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Macroeconomics in an Open Economy

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1 Macroeconomics in an Open Economy
Chapter 19 Macroeconomics in an Open Economy

2 Learning Objectives Explain the main components of the balance of payments and understand how it is calculated. Explain how exchange rates are determined and how changes in exchange rates affect the prices of imports and exports. Understand how different exchange rate systems operate. Discuss the three key aspects of the current exchange rate system.

3 Learning Objectives Explain the saving and investment equation.
Explain the effect of a government budget deficit or surplus on investment in an open economy. Discuss the difference between the effectiveness of monetary and fiscal policy in an open economy and in a closed economy.

4 Australian universities face crunch from rising dollar
The appreciation of the Australian dollar against major currencies increases the cost of studying in Australia for international students.

5 LEARNING OBJECTIVE 1 The balance of payments: Linking Australia to the international economy Open economy: An economy that has interactions in trade and finance with other economies. Closed economy: An economy that has no interactions in trade or finance with other economies.

6 LEARNING OBJECTIVE 1 The balance of payments: Linking Australia to the international economy Balance of payments: The record of a country’s international trade, borrowing, lending, capital and investment flows with other countries. Current account: The part of the balance of payments that records a country’s net exports, net income and net transfers. Australia’s current account is always in deficit.

7 LEARNING OBJECTIVE 1 The balance of payments: Linking Australia to the international economy Net exports (NX): The income received for the export of goods and services minus the amount paid for imports of goods and services. Net exports fluctuate between positive and negative over time. Balance of trade in goods and services: The difference between the value of the goods and services a country exports and the value of the goods and services a country imports.

8 Balance on goods and services, Australia, 1960-2008: Figure 19.1
Figure 19.1: Balance on goods and services, Australia, Source: Australian Bureau of Statistics (2009), Balance of Payments and International Investment Position, Australia, Cat. No , Time Series Workbook. The balance on goods and services has fluctuated since the 1980s, but has predominantly been in deficit during this time. Of particular note is the huge trade deficit experienced between 2005 and 2007. Although not shown in this figure, by 2009, the balance on goods and services was positive. Source: Australian Bureau of Statistics (2009), Balance of Payments and International Investment Position, Australia, Cat. No , Time Series Workbook. Hubbard, Garnett, Lewis and O’Brien: Essentials of Economics © 2010 Pearson Australia

9 LEARNING OBJECTIVE 1 The balance of payments: Linking Australia to the international economy Net income (NY): Income paid overseas on investments in Australia by residents of other countries, eg: profits, dividends and interest repayments on loans, minus income received by Australian residents from investments in other countries.

10 LEARNING OBJECTIVE 1 The balance of payments: Linking Australia to the international economy Net income is always in deficit for Australia. Insufficient domestic saving leads to Australians borrowing from overseas – the interest repayment on loans is the largest deficit component of net income. Foreign investment in Australia generates dividends and profits which flow back overseas.

11 Net income, Australia, 1960-2008: Figure 19.2
Figure 19.2: Net Income, Australia, Source: Australian Bureau of Statistics (2009), Balance of Payments and International Investment Position, Australia, Cat. No , Time Series Workbook. The net income component on Australia’s current account has been consistently negative, or in deficit. A large component of net income is composed of interest repayments on overseas loans. The net outflow of profits and dividends exceeds the inflow that Australian residents receive from overseas investments, which also contributes to the deficit in net income. Source: Australian Bureau of Statistics (2009), Balance of Payments and International Investment Position, Australia, Cat. No , Time Series Workbook. Hubbard, Garnett, Lewis and O’Brien: Essentials of Economics © 2010 Pearson Australia

12 LEARNING OBJECTIVE 1 The balance of payments: Linking Australia to the international economy Net transfers (NT): The difference between transfers made to residents of other countries and transfers received by Australian residents from other countries, including overseas aid, pensions and migrants’ funds. Net transfers fluctuate between positive and negative over time.

13 LEARNING OBJECTIVE 1 The balance of payments: Linking Australia to the international economy The capital account: The part of the balance of payments that records migrants’ asset transfers, debt forgiveness and sales and purchases of non-produced, non- financial assets. The capital account usually has a small surplus, largely due to positive net migration.

