economics chapter 7 exchange rate. currencies do you know these currencies?
TRANSCRIPT
Economics
Chapter 7
Exchange rate
Currencies Do you know these currencies?
Currencies
Currencies
Currencies
Currencies
Currencies
Currencies
Major currencies USA: US Dollar [Code: USD; Sign: $] British: Pound sterling [Code: GBP; Sign: £] Europe: Euro [Code: EUR; Sign:€] China: Renminbi [Code: RMB; Sign: ¥] Hong Kong Dollar [Code: HKD; Sign: $] Japanese yen [Code: JPY; Sign: ¥]
Currencies
Why do we need foreign currencies?
Purchasing materials in foreign countries
Travelling
Investment
Remittances to relatives or friends
Etc.
Exchange rate
Exchange rate
the price at which two currencies are exchanged
the price of a foreign currency in terms of
the local currency, or vice versa
convertibility rate
Exchange rate
Expression (assume USD and HKD)
1. The exchange rate of USD
US$ 1 can be converted into HK$ 7.8
HKD/USD = 7.8 / 1 = 7.8
Exchange rate
Expression (assume USD and HKD)
2. The exchange rate of HKD
HK$ 1 can be converted into US$
USD/HKD =
Floating exchange rate
Exchange rate is
Free-floating
Depends on market demand and supply
Appreciation
A rise in exchange rate
Depreciation
A fall in exchange rate
Appreciation USD Euro
The USD appreciates relative to the EUR
HKD JPY
The HKD appreciates relative to the JPY
Date US$1 equals
1 April 2011 € 0.7
1 May 2011 € 0.8
Date HK$1 equals
1 April 2011 ¥10.40
1 May 2011 ¥11.00
Depreciation USD Euro
The EUR depreciates relative to the USD
HKD JPY
The JPY depreciates relative to the HKD
Date €1 equals
1 April 2011 US$ = US$1.43
1 May 2011 US$ = US$1.25
Date JP¥1 equals
1 April 2011 HK$ = HK$0.096
1 May 2011 HK$ = HK$0.091
Floating exchange rate
Depreciation: exchange rate
Appreciation: exchange rate
• There is only one exchange rate between two currencies.
• Appreciation of one currency = Depreciation of the other
Linked exchange rate system in HK
Since 1983
HKD linked with USD at a fixed exchange rate
Aim: To maintain stability of the exchange rate between
HKD and USD
Exchange rate: US$1:HK$7.75–7.85
Controlled by the HKSAR Gov’t (HKMA)
Brief history of linked exchange rates system in HK:
History of Hong Kong's Exchange Rate SystemPeriod Exchange rate regime Features
1863–1935 Silver Standard Silver dollars as legal tenderDecember 1935–June 1972
Sterling exchange •Standard exchange rate:£1:HK$16 (December 1935–November 1967)•£1:HK$14.55 (November 1967–June 1972)
July 1972–November 1974
Fixed exchange rate against the US dollar
•Exchange rate:US$1:HK$5.650 (June 1972–February 1973)•US$1:HK$5.085 (February 1973–November 1974)
November 1974–October 1983
Free floating •Exchange rates on selected days:US$1:HK$4.965 (25 November 1974)•US$1:HK$9.600 (24 September 1983)
1983–Present Linked exchange rate system
•US$1:HK$7.80 (1983–1998)(for issue and redemption of Certificates of Indebtedness)•US$1:HK$7.75 (1998–2005)(The HKMA undertakes to convert the HK dollars in licensed banks’ clearing accounts maintained with the HKMA into US dollars at the fixed exchange rate of HK$7.75 to US$1. The rate has been moving to 7.80 by 1 pip each calendar day starting from 1 April 1999 ending 12 August 2000.)•US$1:HK$7.75–7.85 (May 2005 onwards)HKMA set up upper and lower guaranteed limit since 18 May 2005
Source: http://en.wikipedia.org/wiki/Hong_Kong_dollar
Linked exchange rate system in HK
Revaluation
Originally, HKMA fixed the rate at US$1:HK$7.8
If HKMA set the rate at US$1:HK$6
(meaning that less HK dollar can be bought by US$1)
(value of HK dollar increases)
the rate of HKD against USD rises
The government re-pegs exchange rate at a higher level
Linked exchange rate system in HK
Devaluation
Originally, HKMA fixed the rate at US$1:HK$7.8
If HKMA set the rate at US$1:HK$9
(meaning that more HK dollar can be bought by US$1)
