 |  Macroeconomics, 9/e Campbell R. McConnell,
University of Nebraska, Lincoln
Stanley L. Brue,
Pacific Lutheran University
Thomas P. Barbiero,
Ryerson University
Exchange Rates and the Balance of Payments
Chapter HighlightsCHAPTER 18- Canadian exports create a foreign demand for dollars and make a supply of foreign exchange available to
Canadians. Conversely, Canadian imports create a demand for foreign exchange and make a supply of dollars
available to foreigners. Generally, a nation's exports earn the foreign currencies needed to pay for its
imports.
- The balance of payments records all international trade and financial transactions taking place between a
given nation and the rest of the world. The trade balance compares exports and imports of goods. The balance
on goods and services compares exports and imports of both goods and services. The current account
balance includes not only goods and services transactions but also net investment income and net transfers.
- A deficit in the current account may be offset by a surplus in the capital account. Conversely, a surplus in the
current account may be offset by a deficit in the capital account. A balance of payments deficit occurs when
the sum of the current and capital accounts is negative. Such a deficit is financed with official international
reserves. A balance of payments surplus occurs when the sum of the current and capital accounts is positive.
A payments surplus results in an increase in official reserves. The desirability of a balance of payments deficit
or surplus depends on its size and its persistence.
- Flexible or floating exchange rates between international currencies are determined by the demand for
and supply of those currencies. Under floating rates a currency will depreciate or appreciate as a result of
changes in tastes, relative income changes, relative price changes, relative changes in real interest rates, and
speculation.
- The maintenance of fixed exchange rates requires adequate international reserves to accommodate periodic
payments deficits. If reserves are inadequate, nations must invoke protectionist trade policies, engage in
exchange controls, or endure undesirable domestic macroeconomic adjustments.
- The gold standard, a fixed rate system, provided exchange-rate stability until its disintegration during the
1930s. Under this system, gold flows between nations precipitated sometimes painful changes in price,
income, and employment levels in bringing about international equilibrium.
- Under the Bretton Woods system, exchange rates were pegged to one another and were stable. Participating
nations were obligated to maintain these rates by using stabilization funds, gold, or loans from the IMF.
Persistent or "fundamental" payments deficits could be resolved by IMF-sanctioned currency devaluations.
- Since 1971 the world's major nations have used a system of managed floating exchange rates. Rates are generally
set by market forces, although governments intervene with varying frequency to alter their exchange
rates.
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2002 McGraw-Hill Higher Education