14 LEARNING OBJECTIVE 1 The balance of payments: Linking Australia to the international economy The financial account: The part of the balance of payments that records purchases of physical and financial assets a country has made abroad and foreign purchases of physical and financial assets in the country. Contains direct investment, portfolio investment, financial derivatives, other investments and Reserve Bank assets. The financial account must always be in surplus, to balance the current account deficit.

15 LEARNING OBJECTIVE 1 The balance of payments: Linking Australia to the international economy The financial account. Net foreign investment: The difference between capital outflows from a country and capital inflows, also equal to net foreign direct investment plus net foreign portfolio investment.

16 LEARNING OBJECTIVE 1 The balance of payments: Linking Australia to the international economy The balance of payments always sums to zero. A current account deficit will be exactly offset by a capital and financial account surplus. Some countries have current account surpluses, which are exactly offset by capital and financial account deficits.

17 Please insert Table 19.1 from page 615.
Balance of payments, Australia, 2007/08: Table 19.1 Please insert Table 19.1 from page 615. Table 19.1: Balance of payments, Australia, 2007/08. Source: Australian Bureau of Statistics (2009), Balance of Payments and International Investment Position, Australia, Cat. No Source: Australian Bureau of Statistics (2009), Balance of Payments and International Investment Position, Australia, Cat. No Hubbard, Garnett, Lewis and O’Brien: Essentials of Economics © 2010 Pearson Australia

18 The balance of payments
LEARNING OBJECTIVE 1 The balance of payments A media commentator noted that exports of Australian goods were set to exceed imports for year 2009, hence he predicted that the Australian economy would no longer run a current account deficit. Is the media commentator correct? STEP 1: Review the material in the text book under the section ‘The balance of payments: Linking Australia to the international economy’.

19 The balance of payments
LEARNING OBJECTIVE 1 The balance of payments STEP 2: The media commentator is incorrect. He is confusing the balance on merchandise trade (exports of goods minus imports of goods), with the balance on the current account. The balance on merchandise trade is only one item in the current account, which includes the balance on goods and services, net income and net transfers. Even if the balance on merchandise trade is positive, other components of the current account, especially net income, are likely to remain negative, with the overall current account remaining negative.

20 The foreign exchange market and exchange rates
LEARNING OBJECTIVE 2 The foreign exchange market and exchange rates Nominal exchange rate: The value of one country’s currency in terms of another country’s currency. The market exchange rate is determined by the interaction of demand for and supply of currency.

21 Exchange rates in the financial pages
MAKING THE CONNECTION 19.1 Exchange rates in the financial pages The financial pages of most newspapers provide information on exchange rates. Money changers, hotels and numerous websites also provide up-to-the-minute exchange rates.

22 The foreign exchange market and exchange rates
LEARNING OBJECTIVE 2 The foreign exchange market and exchange rates Three sources of foreign currency demand for the Australian dollar: Foreign firms and consumers who want to buy goods and services produced in Australia. Foreign firms and consumers who want to invest in Australia (direct or portfolio investment). Currency traders who believe that the value of the dollar in the future will be greater than its value today.

23 Equilibrium in the foreign exchange market: Figure 19.3
Exchange rate (¥/$) Supply Supply of dollars in exchange for yen. Surplus of dollars ¥120 100 Demand for dollars in exchange for yen. 80 Figure 19.3: Equilibrium in the foreign exchange market. When the exchange rate is ¥120 to the dollar, it is above its equilibrium level, and there will be a surplus of dollars. When the exchange rate is ¥80 to the dollar, it is below its equilibrium level, and there will be a shortage of dollars. At an exchange rate of ¥100 to the dollar, the foreign exchange market is in equilibrium. Shortage of dollars Demand Quantity of dollars traded Hubbard, Garnett, Lewis and O’Brien: Essentials of Economics © 2010 Pearson Australia

24 The foreign exchange market and exchange rates
LEARNING OBJECTIVE 2 The foreign exchange market and exchange rates Currency appreciation: Occurs when the market value of a currency rises relative to another currency. Currency depreciation: Occurs when the market value of a currency falls relative to another currency.

