First, some differentiation
- Balance of Trade: looks only at a nation's exports and imports of goods.
- Balance of Payments: considers all economic transfers.
For the current and capital accounts:
- if foreign currency is used to complete the transaction, it is a debt (negative)
- if foreign currency is earned in a transaction, it is a credit (positive)
- exchange rate: the price of one currency in terms of another. Generally set by supply and demand.
- increase in the value of a nation's currency in foreign exchange markets
- tends to reduce exports and increase imports
- decrease in the value of a nation's currency in foreign exchange markets
- tends to increase exports and decrease imports
Monetary and Fiscal policies can affect exchange rates, and therefore the international balance of trade and balance of payments.
Recall: Three rules for S/D of currency graphs
- Always change the D line on one currency graph, the S line on the other currency’s graph.
- Move the lines of the two currency graphs the same direction. (demand moves out, supply moves out, etc.)
- One currency will appreciate, the other will depreciate.
- taste and preferences
- demand for products increases
- so will demand for currency
- cell phones, other electronics, etc.
- price level (inflation
- consumers will seek cheaper goods if domestic prices rise
- income
- imports vary directly with its income level
- income rises, people buy more domestic good and more foreign goods.
- real interest rates
- higher real interest rates will attract investment as foreigners seek higher returns