(value of HK dollar decreases)
the rate of HKD against USD falls
The government re-pegs exchange rate at a lower level
Difference:
Exchange rate system Floating Fixed
Exchange rate is determined by Market Government
Exchange rate of local currency against foreign
currency
Increase Appreciation Revaluation
Decrease Depreciation Devaluation
Example countries USA China
Linked exchange rate system in HK
Strong reserves support
A currency board system
HK monetary base is support by USD
Maintain the exchange rate when issuing banknotes
Linked exchange rate system in HK
Operation The bank is going to issue $7,800,000 banknotes It needs to pay USD of equivalent value (US$ 1 : HK$7.8) to
HKMA to buy Certificate of Indebtedness [CIs] (負責證明書 ) As a support for banknotes issued In this case, the bank pays US$1 million to HKMA
* In reverse, banks return HKD & CIs to the HKMA and get back the USD.
Certificatesof
Indebtedness
US$ 1: HK$7.8
HKMA
Linked exchange rate system in HKExchange rates change with the USD Under the linked exchange rate system, the exchange rates of the HKD
against other foreign currencies change with the USD.
Against other currencies if USD appreciation HKD appreciation (against other currencies) if USD depreciation HKD depreciation (against other currencies)
DateUS$1 equals(EUR/USD)
US$1 equals(Linked exchange
rate system, HKD/USD)
Euro 1 equals(HKD/EUR)
1 April 2011 € 0.7 HK$ 7.8 HK$HK$11.14
1 May 2011 € 0.8 HK$ 7.8 HK$HK$9.75
USD appreciatesagainst EUR
Fixed EUR depreciates against HKD, (i.e. HKD appreciates against EUR)
HK people suffer from RMB appreciationExchange rates change with the USD RMB appreciates against USD
since 1994 Since 2006, exchange rose quickly USD depreciation is faster HKD is linked to USD,
so HKD follows USD and depreciates against RMB sharply
Meaning that HK people needs to pay more HKD to buy products fromthe mainland
Before that, HK people went shopping in the mainland
Nowadays, mainland visitor come to HKfor shopping
RMB annual average middle exchange rate from USD and HKD
(1 foreign currency unit to RMB)
year US dollar HK dollar
1996 8.3142 1.07510
1997 8.2898 1.07090
1998 8.2791 1.06880
1999 8.2783 1.06660
2000 8.2784 1.06180
2001 8.2770 1.06080
2002 8.2770 1.06070
2003 8.2770 1.06240
2004 8.2768 1.06230
2005 8.1917 1.05300
2006 7.9718 1.02620
2007 7.6040 0.97459
2008 6.9451 0.8919
2009 6.8310 0.8812
Source: http://en.wikipedia.org/wiki/List_of_Renminbi_exchange_rates
Balance of payment (BOP) account
Definition The record of an economy’s receipts and payments arising from
external transactions
BOP account of HK For a specific time period Economic transactions between HK residents and non-residents
Balance of payment (BOP) account
Components of the BOP account:A. Current account ( 經常帳 )B. Capital and financial account (資本及金融帳 )
International purchases or sales of
assetsCapital transfers
All external transactions not
included in capital & financial account
Capital and financial account
Current account
BOP account
Balance of payment (BOP) account
A. Current account:1. Goods (visible trade) Net receipt brought by merchandise trade (商品貿易 ) Receipt: Exports of goods, e.g. garments, jewellery… Payment: Imports of goods, e.g. rice, cars…
Types of BOT:
Balance of visible trade = Total exports of goods – Total imports of goods
Trade deficit (貿易赤字 ) Exports < Imports BOT < 0
Balance BOT (貿易平衡 ) Exports = Imports BOT = 0
Trade surplus (貿易盈餘 ) Exports > Imports BOT > 0
Balance of payment (BOP) account
A. Current account:
2. Services (invisible trade)
Net receipt brought by services
Receipt: Exports of services, e.g. local airline…
Payment: Imports of services, e.g. World Cup broadcasting…
Balance of invisible trade = Total exports of services – Total imports of services
