1. Chapter 5: Foreign Exchange Markets and the Balance of Payments

2. Foreign exchange market
Foreign exchange = money denominated in foreign currency
Foreign exchange market = global market in which currencies are exchanged for each other
Most foreign exchange transactions involve purchase and sale of bank deposits

3. Exchange rate
Exchange rate = price of one currency in terms of another
Reciprocal exchange rates – If $1 is worth 1/2 British pounds, each British pound is worth 2 of a dollar.
Domestic currency price
= foreign currency price x exchange rate

4. Appreciation and depreciation
If the domestic currency appreciates,
Imports become less expensive
Imports rise
Exports become more expensive in the rest of the world.
Exports decline
If the domestic currency depreciates,
Imports become more expensive
Imports decline
Exports become less expensive in the rest of the world.
Exports rise

5. Balance of payments Double-entry bookkeeping Credits Debits
Two sides to each transaction
Dollar value of money flowing into the country must equal the dollar value of the money flowing out (two sides of the same transaction)
Credits
activities that brings payments into the country
Debits
activities that involve payments to the rest of the world

6. Current and Financial accounts
Current account = trade in goods and services
Financial account = trade in financial assets
Net balance on current account + net balance on capital account + statistical discrepancy = 0 (overall balance of payments = 0)

7. Current account Merchandise – trade in goods
Services – trade in services
Investment income = payment for capital services (interest payments)
Unilateral transfers – payments for which no goods or services are provided in return

8. Balance of payment accounts – 2000 (in millions)
Credit
Debit
Net balance
Merchandise
$183,728
$289,566
$-105,838
Services
$71,309
$51,647
$19,662
Investment income
$79,749
$83,949
-$4,200
Unilateral transfers
-$11,925
Current Account
-$102,301
Capital Account
$215,008
$143,283
$71,725
Statistical discrepancy
-$30,410
Overall BOP $0