International Trade Final
Terms in this set (54)
An increase in the number of dollars required to buy a unit of foreign exchange
a decrease in the number of dollars required to buy a unit of foreign exchange
Purchasing Power Parity
Purchasing power parity is a theory that the change in price level has a significant impact on change in exchange rate
What are the 4 key factors of Long Term exchange rates
Four key factors:
1. Relative price levels
2. Relative productivity levels
3. Consumer preferences for domestic or foreign goods
4. Trade barriers
Short Term Exchange Rates
Driven by speculation and expectation .
Medium Exchange Rates
exchange rate are governed by cyclical factor such as fluctuation in economic activity
Decided upon through economic cycles. Depreciation when value is down, appreciation when value is up - based on cyclical variation
In a free market, exchange rates are determined by market fundamentals and market expectations. The former includes the real interest rates, consumer preferences for domestic or foreign products, productivity, investment profitability, product availability, monetary and fiscal policy, and government trade policy.
Fundamental forces serve to push a currency toward its long-term equilibrium path
Interim cyclical forces can induce fluctuations of a currency above and below its long term equilibrium path
Interim cyclical fluctuations from a currency's long-term equilibrium path can be large at times if economic disturbances induce significant changes in either trade flows or capital movements.
What you think will happen.Currency forecasters use several methods to predict future exchange-rate movements:
Fixed Exchange Rate System
A government defines the official exchange rate for its currency. It then establishes an exchange-stabilization fund, which buys and sells foreign currencies to prevent the market exchange rate from moving above or below the official rate
Floating Exchange Rates
Market forces of supply and demand determine currency values
Arguments for floating rates are:
Independent domestic policies
Reduced need for international reserve
Arguments against floating rates are:
Disorderly exchange markets
Reckless financial policies on the part of governments
Conduciveness to price inflation
Managed floating system
established informal guidelines to coordinate the national exchange rate policies. Combination of fixed and floating
Floating Arose from what two concerns?
Nations might intervene in the exchange markets to avoid exchange rate altercations that would weaken their competitive position
Floats over time might lead to disorderly markets with erratic fluctuations in exchange rates- such destabilizing activity could create an uncertain business climate and reduce the level of world trade
How can a nation alter the degree in which it intervenes in the foreign-exchange market?
Heavier intervention moves the nation nearer to a fixed exchange rate status
Less intervention moves the nation nearer to a floating exchange rate status
Foreign central banks refused to permit the dollar depreciation by intervening in the exchange market
Within a managed floating system, central bank refuses to permit depreciation - free market forces can't naturally change the markets.
A nation makes frequent devaluations (or revaluations) of its currency to restore payments balance
Used primarily by developing nations suffering from high inflation rates
Fixed exchange rate modified often to avoid crisis. Mostly used by developing countries.
Fixed Exchange Rates
A government defines the official exchange rate for its currency. It then establishes an exchange stabilization fund, which buys and sells foreign currencies to prevent the market exchange rate from moving above or below the official rate. Nations may officially devalue/revalue their currencies to store trade equilibrium
It takes fewer units of a nation's currency to purchase a unit of some foreign currency
Causes and consequences
Causes - Increased demand of a good
Consequences - exports down, imports up, makes domestic goods more expensive to foreigners and they have less incentive to buy.
To offset an appreciation in the home country's exchange value
a central bank can sell additional quantities of its currency on the foreign-exchange
initiate an expansionary monetary policy
It takes more units of a nation's currency to purchase a unit of some foreign currency.
Causes and Consequences
Makes foreign goods more attractive.
To offset a depreciation in the home country's exchange value, a central bank can:
Use its international reserves to purchase quantities of that currency on the foreign-exchange market
Initiate a contractionary monetary policy, which leads to higher domestic interest rates, increased investment inflows, and increased demand for home currency
Goes with the market forces by reinforcing fluctuations in a currency's exchange rate.
Magnifies the effect of whatever happens in exchange market.
Can disrupt international transactions in two ways.
What two ways can Destabilizing Speculation disrupt international transactions
Because of the uncertainty of financing exports and imports, the cost of hedging may become so high that international trade is impeded
Unstable exchange rates may disrupt international activity because the cost of obtaining forward cover for international capital transactions may rise significantly as foreign exchange risks intensifies
goes against market forces by moderating or reversing a rise or fall in a currency's exchange rate.
Reduces the effect that happened in exchange market
Ex. A speculator buys foreign currency with domestic currency when the domestic price of the foreign currency falls
The hope is that the domestic price of the foreign currency will soon increase, leading to a profit
Such purchases increase the demand for the foreign currency, which moderates its depreciation
the process of avoiding or covering a foreign-exchange risk.
The forward market eliminates the uncertainty of fluctuating spot rates from international transactions.
Exporters can hedge against the possibility that the domestic currency will appreciate against the foreign currency
Importers can hedge against the possibility that domestic currency will depreciate against the foreign currency
When foreign exchange can be bought and sold for future delivery
The conversion of one currency to another currency at one point in time, with an agreement to reconvert it back to the original currency at a specified time in the future
Undertake policy to offset exchange rate
the purchase or sale of foreign currency by a central bank to influence the exchange value of the domestic currency, without changing the monetary base
Evidence suggests that sterilized intervention is generally incapable of altering exchange rates
What two separate interventions does Sterilized Intervention deal with?
1: the sale or purchase of foreign currency assets
2: an open market operation involving the purchase or sale of Us government securities (in the same size as the first transaction)
The demand for international reserves depends on two major factors which are?
