Textbook Notes (381,082)
CA (168,341)
UTSC (19,304)
MGEA06H3 (35)
Iris Au (35)
Chapter

Week 11 chapter notes

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Department
Economics for Management Studies
Course Code
MGEA06H3
Professor
Iris Au

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Chapter 35 Exchange Rates and the Balance of Payments Notes
35.1 The Balance of Payments
x balance of payments accounts Æ a summary record of a country’s transactions with the rest of the world, including the buying
and selling of goods, services, and assets
x transactions that represent a receipt for Canada, such as the sale of a product or asset to foreigners, are recorded in the balance of
payments account as a credit item; transactions that represent a payment to Canada, such as the purchase of a product or assets
from foreigners, are recorded as a debit item
x there are two main categories to the balance of payments: the current account and the capital account
The Current Account
x current account Æ the part of the balance of payments accounts that 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
x trade account Æ in the balance of payments, this account records exports and imports of goods and services
x Canadian imports of goods and services require a payment to foreigners and thus are entered as debit items on the trade account
x Canadian exports of goods and services require a receipt to Canada and thus are recorded as credit items
x capital-service account Æ in the balance of payments, this account records the payments and receipts that represent income on
assets (such as interest and dividends)
The Capital Account
x capital account Æ the part of the balance of payments accounts that records payments and receipts arising from the import and
export of long-term and short-term financial capital
x purchasing foreign asset requires payment from Canadians to foreigners, it is entered as debit item in Canadian capital account
x note when Canadians purchase foreign assets, financial capital is leaving Canada and going abroad, and so called capital outflow
x sale of Canadian assets to foreigners generates receipt for Canada, and thus is entered as credit item in Canadian capital account
x when Canadians sell assets to foreigners, financial capital is entering Canada from abroad, and so this is called a capital inflow
The Balance of Payments Must Balance
x current account balance is the difference between the payments and receipts from international transactions in goods and services
x capital account balance is the difference between payments and receipts from international transactions in assets
x the balance of payments is the sum of current account and capital account balances
x in any given period (usually a year) the current account plus the capital account must equal zero
x any surplus on the current account must be matched by an equal deficit on the capital account; a current account surplus thus
implies a capital outflow; the balance of payments is always zero
x any deficit in the current account must be matched by an equal surplus in the capital account; a current account deficit thus
implies a net capital inflow; the balance of payments is always zero
A Balance of Payments Deficit?
x a “balance of payments deficit refers to a situation in which the government is selling official foreign-currency reserves
x a “balance of payments surplus” refers to a situation in which the government is buying official foreign-currency reserves
x in both cases, as always, the balance of payments is actually in balance
Summary
1. CA shows all transactions in goods and services between Canada and rest of world (including investment income and transfers).
2. The capital account shows all transactions in assets between Canada and the rest of the world. Part of the capital account shows
the change in the government’s holding of foreign-currency reserves.
3. All transactions involving a payment from appear as debit items. All transactions involving a receipt to appear as credit items.
4. The balance of payments—the sum of the current account and the capital account—must, by definition, always be zero.
35.2 The Foreign-Exchange Market
x trade between countries normally requires the exchange of the currency of one country for that of another
x exchange rate Æ the number of units of domestic currency required to purchase one unit of foreign currency
x appreciation Æ a fall in the exchange rate—the domestic currency has become more valuable so that it takes fewer units of
domestic currency to purchase one unit of foreign currency
x depreciation Æ a rise in the exchange rate—the domestic currency has become less valuable so that it takes more units of
domestic currency to purchase one unit of foreign currency
x appreciation of the Canadian dollar is fall in the exchange rate; depreciation of the Canadian dollar is rise in the exchange rate
x because Canadian dollars are traded for Euros in the foreign exchange market, it follows that a demand for Euros implies a
supply of Canadian dollars and that a supply of Euros implies a demand for Canadian dollars
The Supply of Foreign Exchange
x whenever foreigners purchase Canadian goods, services, or assets, they supply foreign currency to the foreign-exchange market
and demand, in return, Canadian dollars with which to pay for their purchases
x thus, the supply of foreign exchange (and the associated demand for Canadian dollars) arises from Canada’s sales of goods,
services, and assets to the rest of the world
x three important sources of supply of foreign exchange are Canadian exports, asset sales: capital inflows, and reserve currency
x the supply curve for foreign exchange is positively sloped when it is plotted against the exchange rate; a depreciation of the
