Deck 18: A: The Balance of Payments and Exchange Rates

Question 1

What is a balance of payments deficit? What is a balance of payments surplus?

Answer 1

A nation is said to have a balance of payments deficit when imbalances in the combined current and capital accounts lead to a decrease in official reserves.A balance of payments surplus arises when imbalances in the combined current and capital accounts result in an increase in official reserves.

Question 2

Explain how the exchange rate gets determined in a flexible exchange rate system.

Answer 2

If the foreign exchange rate floats freely, the demand for and the supply of foreign currency determine foreign exchange rates.The exchange rate for any foreign currency is the rate at which the quantity of that currency demanded is equal to the quantity supplied.A change in the demand for or the supply of foreign currency will cause a change in the exchange rate for that currency.When there is an increase in the price paid in dollars for a foreign currency, the dollar has depreciated and the foreign currency has appreciated in value.Conversely, when there is a decrease in the price paid in dollars for a foreign currency, the dollar has appreciated and the foreign currency has depreciated in value.The demand for and supply of a foreign currency can change for many reasons.These shifts occur because of changes in tastes, relative incomes, relative price-levels, relative interest rates, relative expected returns, and speculation.

Question 3

Explain the relationship between the current account and the capital account in the balance of payments.

Answer 3

The current account basically shows the position of Canada in terms of trade in goods and services with the rest of the world during a year.The capital account shows the capital flows in the purchase or sale of real and financial assets during a year.The two accounts are interrelated.A current account surplus basically means that Canada's exports of goods and services were greater than imports of goods and services.This difference in value is financed by Canadians lending money abroad or by the purchase of foreign assets.Thus, a current account surplus in Canada is financed by net capital outflows (or a capital account deficit).By contrast, a current account deficit basically means that the value of Canada's exports of goods and services was less than imports of goods and services.This difference in value is financed by Canadians borrowing money from abroad or by selling ownership of Canadian assets to foreigners.A current account deficit in Canada is financed by net capital inflows (or a capital account surplus).

Question 4

Answer the next five questions on the basis of the following hypothetical data for a hypothetical nation Economia.All numbers are in billions of dollars.Assume that there is no Statistical Discrepancy. (a) What is the balance of trade? (b) What is the balance on goods and services? (c) What is the balance on the current account? (d) What is the balance on the capital account? (e) What official reserves will be needed to settle the balance of payment accounts?

Question 5

Explain how a nation might persistently import more goods than it exports and still maintain equilibrium in its balance of payments.

Question 6

What is the official settlement account and how is it used in the balance of payments?

Question 7

Explain how the dollar price of an imported good may change even though the foreign production cost of that product remains unchanged.

Question 8

The table below contains hypothetical international balance of payments data for Canada.All figures are in billions.Assume that there is no Statistical Discrepancy.Compute with the appropriate sign (+ or -) and enter in the table the eight missing items.What is the condition of the balance of payments in Canada?

Question 9

What is meant by currency appreciation?

Question 10

What happens in the foreign exchange market when there is a Canadian import transaction?

Question 11

What were the Current Account Balance, the Capital Account Balance, and the Official Settlement Accounts Balance in Canada for the year 2016? Use Table 18-1.

Question 12

What are the major components of the current account in the balance of payments? How is the current account balance determined?

Question 13

What happens in the foreign exchange market when there is a Canadian export transaction?

Question 14

The table below contains hypothetical international balance of payments data for Canada.All figures are in billions.Assume that there is no Statistical Discrepancy.Compute with the appropriate sign (+ or -) and enter in the table the eight missing items.What is the condition of the balance of payments in Canada?

Question 15

List and explain the major determinants of the demand for, and supply of, the money of a foreign nation.

Question 16

What is the difference between a fixed exchange rate system and a flexible (floating) exchange rate system?

Question 17

What role does the foreign exchange market play in facilitating the trade of goods?

Question 18

Answer the next five questions on the basis of the following hypothetical data for a nation Malthusia.All numbers are in billions of dollars.Assume that there is no Statistical Discrepancy. (a) What was the balance of trade? (b) What was the balance on goods and services? (c) What was the balance on the current account? (d) What is the balance on the capital account? (e) What official reserves will be needed to settle the balance of payment accounts?

Question 19

Is a balance of payments deficit undesirable?

Question 20

If a nation's balance of payments is always in balance, why isn't it also always in equilibrium?

Question 21

What domestic macroeconomic adjustments would be necessary to maintain fixed exchange rates when there are persistent balance of payments deficits? What are the problems with these adjustments?

Question 22

The graph below shows a change in the demand for Swiss francs from D₁ to D₂.What would happen when D₁ shifted to D₂ under a flexible exchange rate system compared to a fixed exchange rate system?

Question 23

Describe the three major disadvantages of flexible exchange rates.

Question 24

Explain the problems with exchange rate controls.

Question 25

In the table below are the supply and demand schedules for Malaysian ringgits. (a) What will be the rate of exchange for the Malaysian ringgit and for the Canadian dollar? (b) What would happen if the Canadian and Malaysian governments wanted to use currency intervention to fix or "peg" the price of a ringgit at $0.50?

Question 26

How does a fixed exchange rate system work? How can a nation maintain its fixed exchange rate?

Question 27

How are flexible exchange rates used to eliminate a balance of payments deficit or surplus?

Question 28

In the table below are the supply and demand schedules for Russian roubles. (a) What will be the rate of exchange for the Russian rouble and for the Canadian dollar? (b) What would happen if the Canadian and Russian governments wanted to use currency intervention to fix or "peg" the price of a rouble at $0.60?

Question 29

Explain how China used the inflationary peg to move it's economy from a communist system to a capitalist system.

Question 30

What is the "managed float"?