade account - payments and receipts related to the import/export of goods or services (including tourism)  Capital-service account - payments and receipts representing income on assets o i.e. dividends on a U.S. company paid to a Canadian - credit in the current account Capital Account  International transactions in assets (bonds, shares, companies, real estate, factories)  Canadian buys a foreign asset - a debit in the capital account (negative)  Foreigner buys Canadian asset - a credit in the capital account (positive)  Official financing account - changes in official reserves (negative) Money flowing to Canada recorded one way Money leaving Canada recorded a different way Balancing the Balance of Payments  Balance of payments must balance - accounting identity  Similar to idea that expenditure must equal income  Value of goods/assets determined by movement of money  If a Canadian purchases a car from Germany, that is recorded as: - A debit to the current account (buys a foreign asset) - Money is leaving the account therefore debit - Buying a car is not an investment, therefore part of the CURRENT account  A US company buys a Cdn company. This is recorded as: - A credit in the capital account - Money flowing to Canada therefore credit - Investment therefore capital account A Balance of Payments Deficit  Common to see media refer to “balance of payments deficit”  Usually mean “current account deficit” o Implies imports > exports  Sometimes mean current account plus capital account o This implies reduction in official international reserves  In both cases, just use the correct term  In a country’s Balance of Payments, a surplus in the current account: - Is associated with a deficit in the … Foreign Exchange  Exchange rate - number of units of domestic currency needed to buy one-unit of foreign currency  Canadian press commonly reports the opposite o Current exchange rate is $1.31, not $0.77  Appreciation - increase in the value of a currency o Appreciation of the Canadian dollar implies a reduction of the exchange rate  Depreciation - decrease in the value of a currency o Depreciation of the Canadian dollar implies an increase of the exchange rate Supply and Demand for Currency  Similar to supply and demand for any product  Focus on the supply/demand for foreign currency (not Cdn dollars)  Price is then the Canadian dollar exchange rate  Remember - increases in the exchange rate correspond to depreciations in the Canadian dollar Supply of Foreign Exchange  Purchases of Canadian exports or assets Buying in Canadian dollars requires selling foreign currency  Banks holding Canadian dollars as a reserve currency  Supply curve slopes upward - when Cdn. dollar depreciates, exports increase and purchases of Canadian assets increase  A Cdn dollar depreciates, Cdn dollar goes up o People buy more from Canada o Exports increase, quantity increases o Supply of foreign exchange increases Demand for Foreign Exchange  Reciprocal of the supply of foreign exchange  Import of goods or assets to Canada o Buying in foreign currency  Bank of Canada holding foreign currency in reserve  Demand curve slopes downward - when Cdn. dollar depreciates, imports decrease and purchases of foreign assets decrease  When demand for oil falls, what happens in the market for foreign exchange? - Supply of foreign exchange falls Determining the Exchange Rate  Flexible exchange rates o Central bank/government allow market to determine the price of foreign exchange  Fixed exchange rates o Central bank/government intervene providing additional supply or demand to ensure a specific exchange rate  Intermediate cases o Adjustable peg - fixed,
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