Please enable JavaScript.

Coggle requires JavaScript to display documents.

Relationship between exchange rates, balance of payments, and the…

- - - - floating rates
      - managed rates (dirty float)
      - fixed rates
        
        devaluation and revaluation of a currency
        
        how fixed exchange rates are maintained
- - - - Zero balance in the balance of payments
      - Credits matched by debits
      - Deficits matched by surpluses
  - - - Balance of trade in goods
      - Balance of trade in services
      - Current transfers
      - Income
    - - Foreign direct investment (FDI)
      - Portfolio investment
      - Reserve assets
      - Official borrowing
    - - Capital transfers
      - Transaction in non-produced, non-financial assets
  - - - trade protection policies
        
        pros
        
        trade deficit (X-M) hence current account deficit are reduced
        
        cons
        
        prices of protected goods increase
        
        consumption of protected goods decrease
        
        increased inefficiency of firms
        
        greater domestic and global resource misallocation
        
        risk of retaliation by other countries
      - depreciation of currency policies
        
        pros
        
        trade deficit (X-M) hence current account deficit are reduced
        
        cons
        
        increased exports → increases AD → risks demand-pull inflation
        
        higher import prices → risks cost-push inflation
    - - contractionary demand-side policies
        
        pros
        
        trade deficit (X-M) hence current account deficit are reduced
        
        higher interest rates attract financial capital creating needed credits in the financial account
        
        cons
        
        contractionary fiscal and monetary policy lead to recession → real GDP decreases and unemployment increases
        
        higher interest rates → currency appreciation → exports decrease, imports increase → trade deficit and current account balance worsen (this partly cancels the effects of expenditure-reducing policies)
    - - market-based policy changes
        
        pros
        
        lower inflation → firms more competitive in international markets → exports increase → trade deficit (X-M) and current account deficit are reduced
        
        cons
        
        need a long time to be effective
      - interventionist supply-side policy changes
        
        pros
        
        lower inflation → firms more competitive in international markets → exports increase → trade deficit (X-M) and current account deficit are reduced
        
        cons
        
        need a long time to be effective
  - - - Lower consumption and hence lower standards of living than necessary since X < M (therefore consumption < domestic production)
      - Lower domestic investment than necessary since funds are leaving the country through the financial account (debits) to balance the credits
    - - Appreciation of the currency may result → reduced export competitiveness → exports decrease, imports increase → net exports (X-M) decrease → AD decreases
    - - High rates of economic growth may result from large volumes of exports and rapid export growth (ex China)