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Chapter 7
Exchange rate
Currencies
Do
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: $]
Japanese yen [Code: JPY; Sign: ]
Currencies
Why do we need foreign currencies?
Travelling
Investment
Etc.
Exchange rate
Exchange rate
convertibility rate
Exchange rate
Expression (assume USD and HKD)
1.
.US$
.HKD/USD
= 7.8 / 1 = 7.8
Exchange rate
Expression
2.
.HK$
.USD/HKD
Exchange rate is
Free-floating
Appreciation
Depreciation
Appreciation
USD Euro
Date
1 April 2011
1 May 2011
US$1 equals
0.7
0.8
HKD JPY
Date
1 April 2011
1 May 2011
HK$1 equals
10.40
11.00
Depreciation
USD Euro
Date
1
1 April
April 2011
2011
US$ = US$1.43
1 May 2011
US$ = US$1.25
HKD JPY
1 equals
Date
1
1 April
April 2011
2011
JP1 equals
HK$ = HK$0.096
1 May 2011
HK$ = HK$0.091
November 1974
October 1983
Free floating
1983Present
Features
Silver dollars as legal tender
Standard exchange rate:1:HK$16 (December 1935
November 1967)
1:HK$14.55 (November 1967June 1972)
Exchange rate:US$1:HK$5.650 (June 1972February 1973)
US$1:HK$5.085 (February 1973November 1974)
Exchange rates on selected days:US$1:HK$4.965 (25
November 1974)
US$1:HK$9.600 (24 September 1983)
US$1:HK$7.80 (19831998)
(for issue and redemption of Certificates of Indebtedness)
US$1:HK$7.75 (19982005)
(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$7.757.85 (May 2005 onwards)
HKMA set up upper and lower guaranteed limit since 18 May
2005
Source: http://en.wikipedia.org/wiki/Hong_Kong_dollar
Difference:
Exchange rate system
Floating
Fixed
Market
Government
Increase
Appreciation
Revaluation
Decrease
Depreciation
Devaluation
USA
China
Exchange rate of
local currency
against foreign
currency
Example countries
Certificates
of
Indebtedness
HKMA
* In reverse, banks return HKD & CIs to the HKMA and get back the USD.
Date
US$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$9.75
USD appreciates
against EUR
Fixed
US dollar
HK dollar
1996
8.3142
1.07510
1997
8.2898
1.07090
1998
8.2791
1.06880
1999
8.2783
1.06660
2000
8.2784
1.06180
2001
8.2770
1.06080
2002
8.2770
1.06070
2003
8.2770
1.06240
2004
8.2768
1.06230
2005
8.1917
1.05300
2006
7.9718
1.02620
2007
7.6040
0.97459
2008
6.9451
0.8919
2009
6.8310
0.8812
Source: http://en.wikipedia.org/wiki/List_of_Renminbi_exchange_rates
BOP account of HK
Current account ( )
Capital and financial account ( )
BOP account
Current account
All external
transactions not
included in capital &
financial account
Capital and
financial account
International
purchases or sales of
assets
Capital transfers
Types of BOT:
Trade deficit ( )
BOT < 0
Balance BOT ( )
Exports = Imports
BOT = 0
Trade surplus ( )
BOT > 0
3.
.
.
Dividends
Interest from deposit
4.
.
.
.
Current transfers
Unilateral ( ) transfer of goods and capital
No economic value being received in return
For example: donations, remittances
500
Imports of goods
200
Exports of services
350
Imports of services
100
50
80
Donation to Japan
120
Capital transfer
External investment
-----------------------------------------------------------------------------------
Changes in reserve assets (the govt buys or sells assets, e.g. gold)
Capital transfer
External investment
-----------------------------------------------------------------------------------
Changes in reserve assets (the govt buys or sells assets, e.g. gold)
Balance of BOP
BOP
Capital flow
Inflow / Outflow
Increase / Decrease
Inflow / Outflow
Increase / Decrease
Inflow / Outflow
Increase / Decrease
Inflow / Outflow
Increase / Decrease
Inflow / Outflow
Increase / Decrease
Inflow / Outflow
Increase / Decrease
BOP
Balance ($)
(A) Current account
(B) Capital and financial account
(1) Balance of capital and financial account
excluding reserve asset transactions
(2) Reserve assets (net change)
BOP = (A) + (B1)
- 1,000
1,000
800
200
- 200
Balance of BOP
100,000
-50,000
80,000
40,000
30,000
- 135,000
35,000
Total = 0
BOP deficit
Payment to USA
$1000
USA
HK
$0
. BOP deficit
BOP surplus
No payments to USA
$0
USA
HK
$1000
. BOP surplus
Balanced BOP
Payments to USA
$1000
USA
HK
$1000
. Balanced
BOP
BOP deficit
Balanced BOP
BOP surplus
0
[ receipts = payments ]
+
[ receipts > payments ]
Actual
Shown in
balance sheet of BOP
+ ve
Unchanged
- ve
Current account
Goods
Services
Factor income
Current transfers
Capital and financial account
Balance of capital and financial account excluding reserve asset transactions
Reserve assets (net change)
580
-430
120
-40
-250
X
Current account
Goods
Services
Factor income
Current transfers
Capital and financial account
Balance of capital and financial account excluding reserve asset transactions
Reserve assets (net change)
580
-430
120
-40
-250
X
a. Suppose the domestic exports of goods are $650 million and imports of goods are $2
00 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
Current account
Goods
Services
Factor income
Current transfers
Capital and financial account
Balance of capital and financial account excluding reserve asset transactions
Reserve assets (net change)
Current account balance = ($580 - $430 + $120 - $40 ) million = $230 million
580
-430
120
-40
-250
X
Current account
Goods
Services
Factor income
Current transfers
Capital and financial account
Balance of capital and financial account excluding reserve asset transactions
Reserve assets (net change)
580
-430
120
-40
-250
X
c. Find the value of X. What is the change in the reserve assets? Find the balance of pa
yments.