Balance of payment (BOP) account
A. Current account:3. Factor income Net income from abraod All forms of investment income
Dividends Interest from deposit
4. Current transfers Unilateral (單向 ) transfer of goods and capital No economic value being received in return For example: donations, remittances 匯款
Net income from abroad = Factor income from abroad – Factor income paid abroad
Balance of payment (BOP) account
A. Current account balance:Total balance of the 4 components: Visible trade Invisible trade Factor income Current transfer
Current account balance
= Balance of (Goods + Services + Factor income + Current
transfer)
Balance of payment (BOP) account
Given the following table, calculate the current account balance of HK:
Current account balance= ( $500 - $200 + $350 - $100 + $50 - $80 - $120 ) million= $400 million
Components Value ($ million)
Exports of goods 500
Imports of goods 200
Exports of services 350
Imports of services 100
Dividends from USA company 50
Compensation to employees in Europe 80
Donation to Japan 120
Balance of payment (BOP) account
B. Capital and financial account:
It records investment and capital transfers between local residents and
non-residents and changes in reserve assets
Capital transfer
External transactions in non-produced, non-financial assets
External investment
------------------------------------------------------------------------------------
Changes in reserve assets (the gov’t buys or sells assets, e.g. gold)
A. Current account balance:Total balance of the 4 components: Visible trade Invisible trade Factor income Current transfer
B. Capital and financial account:
Capital transfer
External transactions in non-produced, non-financial assets
External investment
------------------------------------------------------------------------------------
Changes in reserve assets (the gov’t buys or sells assets, e.g. gold)
BO
P
Bal
ance
of
BO
P
Balance of payment (BOP) accountB. Capital and financial account:
* Think about money inflow (to HK) or outflow (to other countries)
(Textbook p.13)
Transaction Capital flowBalance of capital and
financial account
A US resident buys shares in a listed company in Hong Kong.
Inflow / Outflow Increase / Decrease
A Hong Kong resident transfers his deposits from a local bank too an overseas bank.
Inflow / Outflow Increase / Decrease
A Hong Kong resident buys a property in the mainland.
Inflow / Outflow Increase / Decrease
A Hong Kong company sells the patent of a product to a Japanese company.
Inflow / Outflow Increase / Decrease
A mainland resident sells his property in Hong Kong.
Inflow / Outflow Increase / Decrease
A US company sets up a branch office in Hong Kong
Inflow / Outflow Increase / Decrease
Balance of payment (BOP) accountBOP
= Balance of Current Acc. +
Balance of Capital and financial Acc. (excluding reserve asset transaction)
Balance ($)
(A) Current account(B) Capital and financial account (1) Balance of capital and financial account excluding reserve asset transactions (2) Reserve assets (net change)
- 1,0001,000
800200
BOP = (A) + (B1) - 200
Balance of payment (BOP) accountBalance of BOP
= Balance of Current Acc. + Balance of Capital and financial Acc.
= 0
Balance (HK$ million)
(A) Current account [ (1) + (2) + (3) + (4) ] (1) Goods (2) Services (3) Factor income (4) Current transfer(B) Capital and financial account(C) Net errors and omissions
100,000
- 135,00035,000
-50,00080,00040,00030,000
Balance of BOP = [ (A) + (B) + (C) ] Total = 0
Balance of payment (BOP) account
According to the accounting rule:
Balance of BOP account must be zero.
i.e. Balance of BOP
= Current acc. balance + Capital and financial balance
= 0
If balance of BOP ≠ 0, the difference will be counted as
“Net errors and omissions”.