25 The foreign exchange market and exchange rates
LEARNING OBJECTIVE 2 The foreign exchange market and exchange rates Shifts in the demand and supply curves for foreign exchange Three main factors cause the demand and/or supply curves in the foreign exchange market to shift: Changes in demand for Australian-produced goods and services and/or changes in the demand for foreign-produced goods and services.

26 The foreign exchange market and exchange rates
LEARNING OBJECTIVE 2 The foreign exchange market and exchange rates Shifts in the demand and supply curves for foreign exchange Changes in the desire to invest in Australia and/or changes in the desire to invest in foreign countries. Changes in the expectations of currency traders about the likely future value of the dollar and/or the likely future value of foreign currencies.

27 The foreign exchange market and exchange rates
LEARNING OBJECTIVE 2 The foreign exchange market and exchange rates Shifts in the demand for and supply of foreign exchange. Income levels and economic growth rates in Australia and in other countries. Changes in relative interest rates between countries. Speculation. Speculators: Currency traders who buy and sell foreign exchange in an attempt to profit from changes in exchange rates.

28 Shifts in demand and supply curves resulting in a higher exchange rate: Figure 19.4
2. …while the demand curve for dollars shifts further to the right … S1 S2 1. The supply curve of dollars shifts to the right … ¥130 B 120 A 3. … causing the equilibrium exchange rate to rise. Figure 19.4: Shifts in demand and supply curves resulting in a higher exchange rate. An increase in the supply of Australian dollars will decrease the equilibrium exchange rate. An increase in the demand for dollars will increase the equilibrium exchange rate, holding other factors constant. In the case shown in this figure, the demand curve and the supply curve have both shifted to the right. Because the demand curve has shifted to the right by more than the supply curve, the equilibrium exchange rate has increased from ¥100 to the dollar at point A to ¥120 at point B. D2 D1 Quantity of dollars traded Hubbard, Garnett, Lewis and O’Brien: Essentials of Economics © 2010 Pearson Australia

29 The foreign exchange market and exchange rates
LEARNING OBJECTIVE 2 The foreign exchange market and exchange rates How movements in the exchange rate affects exports and imports. Exchange rate appreciation. Revenue in Australian dollars falls for exporters whose goods are traded in $US. Exports of goods and services fall for goods whose prices are determined in Australia, as they are now more expensive to overseas buyers. Imports become cheaper. Net exports fall, ceteris paribus, reducing the rate of increase of aggregate demand and real GDP.

30 The foreign exchange market and exchange rates
LEARNING OBJECTIVE 2 The foreign exchange market and exchange rates How movements in the exchange rate affects exports and imports. Exchange rate depreciation. Revenue in Australian dollars rises for exporters whose goods are traded in $US. Exports of goods and services increase for goods whose prices are determined in Australia, as they are now less expensive to overseas buyers. Imports become more expensive. Net exports rise, ceteris paribus, increasing the rate of increase of aggregate demand and real GDP.

31 The foreign exchange market and exchange rates
LEARNING OBJECTIVE 2 The foreign exchange market and exchange rates Real exchange rate: The price of domestic goods and services in terms of foreign goods and services. Real exchange rate = Nominal exchange rate x

32 Exchange rate determination
LEARNING OBJECTIVE 2 Exchange rate determination Suppose the Australian dollar and Japanese yen are initially in equilibrium at ¥100 = $1. Imagine now the Japanese economy experiences a strong recovery with rising GDP and falling unemployment, while conditions in the Australian economy remain stable. How will this change the exchange rate between the dollar and the yen?

33 Exchange rate determination
LEARNING OBJECTIVE 2 Exchange rate determination STEP 1: Review the material. This problem is about shifts in demand and supply for a currency, so you may like to review the section in the text book ‘How do shifts in demand and supply affect the exchange rate?’

34 Exchange rate determination
LEARNING OBJECTIVE 2 Exchange rate determination STEP 2: Strong growth in Japan will lead to an increase in income for Japanese consumers, increasing demand for goods and services, including imported goods and services from trading partners such as Australia. More importantly, demand for Australian resources to fuel Japanese production will also increase. This will result in an increase in demand for the Australian dollar, as Japanese consumers and producers exchange yen for dollars to purchase Australian resources and other goods. The Australian dollar will therefore appreciate against the yen.