Answer: Balance of BOP = Bal. of current acc. + Bal. of capital and financial acc. = $0
i.e.
NX = Net exports
Capital
NX X - M
Type
NX
KA
Type
Surplus
+ve
-ve
Deficit
Balanced
Balanced
Deficit
-ve
+ve
Surplus
Y = National income
C = Private consumption expenditure
I = Investment expenditure
G = Government consumption expenditure
NX = Net exports
Y C + I + G + NX
(1)
Y = National income
C = Private consumption expenditure
SP = Private saving
T = Tax revenue
Y C + SP + T
(2)
Y C + I + G + NX
(1)
Y C + SP + T
(2)
C + I + G + NX = C + SP + T
I + G + NX = SP + T
NX = SP + ( T G ) I (3)
or NX = ( SP I ) ( G T )
NX SP + T G I
Equation (4) :
NX SP + SG I
NX SP + SG I
SP = Private saving
SG = Government saving
In total:
SN = SP + SG = National saving
Equation (5):
NX SN I
Meaning that:
Current account balance is domestic (national) saving minus do
mestic investment.
Economic implications of NX = SN - I
Given NX = SN I and NX = - KA
Current account
(NX)
Surplus
( NX > 0 )
Balanced
( NX = 0 )
Deficit
( NX < 0 )
Capital and
financial
account
( KA = - NX )
Capital flow
KA < 0
SN > I
Saving > Investment
Outward investment
KA = 0
SN = I
Saving = Investment
Domestic saving
equals domestic
investment
KA > 0
SN < I
Saving < Investment
Inward investment
Question
Which of the following statements about national saving is COR
RECT?
A. National saving must be equal to domestic investment in a cl
osed 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. A
s 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 investme
nt.
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.
B.
C.
D.
Answer
C
(2) is correct. Public saving = Tax revenue Government consum
ption expenditure
If government consumption expenditure is larger than tax revenu
e, public saving will be negative.
(3) is correct. When government consumption expenditure is larg
er 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 sav
ing, there will be a _____________ and the net capital outflow is
_____________.
A.
B.
C.
D.
Answer
D
As S I = NX, when I > S, NX < 0. Therefore, there will be a tra
de deficit. As part of domestic investment is financed by borrowi
ng from abroad, there is a net capital inflow (i.e. the net capital o
utflow is negative).
Question
In an open economy, if national saving is larger than domestic inv
estment, the value of exports will be _____________ than the val
ue 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 expor
ts will be greater than the value of imports. As the surplus in savi
ng is used to finance foreign investment, there will be a net capita
l outflow. The capital and financial account will be negative.
Question
Given
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 savin
g is equal to the national income minus private consumption exp
enditure 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)
b)
S N S P + SG
YTC+TG
YCG
In a closed economy, Y C + I + G
YCGI
SN I
Question
Given
NX = 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
allocatio
n of private saving.(1 mark)
(b) With reference to Equation A, state the condition under whic
h a country with a budget deficit will also have a current acco
unt 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
Question
Given
Local resident expenditure is the total expenditure of local house
holds, 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 resi
dent expenditure, it will have a current account surplus; when
the income of an economy is lower than its resident expenditu
re, it will have a current account deficit. (3 marks)
(b) With reference to the answer in (a), if the income of an econo
my is higher than its resident expenditure, how will the capita
l 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.
Question
Below is the data of a country.
$ billion
Exports
Imports
GDP
Consumption expenditure
Government consumption expenditure
Investment expenditure
Tax revenue
50
60
470
80
90
X
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 + (4703080) billion = $300 billion (2)
Question
The table shows the current account of the balance of payments accou
nt of country A.
$ million
Domestic exports
120
Reexports
130
Exports of services
150
Imports of goods
200
Imports of services
160
(a) Find the net exports of Country A. (1 mark)
(b) With the result in (a), prove that the countrys saving was not
su
fficient to finance its domestic investment. (3 marks)
(c) Let net exports be the current account balance. Find the implied ca
pital and financial account balance. Was there a net capital inflow or o
utflow? (3 marks)
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 current account balance) implies
a positive balance in the capital and financial account. (1)
This means the country had a net capital inflow. (1)