The meaning of BOP1. BOP deficit
HK buys thing from the USA Payment to USA
HK has nothing to sell to the USA No receipts from USA
HK has no additional money for receipt. Need to pay from its reserves asset. reserves assets
BOP deficit will be found if the payments of an economy are larger than its receiptsin its external transactions excluding reserve asset transactions.
HK USA
$1000
$0
The meaning of BOP2. BOP surplus
HK sells thing to the USA Receipts from USA
HK buys nothing from the USA No payments to USA
HK has received payment. reserves assets
BOP surplus will be found if the receipts of an economy are larger than its paymentsin its external transactions excluding reserve asset transactions.
HK USA
$0
$1000
The meaning of BOP3. Balanced BOP
HK sells thing to the USA Receipts from USA
HK buys thing from the USA Payments to USA
HK has received and made payments. reserves assets remains unchanged
Balanced BOP will be found if the receipts of an economy equal to its paymentsin its external transactions excluding reserve asset transactions.
HK USA
$1000
$1000
The meaning of BOP
Summary
BOPReserve assets
ActualShown in
balance sheet of BOP
BOP deficit -[ receipts < payments ]
+ ve
Balanced BOP 0[ receipts = payments ]
Unchanged 0
BOP surplus +[ receipts > payments ]
- ve
Balance of payment (BOP) account
Example: Below is the balance of payment account of a country
Answer the questions based on the information above.
a. Suppose the domestic exports of goods are $650 million and imports of goods are $200 million. Find the value of re-exports. (2%)
b. Find the current account balance. (2%)
c. Find the value of X. What is the change in the reserve assets? Find the balance of payments. (4%)
Balance (HK$
million)
Current account Goods Services Factor income Current transfersCapital and financial account Balance of capital and financial account excluding reserve asset transactions Reserve assets (net change)
580-430120-40
-250X
Balance of payment (BOP) account
Example: Below is the balance of payment account of a country
a. Suppose the domestic exports of goods are $650 million and imports of goods are $200 million. Find
the value of re-exports. (2%) Answer:
Balance of goods trade = Exports of goods + Re-exports of goods– Total imports of goods
$580 million = $650 million + Re-exports - $200 million
The value of re-export = ( $580 + $200 - $650 ) million = $130 million
Balance (HK$
million)
Current account Goods Services Factor income Current transfersCapital and financial account Balance of capital and financial account excluding reserve asset transactions Reserve assets (net change)
580-430120-40
-250X
Balance of payment (BOP) account
Example: Below is the balance of payment account of a country
b. Find the current account balance. (2%)
Answer:
Current account balance = ($580 - $430 + $120 - $40 ) million = $230 million
Balance (HK$
million)
Current account Goods Services Factor income Current transfersCapital and financial account Balance of capital and financial account excluding reserve asset transactions Reserve assets (net change)
580-430120-40
-250X
Balance of payment (BOP) account
Example: Below is the balance of payment account of a country
c. Find the value of X. What is the change in the reserve assets? Find the balance of payments. Answer: Balance of BOP = Bal. of current acc. + Bal. of capital and financial acc. = $0
i.e. $230 million - $250 million +X = 0
X = $20 million
Since reserve assets decrease by $20 million, we can see BOP deficit.