35 LEARNING OBJECTIVE 3 Exchange rate systems Not all exchange rates are determined in the market. A country’s exchange rate can be determined in several ways. Exchange rate system: An agreement between countries on how exchange rates should be determined.

36 LEARNING OBJECTIVE 3 Exchange rate systems Floating currency: The outcome of a country allowing its currency’s exchange rate to be determined by demand and supply. Managed float exchange rate system: The current exchange rate system under which the value of most currencies is determined by demand and supply, with occasional central bank or government intervention.

37 LEARNING OBJECTIVE 3 Exchange rate systems Fixed exchange rate system: A system under which countries agree to keep the exchange rates between their currencies fixed. Pegging: The decision by one country to keep the exchange rate fixed between its currency and another currency.

38 The current exchange rate system
LEARNING OBJECTIVE 4 The current exchange rate system The current exchange rate system has three important aspects. Australia, like Britain, the USA, Japan and much of Europe, allow their currencies to float against other currencies, with occasional central bank intervention. Many nations in the European Union have adopted the single currency, the Euro. Some developing countries have attempted to keep their currencies fixed against the US dollar or another major currency.

39 Trade-weighted index of the Australian dollar, 1970-2009: Figure 19.5
Figure 19.5: Trade-weighted index of the Australian dollar, Source: Reserve Bank of Australia, Statistics (2009), Exchange Rates, Table F11, viewed 27 March 2009, at <www.rba.gov.au>. The Australian dollar used to be pegged against the British pound, then against the US dollar, then against a basket of currencies of countries Australia traded with. In December 1983 the Australian dollar was floated and allowed to find its own value against other currencies. Source: Reserve Bank of Australia, Statistics (2009), Exchange Rates, Table F11, viewed 27 March 2009, at <www.rba.gov.au> Hubbard, Garnett, Lewis and O’Brien: Essentials of Economics © 2010 Pearson Australia

40 The current exchange rate system
LEARNING OBJECTIVE 4 The current exchange rate system What determines exchange rates in the long run? The theory of purchasing power parity. Purchasing power parity: The theory that in the long run exchange rates move to equalise the purchasing power of different currencies.

41 The current exchange rate system
LEARNING OBJECTIVE 4 The current exchange rate system Three real world complications keep purchasing power parity from being a complete explanation of exchange rates, even in the long run. Not all products can be traded internationally. Products and consumer preferences are different across countries. Countries impose barriers to trade.

42 The current exchange rate system
LEARNING OBJECTIVE 4 The current exchange rate system Barriers to trade include: Tariff: A tax imposed by a government on imported goods which makes them more expensive on the domestic market. Quota: A limit on the quantity of a good that can be imported.

43 The Big Mac theory of exchange rates.
MAKING THE CONNECTION 19.2 The Big Mac theory of exchange rates. The Big Mac Index shows what the exchange rate should be if purchasing power parity held for Big Macs.

44 The current exchange rate system
LEARNING OBJECTIVE 4 The current exchange rate system The four determinants of exchange rates in the long run. Relative price levels. Relative rates of productivity growth. Preferences for domestic and foreign goods. Tariffs and quotas.

45 The international sector and national saving and investment
LEARNING OBJECTIVE 5 The international sector and national saving and investment Current account balance (CAB) equals net foreign investment. CAB = NX + NY + NT Current Account Balance + Financial Account Balance = 0 or, Current Account Balance = - Financial Account Balance Net Exports + Net Income + Net Transfers = Net Foreign Investment Note: Assumes Capital Account balance is zero.

