International Trade and Exchange Rates - PowerPoint PPT Presentation

Loading...

PPT – International Trade and Exchange Rates PowerPoint presentation | free to view - id: 147b21-YWZmZ



Loading


The Adobe Flash plugin is needed to view this content

Get the plugin now

View by Category
About This Presentation
Title:

International Trade and Exchange Rates

Description:

... in nominal exchange rate is referred to as a currency appreciation or ... Multilateral exchange rate: measurement of the value of one currency against a ... – PowerPoint PPT presentation

Number of Views:59
Avg rating:3.0/5.0
Slides: 69
Provided by: laura136
Category:

less

Write a Comment
User Comments (0)
Transcript and Presenter's Notes

Title: International Trade and Exchange Rates


1
International Trade and Exchange Rates
  • Chapter 5

2
  • The Canadian economy is linked to the rest of the
    world through trade in goods and services, and
    finance.

3
Goods and Services Trade
  • The Canadian economy is a small and relatively
    open economy.
  • In 2005, exports comprised 37.6 of GDP and
    imports comprised 34.1 of GDP.
  • In 2006, the trade balance was 51 billion.

4
In contrast, the US economy is a large and
relatively closed economy.
  • In 2006, exports comprised 11.1 of GDP and
    imports comprised 16.6 of GDP.
  • As of 2007 the trade balance is -226 (US)
    billion.

5
Where do Canadian exports go?
  • 81 to US
  • 6 to EU
  • 2 to Japan

6
Where do Canadians import from?
  • 67 from US
  • 10 from EU
  • 3 from Japan

7
What does Canada export?
  • Machinery and equipment 21
  • Auto parts 19
  • Industrial goods 19
  • Energy 19
  • Forestry products 8
  • Agriculture fish 7
  • Consumer goods 4

8
What does Canada import?
  • Machinery and equipment 28
  • Auto parts 20
  • Industrial goods 20
  • Consumer goods 13
  • Energy 9
  • Agriculture and fish 6
  • Forestry products 1

9
International Finance
  • Canadians can hold assets in foreign countries.
  • Foreigners can hold assets in Canada.

10
  • I. The Balance of Payments Accounts
  • A record of the transactions of a country with
    the rest of the world.
  • It is comprised of 2 majors accounts the current
    account and the capital account.

11
  • Current Account an account of trade in currently
    produced goods and services.
  • Consists of 3 major components net exports, net
    income from assets and net transfers.

12
  • 1. Net Exports exports - imports
  • the merchandise trade balance refers to net
    exports of goods only.
  • trade in services consists of items such as
    tourism and education.

13
  • 2. Net income from assets net returns of
    financial instruments

14
  • 3. Net transfers includes items such as foreign
    aid, gifts between family members of different
    countries.

15
  • Current account balance the sum of the 3
    components.

16
1. Capital Account
  • An account of trade in existing assets

17
  • The capital account consists of 2 items
  • Capital account
  • Financial account
  • Together they are referred to as the capital
    account.

18
  • The capital account includes items such as
    inheritances and trade in intellectual property

19
  • Financial account a record of direct investment
    and portfolio investment.

20
  • One final item in the capital account is
    official reserves, which are assets held by
    central banks that can be used to make
    international payments.

21
Official reserves are assets
  • If the amount is positive then the Bank of Canada
    has sold foreign reserves.
  • If the amount is negative then the Bank of Canada
    has bought foreign reserves.
  • The amount of official reserves equals the
    balance of payments deficit.

22
  • The overall balance of payments must equal zero.

23
  • II. Savings and Investment in a small open
    economy
  • In previous chapters we stated that in long run
    equilibrium, savings equals investment. This
    statement was made in the context of a closed
    economy.

24
  • The GDP identity Y C I G NX
  • From chapter 2 S I (NX YNR),
  • where YNR is net investment income from
    non-residents.

25
  • Since NX YNR the current account (CA)
  • Then, S I CA
  • or, S - I CA .... how do we interpret this
    equation?

26
  • To simplify analysis in this chapter we make the
    assumption that the current account equals net
    exports...we use the terms interchangeably.

27
  • Therefore, S- I NX

28
  • So, in an open economy the long run
    equilibrium condition is that foreign investment
    must equal the trade balance.

29
  • III. The Importance of the World Real Interest
    Rate
  • The world real interest rate is the real rate of
    interest that prevails in international capital
    markets.
  • It is assumed that individuals, businesses and
    governments can borrow or lend at this rate.

30
  • Canada, being a small open economy, takes the
    world real interest rate as an exogenous
    variable.

31
Fiscal Policy and Twin Deficits
  • Expansionary fiscal policy results in a shift of
    the savings curve to the left.
  • The leftward shift results in a higher domestic
    real interest rate and thus there is an excess of
    domestic investment over savings......we have a
    trade deficit and negative net foreign lending.

32
  • This is called the twin deficit problem ----
    budget deficit leads to a trade deficit.

33
Twin Deficit Problem
34
IV. Exchange Rates
  • Exchange rate determination
  • A nominal exchange rate indicates the number of
    Canadian dollars that must be given up in order
    to purchase a unit of foreign currency.
  • For instance, on January 28, 2008 the Canada -
    US exchange rate was 0.99

35
  • The nominal exchange rate is determined by
    supply and demand in the foreign exchange market.