Canadian dollar (a rise in the exchange rate) increases the quantity of foreign exchange supplied
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Description
Chapter 35 Exchange Rates and the Balance of Payments Notes 35.1 The Balance of Payments N balance of payments accounts a summary record of a countrys transactions with the rest of the world, including the buying and selling of goods, services, and assets N transactions that represent a receipt for Canada, such as the sale of a product or asset to foreigners, are recorded in the balance of payments account as a credit item; transactions that represent a payment to Canada, such as the purchase of a product or assets from foreigners, are recorded as a debit item N there are two main categories to the balance of payments: the current account and the capital account The Current Account N current account the part of the balance of payments accounts that 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 N trade account in the balance of payments, this account records exports and imports of goods and services N Canadian imports of goods and services require a payment to foreigners and thus are entered as debit items on the trade account N Canadian exports of goods and services require a receipt to Canada and thus are recorded as credit items N capital-service account in the balance of payments, this account records the payments and receipts that represent income on assets (such as interest and dividends) The Capital Account N capital account the part of the balance of payments accounts that records payments and receipts arising from the import and export of long-term and short-term financial capital N purchasing foreign asset requires payment from Canadians to foreigners, it is entered as debit item in Canadian capital account N note when Canadians purchase foreign assets, financial capital is leaving Canada and going abroad, and so called capital outflow N sale of Canadian assets to foreigners generates receipt for Canada, and thus is entered as credit item in Canadian capital account N when Canadians sell assets to foreigners, financial capital is entering Canada from abroad, and so this is called a capital inflow The Balance of Payments Must Balance N current account balance is the difference between the payments and receipts from international transactions in goods and services N capital account balance is the difference between payments and receipts from international transactions in assets N the balance of payments is the sum of current account and capital account balances N in any given period (usually a year) the current account plus the capital account must equal zero N any surplus on the current account must be matched by an equal deficit on the capital account; a current account surplus thus implies a capital outflow; the balance of payments is always zero N any deficit in the current account must be matched by an equal surplus in the capital account; a current account deficit thus implies a net capital inflow; the balance of payments is always zero A Balance of Payments Deficit? N a balance of payments deficit refers to a situation in which the government is selling official foreign-currency reserves N a balance of payments surplus refers to a situation in which the government is buying official foreign-currency reserves N in both cases, as always, the balance of payments is actually in balance Summary 1. CA shows all transactions in goods and services between Canada and rest of world (including investment income and transfers). 2. The capital account shows all transactions in assets between Canada and the rest of the world. Part of the capital account shows the change in the governments holding of foreign-currency reserves. 3. All transactions involving a payment from appear as debit items. All transactions involving a receipt to appear as credit items. 4. The balance of paymentsthe sum of the current account and the capital accountmust, by definition, always be zero. 35.2 The Foreign-Exchange Market N trade between countries normally requires the exchange of the currency of one country for that of another N exchange rate the number of units of domestic currency required to purchase one unit of foreign currency N appreciation a fall in the exchange ratethe domestic currency has become more valuable so that it takes fewer units of domestic currency to purchase one unit of foreign currency N depreciation a rise in the exchange ratethe domestic currency has become less valuable so that it takes more units of domestic currency to purchase one unit of foreign currency N appreciation of the Canadian dollar is fall in the exchange rate; depreciation of the Canadian dollar is rise in the exchange rate N because Canadian dollars are traded for Euros in the foreign exchange market, it follows that a demand for Euros implies a supply of Canadian dollars and that a supply of Euros implies a demand for Canadian dollars The Supply of Foreign Exchange N whenever foreigners purchase Canadian goods, services, or assets, they supply foreign currency to the foreign-exchange market and demand, in return, Canadian dollars with which to pay for their purchases N thus, the supply of foreign exchange (and the associated demand for Canadian dollars) arises from Canadas sales of goods, services, and assets to the rest of the world N three important sources of supply of foreign exchange are Canadian exports, asset sales: capital inflows, and reserve currency N the supply curve for foreign exchange is positively sloped when it is plotted against the exchange rate; a depreciation of the Canadian dollar (a rise in the exchange rate) increases the quantity of foreign exchange supplied www.notesolution.com
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