46 The international sector and national saving and investment
LEARNING OBJECTIVE 5 The international sector and national saving and investment Domestic saving, domestic investment and net foreign investment Private saving = national income – consumption - taxes or, Sprivate = Y – C - T Government saving = taxes – government spending or, Spublic = T - G National saving = private saving + public saving or, S = Sprivate + Spublic

47 The international sector and national saving and investment
LEARNING OBJECTIVE 5 The international sector and national saving and investment Domestic saving, domestic investment and net foreign investment Remember the basic macroeconomic equation for GDP or national income: Y = C + I + G + NX

48 The international sector and national saving and investment
LEARNING OBJECTIVE 5 The international sector and national saving and investment Gross national income (GNY): Is equal to GDP (C+I+G+NX) plus the income transfers received from other countries, including dividends and interest earned. It measures the total income that a country has for expenditure and saving. GNY = C + I + G + NX + NY + NT GNY = GDP + NY + NT

49 The international sector and national saving and investment
LEARNING OBJECTIVE 5 The international sector and national saving and investment Recall that national saving is what remains after C and G have been paid for. Therefore national saving can be expressed as: S = GNY – C – G = GDP + NY + NT – C – G = (C + I + G + NX) + NY + NT – C – G

50 The international sector and national saving and investment
LEARNING OBJECTIVE 5 The international sector and national saving and investment As the consumption and government expenditure parts of the equation cancel each other out this leaves: S = I + NX + NY + NT Recall that NX + NY + NT equals the current account balance (CAB), therefore: S = I + CAB

51 The international sector and national saving and investment
LEARNING OBJECTIVE 5 The international sector and national saving and investment Saving and investment equation: An equation showing that national saving is equal to domestic investment plus net foreign investment. National saving = domestic investment + net foreign investment or, S = I + NFI

52 The international sector and national saving and investment
LEARNING OBJECTIVE 5 The international sector and national saving and investment For Australia, net foreign investment is negative; its domestic saving is less than its domestic investment. Therefore, S – I = NFI

53 The effect of a government budget deficit on investment
LEARNING OBJECTIVE 6 The effect of a government budget deficit on investment Fiscal policy revision: Recall that if the Federal government runs a budget deficit, it must raise an amount equal to the deficit by selling bonds and securities. To attract investors, the interest rates offered must be increased, which also causes other interest rates to rise. Higher interest rates can lead to crowding out, as private investment and consumption are lowered.

54 The effect of a government budget deficit on investment
LEARNING OBJECTIVE 6 The effect of a government budget deficit on investment Fiscal policy revision: Higher interest rates can also lead to an exchange rate appreciation, reducing net exports. A budget deficit concurrent with a current account deficit is known as the twin deficits hypothesis.

55 The effect of a government budget deficit on investment
LEARNING OBJECTIVE 6 The effect of a government budget deficit on investment The twin deficits hypothesis was widely discussed in Australia from the mid 1970s and through to the 1980s. The theory appeared to be supported by the evidence during this time. However, the twin deficits hypothesis does not match Australia’s experience in the 1990s and early 2000s, as large budget surpluses were accompanied by large current account deficits.

56 The twin deficits, 1974/75-2007/08: Figure 19.6
Figure 19.6: The twin deficits, 1974/ /08. Sources: Australian Bureau of Statistics (2009), Balance of Payments and International Investment Position, Australia, Cat. No , Time Series Workbook; Australian Government (2007), Budget Overview, Appendix G, historical budget and net debt data, viewed 5 May 2008 at <www.ato.gov.au>; Australian Government (2008), Budget Overview, Appendix I, historical budget and net worth data, viewed 29 March 2009, at <www.ato.gov.au>. The twin deficits idea became widely discussed in Australia from the mid-1970s and throughout the 1980s, when the federal government ran large budget deficits that resulted in high interest rates, a high exchange value of the dollar and large current account deficits. However, in the 1990s and 2000s the government began to operate budget surpluses, and yet the current account deficits remained large. Sources: Australian Bureau of Statistics (2009), Balance of Payments and International Investment Position, Australia, Cat. No , Time Series Workbook; Australian Government (2007), Budget Overview, Appendix G, historical budget and net debt data, viewed 5 May 2008 at <www.ato.gov.au>; Australian Government (2008), Budget Overview, Appendix I, historical budget and net worth data, viewed 29 March 2009, at <www.ato.gov.au> Hubbard, Garnett, Lewis and O’Brien: Essentials of Economics © 2010 Pearson Australia

57 The effect of a government budget deficit on investment
LEARNING OBJECTIVE 6 The effect of a government budget deficit on investment Is Australia’s current account deficit a problem? Australia’s current account is always in deficit. Largely due to Australian net foreign investment being negative. Australians borrows funds from overseas and foreigners purchase Australian assets. Therefore there is an outflow of interest repayments and profits and dividends.

