CHAP 19

• The balance of payments accounts is a summary record of a country’s transactions with the rest of the world, including the buying and selling of goods, services, and assets.
• The current account records transactions arising from trade in goods and services.
• The current account includes net investment income earned from foreign asset holdings.
• Sections of the current account

  • Trade account
  • Capital-service account
• The trade account records payments and receipts arising from the import and export of goods and services. (exports and imports)
• The capital-service account records the payments and receipts that represent income earned from asset holdings. (inflow and outflow)
• The capital account records international transactions in assets, including bonds, shares of companies, real estate, and factories.
• When Canadians purchase foreign assets, financial capital is leaving Canada and going abroad, so this is called a capital outflow.
• When Canadians sell assets to foreigners, financial capital is entering Canada from abroad, so this is called a capital inflow.
• The official financing account is the government’s transactions in its official foreign-exchange reserves.
• The balance of payments is always zero.
• Any surplus in the current account

  Must be matched by an equal deficit in the capital account.
• A current account surplus

  Implies a capital outflow.
• Any deficit in the current account

  Must be matched by an equal surplus in the capital account.
• A current account deficit

  Implies a capital inflow.
• The term “balance of payments deficit” (or surplus) does not make sense since the balance of payments must always balance.
• Trade between countries normally requires the exchange of one currency for that of another.
• Exchange rate


  The number of units of domestic currency required to purchase one unit of foreign currency.
• In April 2021, the Canadian-US exchange rate was 1.25, meaning it takes $1.25 CDN to purchase one USD.
• Appreciation of the domestic currency


  A fall in the exchange rate, meaning it takes fewer units of domestic currency to purchase one unit of foreign currency.
• Depreciation of the domestic currency


  A rise in the exchange rate, meaning it takes more units of domestic currency to purchase one unit of foreign currency.
• The supply of foreign exchange is the sum of the supplies for Canadian exports, Canadian asset sales, and reserve currency.
• The supply curve of foreign exchange is positively sloped.
• A depreciation of the Canadian dollar increases the quantity of foreign exchange supplied.
• The demand curve for foreign exchange is negatively sloped.
• An appreciation of the Canadian dollar increases the quantity of foreign exchange demanded.
• A flexible exchange rate is an exchange rate that is left free to be determined by the forces of demand and supply on the free market, with no intervention by central banks.
• A fixed exchange rate is an exchange rate that is maintained within a small range around its publicly stated par value by the intervention in the foreign exchange market by a country’s central bank.
• Flexible exchange rate


  An exchange rate that is left free to be determined by the forces of demand and supply on the free market, with no intervention by central banks
• Fixed exchange rate


  An exchange rate that is maintained within a small range around its publicly stated par value by the intervention in the foreign exchange market by a country’s central bank
• In the absence of intervention by the central bank, the exchange rate adjusts to clear the foreign-exchange market
• Central bank must transact in the foreign-exchange market to offset any excess demand or excess supply of foreign exchange that arises at that exchange rate
• If there is an excess supply (or demand) of foreign exchange

  The central bank will purchase (or sell) foreign exchange and sell (or purchase) dollars
• Exchange rates often respond to changes in the prices of major exports and imports
• A rise in the world price of Canadian exports

  Causes the Canadian dollar to appreciate
• A rise in the foreign prices of Canadian imports

  Can cause the Canadian dollar to appreciate or depreciate, depending on the price responsiveness of demand for those imports
• If Canada has higher inflation than other countries

  The Canadian dollar will be depreciating relative to other currencies
• If Canada has lower inflation than other countries

  The Canadian dollar will be appreciating
• Changes in monetary policy

  Lead to changes in interest rates and to international flows of financial capital
• A contractionary monetary policy in Canada

  Will lead to a rise in Canadian interest rates, a capital inflow, and an appreciation of the dollar