36
  • Flexible exchange rate system exchange rate is
    determined in the foreign exchange market.
  • A change in nominal exchange rate is referred to
    as a currency appreciation or depreciation.
  • If the Cdn-US exchange rate changes from 1.11 to
    1.01, then Canadian currency has appreciated and
    US currency has depreciated.

37
  • Fixed exchange rate system central banks buy
    and sell currency at a fixed rate in terms of
    foreign exchange. This system is an example of a
    price support.

38
  • A change in the price of foreign exchange under
    the fixed system is referred to as currency
    devaluation or revaluation.
  • A devaluation (revaluation) occurs when the
    value of the currency in terms of foreign
    exchange is reduced (increased) by official
    action.

39
  • In the fixed system, the central bank uses
    exchange market intervention to make up any
    excess supply or demand arising form private
    transactions.
  • In order to carry out such intervention the
    central bank must hold an inventory of foreign
    exchange that can be sold in exchange for
    domestic currency when necessary.

40
  • If a country has an exchange rate crisis and
    their central bank does not have enough foreign
    currency to maintain the fixed rate, the central
    bank will likely resort to a devaluation.

41
  • A managed or dirty system is one in which
    exchange rates are typically determined in the
    foreign exchange market, but the central bank may
    use intervention to smooth out large fluctuations
    in exchange rates.

42
History of the Canadian exchange rate system
  • Throughout history Canada s exchange rate has
    intermittently been fixed and flexible.
  • Since 1973, the exchange rate has been managed.
  • In the early 1970s Canadian currency
    appreciated and then started to depreciate slowly
    until 2003, when a sharp appreciation occurred.

43
  • Bilateral exchange rate an exchange rate that
    measures the value of one currency against
    another currency,

44
  • Multilateral exchange rate measurement of the
    value of one currency against a basket of other
    currencies

45
Exchange rate in the long run
  • The purchasing power parity (PPP) theory states
    that in the long run the nominal exchange rate
    moves primarily as a result of difference in
    price level behaviour between two countries.

46
  • An oversimplified example if a pen can be
    purchased in US for 2US and in Canada for 2CDN,
    then the exchange rate is 11.

47
The logic behind purchasing power parity
  • Based on a principle called the law of one price.

48
  • This law asserts that a good must sell for the
    same price in all locations. If not,
    opportunities for profit would be left
    unexploited.

49
  • The process of taking advantage of difference in
    prices in different markets is called arbitrage.

50
  • The logic of the law of one price leads to the
    theory of purchasing power parity.

51
Limitations of the model
  • 1. Many goods are not easily traded.
  • 2. Tradable goods are not always perfect
    substitutes.
  • 3. The existence of barriers to the movement of
    goods.

52
  • Consider, for instance a Big Mac, which is almost
    identical regardless of which country produced
    it.

53
  • The Economist magazine gathers information every
    year on the price of a Big Mac in local
    currencies around the world, and puts the
    information together with exchange rates to test
    the theory of PPP.

54
  • If PPP holds, then all Big Mac prices would be
    the same, if measured in US dollars.

55
  • Purchasing power parity is not a precise theory
    of exchange rates, but it often is a reasonable
    first approximation.
  • It is supposed to indicate which direction the
    currency will move in the long run.

56
Real Exchange Rates
  • The rate at which a person can trade the goods
    and services of one country for the goods and
    services of another.

57
  • Suppose that you go shopping and find that a pair
    of Canadian blue jeans is twice as expensive as a
    pair of US blue jeans.
  • We say that the real exchange rate is ½ pair of
    Canadian blue jeans per pair of US blue jeans.

58
  • Similar to the nominal exchange rate, we express
    the real exchange rate as units of the domestic
    item per unit of the foreign item.
  • Real and nominal exchange rates are closely
    related.

59
  • Real exchange rate
  • Nominal exchange rate x foreign price
  • Domestic price

60
  • The real exchange rate is a key determinant of
    how much a country exports and imports.
  • For instance, when Five Roses Inc. Is deciding
    whether to buy French or Canadian wheat to make
    flour, it will ask which wheat is cheaper

61
  • As macroeconomists, we focus on the overall price
    rather than the prices of individual items.
  • We use price indexes to measure the real exchange
    rate.

62
  • Real exchange rate e x (Pf/P)
  • e is the nominal exchange rate between the
    Canadian dollar and foreign currencies.
  • P is the price index for a Canadian basket.
  • Pf is the price index for a foreign basket.

63
  • The real exchange rate measures the price of a
    basket of goods and services available
    domestically relative to a basket of goods and
    services available abroad.

64
  • If the real exchange rate is greater than 1, then
    we expect demand for domestic produced goods to
    rise.
  • Eventually the price will be driven up or the
    exchange rate will be driven down.
  • In other words, we will move towards PPP over
    time.

65
  • Since P and Pf refer to different baskets, we do
    not expect the real exchange rate to equal 1.
  • In the long run, we expect the real exchange rate
    to return to its average level.

66
A Monetary Union
  • The euro is a currency of a monetary union of
    many countries.

67
  • In order for countries to participate in the
    monetary union they were required to meet
    specific economic targets.

68
  • Referred to as the Maastrict criteria
  • 1. 2 maximum inflation rate
  • 2. Budget deficit of less than 2 of GDP
  • 3. Debt ratio less than 60 of GDP
  • As well, there were to be no restrictions of
    capital flows and no devaluation in the two
    preceding periods.
About PowerShow.com