58 The effect of a government budget deficit on investment
LEARNING OBJECTIVE 6 The effect of a government budget deficit on investment Is Australia’s current account deficit a problem? Net foreign debt: The difference between the amount Australia lends to other countries and the amount that Australia borrows from overseas. Net foreign liability = net foreign debt liabilities + net foreign equity liabilities. Both have risen significantly as a proportion of GDP over time.

59 Net foreign debt and total net foreign liabilities as a percentage of GDP, Australia, 1975/ /08: Figure 19.7 Figure 19.7: Net foreign debt and total net foreign liabilities as a percentage of GDP, Australia, 1975/ /08. Source: Australian Bureau of Statistics (2009), Balance of Payments and International Investment Position, Australia, Cat. No , Table 30 and Table 39, Time Series Workbook. Net debt and total net foreign liabilities as a proportion of GDP have been rising significantly over time. Source: Australian Bureau of Statistics (2009), Balance of Payments and International Investment Position, Australia, Cat. No , Table 30 and Table 39, Time Series Workbook. Hubbard, Garnett, Lewis and O’Brien: Essentials of Economics © 2010 Pearson Australia

60 The effect of a government budget deficit on investment
LEARNING OBJECTIVE 6 The effect of a government budget deficit on investment Is Australia’s current account deficit a problem? The issues to consider include: Australia must borrow from overseas to finance investment required for economic growth, as domestic savings are not sufficient to fund domestic investment. Can Australia service its debt, and what proportion of GDP is required to service the debt?

61 The effect of a government budget deficit on investment
LEARNING OBJECTIVE 6 The effect of a government budget deficit on investment Is Australia’s current account deficit a problem? What proportion of debt is private and what proportion is government? Private debt does not burden tax payers. For Australia, borrowing is essential to finance investment, and the debt burden is a relatively small proportion of GDP.

62 The effect of a government budget deficit on investment
LEARNING OBJECTIVE 6 The effect of a government budget deficit on investment Is Australia’s current account deficit a problem? For some developing countries, debt servicing burdens are so high (much of which is government debt), that at times borrowing occurs to just to make the interest repayments on borrowing. Spiralling debt for developing countries has led to debt forgiveness initiatives.

63 International debt relief for poor countries.
MAKING THE CONNECTION 19.3 International debt relief for poor countries. Debt reduction and forgiveness programs are currently operating in a large number of countries in Africa.

64 Monetary policy and fiscal policy in an open economy
LEARNING OBJECTIVE 7 Monetary policy and fiscal policy in an open economy Monetary policy in an open economy. Monetary policy has a greater impact on aggregate demand in an open economy than in a closed economy. Example: Expansionary monetary policy: interest rates are reduced. Domestically, lower interest rates tend to increase investment and consumption spending. In an open economy, lower interest rates also tend to lead to an exchange rate depreciation, which increases net exports, increasing aggregate demand.

65 Monetary policy and fiscal policy in an open economy
LEARNING OBJECTIVE 7 Monetary policy and fiscal policy in an open economy Fiscal policy in an open economy. Fiscal policy has a smaller impact on aggregate demand in an open economy than in a closed economy. Example: Expansionary fiscal policy: increases in government purchases and/or tax cuts. To fund expansionary policy more government bonds will be sold, putting upward pressure on interest rates. Higher interest rates may lead to an exchange rate appreciation, reducing net exports, reducing the rate of increase of aggregate demand.

66 Get Thinking! Exchange rates between the Australian dollar and other currencies can be found in the nation’s newspapers and heard on television. Currency values can be found even more easily on the internet. Go to the link below and find the current value of the Australian dollar against the US dollar, the Euro and the Japanese yen. Note: This is just one of may sites on the internet where exchange rates can be found.

