ECON 102 Chapter Notes - Chapter 35: Fixed Exchange-Rate System, Foreign Exchange Market, Reserve Currency

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Published on 13 Apr 2013
School
UBC
Department
Economics
Course
ECON 102
Economics 102: Principles of Macroeconomics
Chapter 35
35.1 The Balance of Payments
Balance of payments accounts: summary record of a country's transactions with the rest of
the world
o Includes the buying and selling of goods, services, and assets
o The sum of the current account and capital account balance
o Categorized by whether a transaction generates a payment or a receipt for Canada
Credit: transactions that represent a receipt, the sale of a product or asset
Debit: transaction that represents a payment, the purchase of a product or asset
The Current Account:
Records payments and receipts arising from trade in goods and services and from interest
and dividends that are earned by capital owned in one country and invested in another
Trade account: records the value of exports and imports of goods and services
Capital-service account: records the payment and receipts that represent income on assets
The Capital Account:
Records payments and receipts arising from the purchase and sale of assets
o Includes bonds, shares, real estate, and factories
Direct investment: the purchase or sale of assets that alter the legal control of those assets
Portfolio investment: transactions in assets that do not alter the legal control of the assets
Official financing account: the government transactions in its official foreign-exchange
reserves
The Balance of Payments Must Balance:
o CA: capital account; KA: capital account
Any surplus on the current account must be matched by an equal deficit on the capital
account
o A CA surplus thus implies a capital outflow; the balance of payments is always zero
Any deficit in the current account must be matched by an equal surplus in the capital
account
o A CA deficit thus implies a capital inflow; the balance of payments is always zero
A Balance of Payments Deficit?
Balance of payments deficit usually refers to a situation in which the government is selling,
official foreign-currency reserves
Balance of payments surplus usually refers to a situation in which the government is
buying official foreign currency reserves
o In both cases, the balance of payments is actually in balance
35.2 The Foreign-Exchange Market
Exchange rate: the number of units of domestic currency required to purchase one unit of
foreign currency
o Appreciation: fall in the exchange rate
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Economics 102: Principles of Macroeconomics
o Depreciation: rise in the exchange fall
The Supply of Foreign Exchange:
Supply of foreign exchange arises from Canada's sale of goods, services, and assets to the
rest of the world
Canadian Exports:
Foreign exchange arising out of international trade
Each potential buyer wants to sell its own currency in exchange for CND that it can use to
purchase Canadian goods or services
Asset Class: Capital Inflows
Purchase of Canadian assets (government/corporate bonds, real estate, or shares)
Sell foreign currency for CND in order to buy Canadian assets
Reserve Currency:
Firms, banks and governments often accumulate and hold foreign exchange reserves
o Countries may hold several different currencies at the same time
The Total Supply of Foreign Exchange:
The supply of foreign exchange or the demand for CND by holders of foreign currencies
People, firms, and governments in all countries purchase goods/assets from many other
countries, the demand for any one currency will be the AD of individuals, firms, and
governments in a number of different countries
The Supply Curve for Foreign Exchange:
Vertical axis is the exchange rate, the horizontal axis is the quantity of currency
Depreciation of the CND increases the quantity of foreign exchange supplied
The Demand for Foreign Exchange:
Arises from all international transactions that represent a payment in Canada's balance of
payments
The Demand Curve for Foreign Exchange:
An appreciation of the CND increases the quantity of foreign exchange demanded
35.3 The Determination of Exchange Rates
Flexible exchange rates: when the central bank makes no transactions in the forex market
o The forces of supply and demand determine the exchange rate
Fixed exchange rate: exchange rate is maintained within a small range around its publicly
stated par value by the intervention in the foreign exchange market by a country's central
bank
Adjustable peg system: rates are fixed in the short-term but are occasionally changed in
response to changes in economic events
Managed float: central bank seeks to have some stabilizing influence on the exchange rate
but does not try to fix it at some publicly announced value
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Document Summary

Balance of payments accounts: summary record of a country"s transactions with the rest of the world. Includes the buying and selling of goods, services, and assets: the sum of the current account and capital account balance, categorized by whether a transaction generates a payment or a receipt for canada. Credit: transactions that represent a receipt, the sale of a product or asset. Debit: transaction that represents a payment, the purchase of a product or asset. Records payments and receipts arising from trade in goods and services and from interest and dividends that are earned by capital owned in one country and invested in another. Trade account: records the value of exports and imports of goods and services. Capital-service account: records the payment and receipts that represent income on assets. Records payments and receipts arising from the purchase and sale of assets. Direct investment: the purchase or sale of assets that alter the legal control of those assets.

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