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Exchange rates the balance of payments

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					Chapter 22
Exchange rates & the balance of
payments
Exchange Rate

   The exchange rate of a currency is the price
    of that currency in terms of another currency

   e.g.
   US $1 : HK $7.8
The Floating Exchange Rate System
P yen (in HK $)


                   P yen   Qd yen 




                              D
                                  Q yen
The Floating Exchange Rate System
P yen (in HK $)
                           S




                        P yen   Qs yen 
                        P yen  Qs yen 




                               Q yen
 Determining the equilibrium exchange rate
           P yen (in HK $)
                                      S


               0.08
Appreciation
               0.07
Depreciation
               0.06


                             ED       D
                                          Q yen
   Factors affecting the exchange rate
   Income   M   D yen            Income   M   D yen   S HK$  
    Yen appreciate                   HK$ depreciate

(in HK $)                          (in yen)
   P yen                              P HK
                               S                                   S

                                                                       S’
0.08

0.07                               14.3

                                   12.5
                                      D’
                               D                                   D

                              Q yen                                 Q HK

               Yen                                  HK $

       Increase in the level of domestic income
   Factors affecting the exchange rate
Price   M , X   D yen , S yen        Price   M , X   S HK  D HK ,
 Yen appreciate                             HK$ depreciate
(in HK $)                       S’   (in yen)
   P yen                                P HK
                                 S                                       S
0.09
                                                                             S’


0.07                                 14.3


                                     11.1
                                     D’
                                 D                                       D
                                                                 D’
                               Q yen                                      Q HK

                Yen                                     HK $

                Increase in the price level
   Factors affecting the exchange rate
i   capital inflow S yen                i   capital inflow  D HK 
 Yen depreciate                             HK$ appreciate
(in HK $)                            (in yen)
   P yen                                P HK
                                 S                                          S


                                     16.7
                                S’
0.07                                 14.3


                                                                                D’
0.06
                                 D                                          D

                                Q yen                                       Q HK

                 Yen                                      HK $

        Increase in the domestic interest rate
   Factors affecting the exchange rate
Political disturbance  D yen , S yen        Political disturbance  S HK  D HK ,
 Yen appreciate                                HK$ depreciate
(in HK $)                          S’   (in yen)
   P yen                                   P HK
                                    S                                          S
0.09
                                                                                   S’


0.07                                    14.3


                                        11.1
                                        D’
                                    D                                          D
                                                                       D’
                                  Q yen                                         Q HK

                 Yen                                         HK $

                       Political Disturbance
 Fixed exchange rate system
              P yen (in HK $)
                                      S


              0.08
Revaluation
              0.07
Devaluation
              0.06


                                      D
                                          Q yen
                                Yen
Appreciation or Depreciation

   Appreciation refers to the increase in the
    exchange value of a currency in terms of
   another currency.

   Depreciation refers to the decrease in the
    exchange value of a currency in terms of
    another currency.
Thinking Time

   If the Hong Kong dollar depreciate again Yen,
    is it possible for the Yen not to appreciate
    against the Hong Kong dollar?
Effects of currency depreciation

   Thinking
   Suppose Hong Kong dollar depreciates
    against Yen.

   From HK $1:Yen $70 to HK $1:Yen $65

   How does it affect our volume of exports and
    imports?
Effects of currency depreciation

   Currency depreciation will lead to a drop in
    the price of exports (in terms of the foreign
    currency) and an increase in the volume of
    exports.

				
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posted:10/13/2011
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