Macroeconomics: Unit 6 - Foreign Exchange Markets

Introduction

• Presenter: Jacob Reed from ReviewEcon.com
• Focus: Understanding foreign exchange markets for macroeconomics

Balance of Payments

• Definition: Accounting of transactions between countries
• Components:
  • Current Account:
    • Purchases of goods and services
    • Investment income
    • Net transfers (e.g., remittances)
  • Capital and Financial Account:
    • Purchases of assets (physical and financial such as stocks, currency, and bonds)

Credits and Debits

• Credits/Inflows: Money into the economy (positive numbers)
• Debits/Outflows: Money out of the economy (negative numbers)
• Surplus: More credits than debits
• Deficit: More debits than credits
• Balance: The sum of the current account and the capital and financial account is zero

Trade Balance

• Surplus: Exports > Imports
• Deficit: Imports > Exports
• Example:
  • Increase in domestic price levels leads to more imports, fewer exports (decreases current account)

Interest Rates

• Impact on capital flows:
  • High interest rates attract foreign investment (capital inflow)
  • Low interest rates lead to capital outflow

Exchange Rates

• Definition: Price of one currency in terms of another
• Appreciation: Currency value increases
• Depreciation: Currency value decreases

Foreign Exchange Markets

• Supply and Demand:
  • Demand for U.S. Dollars:
    • Determined by demand for exports, interest rates, and expected future rates
  • Supply of Currency:
    • Determined by demand for imports, domestic tastes, national income, and other factors

Graphical Analysis

• Equilibrium Exchange Rate: Intersection of supply and demand curves
• Shifts:
  • Demand for exports, interest rates, and policy can shift curves
  • Double shifts (both supply and demand) impact equilibrium quantity

Examples

• Price Level Increase:

  • Leads to increased imports and supply of U.S. dollars
  • Causes decrease in demand for U.S. dollars

• Interest Rate Change:

  • Higher U.S. interest rates lead to financial capital inflow
  • Shifts in foreign exchange markets affect currency value

Economic Impact

• Exchange Rate Changes:
  • Appreciation makes imports cheaper, exports more expensive
  • Depreciation makes imports more expensive, exports cheaper
  • Affects aggregate demand and overall economy

Conclusion

• Comprehensive understanding can aid in acing exams
• Additional resources available at ReviewEcon.com