67 An Inside Look Figure 1: Foreign portfolio investment in Australia and Australian portfolio investment abroad both increased significantly in 2006 and 2007. Very large increases in foreign portfolio investment into Australia in 2006 and 2007 increased the demand for the Australian dollar. The exchange rate effect of this was partially offset by the large increases in portfolio investment made by Australians abroad. Source: Australian Bureau of Statistics (2007), Balance of Payments and international Investment Position, Australia, Cat. No , Time Series Workbook. Hubbard, Garnett, Lewis and O’Brien: Essentials of Economics © 2010 Pearson Australia

68 An Inside Look Figure 2: Direct foreign investment in Australia and Australian direct investment abroad both increased in 2006 and 2007. Direct foreign investment in Australia and Australian direct investment abroad both increased in 2006 and 2007. Source: Australian Bureau of Statistics (2007), Balance of Payments and international Investment Position, Australia, Cat. No , Time Series Workbook. Hubbard, Garnett, Lewis and O’Brien: Essentials of Economics © 2010 Pearson Australia

69 Key Terms Balance of payments Balance of trade in goods and services
Capital account Closed economy Currency appreciation Currency depreciation Current account Exchange rate system Financial account Fixed exchange rate system Floating currency Gross national income Managed float exchange rate system Net foreign investment Net foreign debt Nominal exchange rate Open economy Pegging Purchasing power parity Quota Real exchange rate Saving and investment equation Speculators Tariff

70 Check Your Knowledge Q1. Nearly all economies of the world are:
Open economies. Closed economies. Closed economies about to become open in today’s global economy. Open to trade but closed to investment and finance interactions with other economies.

71 Check Your Knowledge Q1. Nearly all economies of the world are:
Open economies. Closed economies. Closed economies about to become open in today’s global economy. Open to trade but closed to investment and finance interactions with other economies.

72 Check Your Knowledge Q2. Which of the following are sources of foreign demand for Australian dollars: Foreign firms and consumers who want to buy goods and services produced in Australia. Foreign firms and consumers who want to invest in Australia. Currency traders who believe that the value of the dollar in the future will be greater than its value today. All of the above.

73 Check Your Knowledge Q2. Which of the following are sources of foreign demand for Australian dollars: Foreign firms and consumers who want to buy goods and services produced in Australia. Foreign firms and consumers who want to invest in Australia. Currency traders who believe that the value of the dollar in the future will be greater than its value today. All of the above.

74 Check Your Knowledge Q3. When will the demand curve for Australian dollar shift to the right? When incomes in Japan fall. When interest rates in Australia fall. When speculators decide that the value of the Australian dollar will rise relative to the value of the yen. All of the above.

75 Check Your Knowledge Q3. When will the demand curve for Australian dollar shift to the right? When incomes in Japan fall. When interest rates in Australia fall. When speculators decide that the value of the Australian dollar will rise relative to the value of the yen. All of the above.

76 Check Your Knowledge Q4. Which of the following happens in a managed float exchange rate system? a. Countries agree to keep the value of their currencies constant. b. Countries agree on how exchange rates should be determined. c. Countries occasionally intervene to buy and sell their currency or other currencies to affect exchange rates. d. Countries allow the currency’s exchange rate to be determined by supply and demand.

77 Check Your Knowledge Q4. Which of the following happens in a managed float exchange rate system? a. Countries agree to keep the value of their currencies constant. b. Countries agree on how exchange rates should be determined. c. Countries occasionally intervene to buy and sell their currency or other currencies to affect exchange rates. d. Countries allow the currency’s exchange rate to be determined by supply and demand.

78 Check Your Knowledge Q5. Among the important aspects of the exchange rate system today is that: a. Many countries allow their currencies to float against other currencies. b. Many countries in Western Europe have adopted a single currency, the Euro. c. Some developing countries have attempted to keep their currency’s exchange rate fixed against a major currency such as the US dollar. d. All of the above.

79 Check Your Knowledge Q5. Among the important aspects of the exchange rate system today is that: a. Many countries allow their currencies to float against other currencies. b. Many countries in Western Europe have adopted a single currency, the Euro. c. Some developing countries have attempted to keep their currency’s exchange rate fixed against a major currency such as the US dollar. d. All of the above.


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