BOP = $230 million - $250 million = - $20 million
Balance (HK$
million)
Current account Goods Services Factor income Current transfersCapital and financial account Balance of capital and financial account excluding reserve asset transactions Reserve assets (net change)
580-430120-40
-250X
National income identity and the BOP
Current account balance (CA) or (NX) X = Total exports of goods and services M = Total imports of goods and services Assume:
No factor income flow No current transfer
NX = Net exports
Capital and financial account balance (KA)
NX X - M
National income identity and the BOP
According to the accounting rule, Current account balance (NX) and Capital and financial account balance (KA)
will offset each other. i.e. NX + KA = 0 NX = - KA NX - KA
Current account balance Capital and financial account balance
Type NX KA Type
Surplus +ve -ve Deficit
Balanced 0 0 Balanced
Deficit -ve +ve Surplus
National income identity and the BOP
National income identity National income (from expenditure approach)
Y = National income C = Private consumption expenditure I = Investment expenditure G = Government consumption expenditure NX = Net exports
Y C + I + G + NX …… (1)
National income identity and the BOP
National income identity Another expression
Y = National income C = Private consumption expenditure SP = Private saving T = Tax revenue
Y C + SP + T …… (2)
National income identity and the BOP
Put (2) into (1)
C + I + G + NX = C + SP + T
I + G + NX = SP + T
NX = SP + ( T – G ) – I ……(3)
or NX = ( SP – I ) – ( G – T )
Y C + SP + T …… (2)
Y C + I + G + NX …… (1)
National income identity and the BOP
Equation (3) :
( T – G ) = Gov’t tax revenue – Gov’t expenditure
i.e. The gov’t budget surplus
If surplus budget, i.e. T > G, then gov’t reserves increases
i.e. public saving ( SG) increases
Equation (4) :
NX SP + T – G – I
NX SP + SG – I
National income identity and the BOP
Equation (4) :
SP = Private saving SG = Government saving
In total:
SN = SP + SG = National saving
Equation (5):Meaning that:
Current account balance is domestic (national) saving minus domestic investment.
NX SP + SG – I
NX SN – I
Economic implications of NX = SN - I
Given NX = SN – I and NX = - KA
Current account(NX)
Capital and financial account
( KA = - NX )
Capital flowDomestic saving vs. Domestic investment
Surplus( NX > 0 )
KA < 0
• Capital and financial acc. offsets current acc. surplus
• Net capital flow < 0• Net capital outflow
• SN > I• Saving > Investment• Outward investment
Balanced( NX = 0 )
KA = 0
• Capital and financial acc. is balanced
• Net capital flow = 0• No capital
inflow or outflow
• SN = I• Saving = Investment• Domestic saving
equals domestic investment
Deficit( NX < 0 )
KA > 0
• Capital and financial acc. offsets current acc. deficit
• Net capital flow > 0• Net capital inflow
• SN < I• Saving < Investment• Inward investment
Question
Which of the following statements about national saving is CORRECT?
A. National saving must be equal to domestic investment in a closed economy.
B. Private saving must be equal to public saving.
C. National saving must not be equal to domestic investment in an open economy.
D. None of the above.
Answer
A
In a closed economy, Y = C + I + G, so I = Y – C – G. As S = Y – C – G, S = I.
Option C is incorrect. In an open economy, S – I = NX. If NX = 0, national saving is equal to domestic investment.
Question
If government consumption expenditure exceeds tax revenue,
(1) national saving is negative.
(2) public saving is negative.
(3) there is a budget deficit.
A. (1) and (2) only
B. (1) and (3) only
C. (2) and (3) only
D. (1), (2) and (3)
Answer
C
(2) is correct. Public saving = Tax revenue – Government consumption expenditure
If government consumption expenditure is larger than tax revenue, public saving will be negative.
(3) is correct. When government consumption expenditure is larger than tax revenue, the government revenue cannot cover all her expenses. There is a budget deficit.
(1) is incorrect. National saving = Private saving + Public saving
We can only tell that public saving is negative. Whether national saving is negative or not depends on the value of private saving.
Question
In an open economy, if domestic investment exceeds national saving, there will be a _____________ and the net capital outflow is _____________.
A. trade surplus … positive
B. trade surplus … negative
C. trade deficit … positive
D. trade deficit … negative
Answer
D
As S – I = NX, when I > S, NX < 0. Therefore, there will be a trade deficit. As part of domestic investment is financed by borrowing from abroad, there is a net capital inflow (i.e. the net capital outflow is negative).
Question
In an open economy, if national saving is larger than domestic investment, the value of exports will be _____________ than the value of imports. The capital and financial account balance will be _____________.
A. greater … positive
B. greater … negative
C. smaller … positive
D. smaller … negative
Answer
B
As S – I = NX, when S > I, NX > 0. Therefore, the value of exports will be greater than the value of imports. As the surplus in saving is used to finance foreign investment, there will be a net capital outflow. The capital and financial account will be negative.