1. The monetary value of international transactions
2. The size and duration of the balance-of-payments disequilibrium
The supply of international reserves consists of owned and borrowed reserves. Among the major sources of reserves are:
Special drawing rights
IMF drawing positions
The General Arrangements to Borrow
refer to the movement of money for the purpose of investment, trade or business production, including the flow of capital within corporations in the form of investment capital, capital spending om operations and research development
On a larger scale, a government directs capital flows from tax receipts into programs and operations and through trade with other nations and currencies
Individual direct savings and investment capital into securities, such as stocks, bonds, and mutual funds
The Latin American debt crisis was a financial crisis that originated in the early 1980s (and for some countries starting in the 1970s), often known as the "lost decade", when Latin American countries reached a point where their foreign debt exceeded their earning power and they were not able to repay it.
In response to the crisis most nations abandoned their import substitution industrialization models of economy and adopted an export-oriented industrialization strategy, usually the neoliberal strategy encouraged by the IMF
Countries thought since they were rich in raw materials and natura resources, it would be a good place to invest. Commodity prices dropped
Replacing goods you import and trying to produce them yourselves
A massive process of capital outflow, particularly to the United States, served to depreciate the exchange rates, thereby raising the real interest rate.
Real GDP growth rate for the region was only 2.3 percent between 1980 and 1985, but in per capita terms Latin America experienced negative growth of almost 9 percent. Between 1982 and 1985, Latin America paid back 108 billion dollars
Asian Financial Crisis
Was a series of currency devaluations and other events that spread through many Asian markets beginning in the summer of 1997.
Global Financial Crisis
(2007-2009) Began as a bursting of the US housing market bubble and an increase in foreclosures ballooned into a global financial and economic crisis.
When the US financial system stumbles it tends to bring major part of the world down this is. This is because the US is the main guarantor for the international financial system, the provider of dollars widely used as currency reserves and as an international medium of exchange, and a contributor to much of the financial capital that sloshes around the world seeking higher yields
Countries had their currency pegged to US and there was no currency that could replace USD
COUNTRIES USED USD AS THEIR CURRENCY
Refer to Google Doc
Debt Service is the amount a country has to pay in interest and the principle to pay back the loan
Value a country is having to pay back + interest and change in currency
Debt service ratio
Limits the amount an investor can invest or buy in a foreign countries, but it is controlled by the domestic country
Tax on all international financial taxes. Discourages multi-national companies from going to different countries making profits.
The movement of money from one investment to another in search of greater stability or increased returns.
Automatic adjustment mechanism
Fixed exchange rate response.
Occurs because of the Change in money supply. Dampens the initial shock and tires to bring the country back to equilibrium.
Exchange rate pass through
The extent to which changing currency values lead to changes in import and export prices
The more companies use foreign inputs, the less a government can help the balance of trade deficit
What you pay to get materials will cost more because of a devaluation in your own
Devaluation leads to reduction in BOT deficit
The Marshall-Lerner condition
The Marshall Lerner The Marshall-Lerner condition illustrates the price effects of currency depreciation on the home-country's trade balance.
Main idea. BOT deficit(supply is greater then demand for currency) will decrease before it gets better.
When a nation realizes neither deficits nor surpluses in its current account.
External balance = current account equilibrium
BOT is equal
When a nation's government has actively pursued the goal of economic stability at full employment
Reaching full employment
Monetary and Fiscal Policy
Fiscal is fixed -
Monetary is flexible - First shift is money supply
Fiscal policy is government spending and taxes
Monetary is everything else
Expansionary Fiscal Policy
Increase in govt spending or decrease in taxes (which would encourage more spending)
Bretone Woods system
An international monetary policy that was created. Its founders felt that completely fixed exchange rates nor floating rates were optimal; instead they adopted a kind of semi-fixed exchange-rate system known as adjustable pegged exchange rates.
International Monetary Fund (IMF)
(International Monetary Fund) headquarters in Washington, and consisting of 184 nations, the IMF can be thought of as a bank for the central banks of member nations
Country in crisis can come for money
Used for short term shocks
By making available currencies to the IMF, the surplus nations channel funds to nations with temporary deficits. Over the long term, deficits must be corrected, and the IMF attempts to ensure that this adjustment will be as prompt and orderly has possible
Funds come from two major sources: quotas & loans
Quotas: the size of the member's quota depends on its economic and financial importance in the world; nations with larger economic importance have larger quotas. The quotas are increased periodically as a means of boosting IMF's resources
Loans: IMF get loans from other member nations. The IMF has lines of credit with major industrial nations as well as Saudi Arabia
An international organization made up of 185 member countries that provides loans to developing nations aimed toward poverty reduction and economic development. It lends money to member governments and their agencies and to private firms in the member nations. These nations are jointly responsible for how institution is financed and how the money is spent
Targeted at long term development
What makes them different is that their interest rates are either low or non existent because a country will have trouble paying an interest rate
In recent years the World Bank has financed debt-refinancing activities in developing nations. The bank encourages private investment in member nations.
WTO- (World Trade Organization)
WTO- (World Trade Organization) Member nations open their markets through the removal of barriers to trade and "bind" their commitments.
Attempt to remove trade barriers between countries
Problem is that Terms of trade favour large countries
Exorbitant privilege of the US
Negative influences of being a reserve currency- leads to a higher exchange rate, thereby reducing the competitiveness of export-reliant businesses abroad
The market in which participants from around the world are able to buy, sell, exchange, and speculate on different currencies
Special drawing right
As global economy expanded, there needed to be more money
IMF created special drawing rights so they would not run out of money
Distributed by size of country
Larger countries = more money
Role of conditionality is to ensure money is used for good and puth the country in a position where it will be able to repay their loans