QuestionGiven
SP = Y – T – C where SP = Private saving
SG = T – G SG = Public saving
SN = SP + SG Y = National income
T = Tax revenue
C = Private consumption expenditure
G = Government consumption expenditure
SN = National saving
(a) Prove that SN = Y – C – G (i.e., prove that the national saving is equal to the national income minus private consumption expenditure and government consumption expenditure). (3 marks)
(b) Prove that in a closed economy, SN = I (i.e., prove that when there is no external trade, domestic saving is
always equal to domestic investment). (4 marks)
Answer
a) SN SP + SG
Y – T – C + T – G
Y – C – G
b) In a closed economy, Y C + I + G
Y – C – G ISN I
QuestionGivenNX = SN – I … (1)
SN = SP + SG … (2)
SG = T – G … (3)
Put (2) and (3) into (1):
NX = (T – G) + (SP – I) … Equation A
(a) With reference to Equation A, state one possible allocation of private saving.(1 mark)
(b) With reference to Equation A, state the condition under which a country with a budget deficit will also have a current account deficit (i.e., twin deficits). (4 marks)
Answer
a. From Equation A, we have: SP = I + (G – T) + NX I = Domestic investment NX = Outward investment G – T = Purchase of new government debts
b. From (a), we have: SP = I + (G – T) + NX
NX = (SP - I ) - (G – T)
If the budget deficit (G – T) of a country is larger than the difference between private saving and domestic investment (SP – I), there will be twin deficits.
QuestionGivenLocal resident expenditure is the total expenditure of local households, firms and the government.
Local resident expenditure = C + I + G where C = Private consumption expenditure
I = Gross investment expenditure
G = Government consumption expenditure
(a) Prove that if the income of an economy is higher than its resident expenditure, it will have a current account surplus; when the income of an economy is lower than its resident expenditure, it will have a current account deficit. (3 marks)
(b) With reference to the answer in (a), if the income of an economy is higher than its resident expenditure, how will the capital and financial account be affected? (2 marks)
Answer
(a) Given Y C + I + G + NX
NX Y – (C + I + G)
If Y > (C + I + G), NX > 0;
If Y < (C + I + G), NX < 0.
(b) From (a),
If Y > (C + I + G), NX > 0;
Since NX = - KA
KA < 0
That is, there is a net capital outflow.
QuestionBelow is the data of a country.
(a) Calculate the public saving. (2 marks)
(b) Calculate X. (2 marks)
(c) Calculate the national saving. (2 marks)
$ billion
ExportsImportsGDPConsumption expenditureGovernment consumption expenditureInvestment expenditureTax revenue
5060
4708090X
30
Answer(a)
Public saving = Tax revenue – Government consumption expenditure
= $(30 – 90) billion = –$60 billion (2)
(b) GDP = C + I + G + NX
$470 billion = 80 + X + 90 + (50 – 60) billion
X = 310 (2)
(c)
National saving = Public saving + Private saving
National saving = –$60 billion + (GDP – tax – consumption)
National saving = –$60 billion + (470–30–80) billion = $300 billion (2)
QuestionThe table shows the current account of the balance of payments account of country A.
(a) Find the net exports of Country A. (1 mark)
(b) With the result in (a), prove that the country’s saving was not sufficient to finance its domestic investment. (3 marks)
(c) Let net exports be the current account balance. Find the implied capital and financial account balance. Was there a net capital inflow or outflow? (3 marks)
$ millionDomestic exports 120Re–exports 130Exports of services 150Imports of goods 200Imports of services 160
Answer(a) Net exports = 120 + 130 + 150 – 200 – 160 = –$40 million (1)
(b) C + S + T = Y = C + I + G + NX (1)
NX = SN – I (1)
Since NX < 0, SN < I (1)
(c) Current account balance + capital and financial account balance = 0 (1)
A deficit in net exports (or 他和 current account balance) implies
a positive balance in the capital and financial account. (1)
This means the country had a net capital inflow. (1)