International Economics - Monetary Economics

International Economics - Monetary Economics

• Exchange Rates and Foreign Exchange Markets: Exchange rates are determined by market equilibrium, where demand equals supply. Demand and supply are influenced by economic factors like exports, imports, and investment flows.
• Balance of Payments: The balance of payments tracks all economic transactions between a country and other countries. It has two main components: the current account (including goods and services trade, investment income, and current transfers) and the capital account (including financial investment and capital transfers). A surplus in the current account indicates more income from foreign transactions than spending on foreigners.
• Exchange Rate Determination: Different theories explain how exchange rates are determined, including factors like interest rate differentials and macroeconomic conditions.
• Optimum Currency Areas and the Euro: The theory of optimum currency areas (OCA) examines the ideal circumstances for a single currency. Criteria like factor mobility, economic similarity, and trade flows matter for deciding whether a group of countries should share a common currency. The eurozone, in particular, operates under such a system.
• Economic Policy in an Open Economy: Economic policies within one country affect other countries, particularly in an open economy. Influences including trade flows, capital flows, exchange rates and fiscal policies must be considered in the open economy.
• What are Exchange Rates? Exchange rates can be expressed as the price of one currency in terms of another (price notation) or as the quantity of one currency that can be bought with one unit of another currency (quantity notation).
• Changes in Exchange Rates: Changes in exchange rates can be devaluations (domestic currency loses value) or appreciations (domestic currency gains value). These changes can be related to factors affecting domestic demand and supply of currencies in the market.
• Driving Forces of Exchange Rates: Macroeconomic factors like economic growth, interest rates (differences between interest rates in countries), trade flows, and perceived risk play a critical role in determining exchange rates.
• Exchange Rate Regimes: Exchange rate regimes determine how the value of a currency is set. Fixed exchange rates involve central bank intervention to maintain a specific rate, whereas flexible exchange rates rely on market forces.
• Foreign Exchange Markets with Flexible Exchange Rates: A flexible exchange rate system allows the value of a currency to adjust based on market forces of demand and supply. Transactions like exports and imports cause currency demand and supply fluctuations. Currency appreciation or depreciation are possible outcomes of these changes.
• Foreign Exchange Markets with Fixed Exchange Rates: In a fixed exchange rate system, central banks intervene to maintain the desired exchange rate. They adjust the money supply to match and counter the upward or downward pressure on the rate. Countries following this regime are not independent in their monetary policy decision.
• Choice Between Domestic and Imported Goods: The choice influences country's trade balance and competitiveness. Consumers make their decisions based on relative prices of goods in the domestic market vs. foreign markets. Interest rate differences, and exchange rate expectations are relevant to domestic vs foreign investment.
• Choice Between Domestic and Foreign Investments: The choice involves considering interest rate differentials and expectations about future exchange rates.
• Interest Rate Parity: This principle suggests that returns on investment should be similar in different countries, leading to a relationship between interest rates and expected exchange rate changes.
• International Transactions in the Statistics: The balance of payments tracks a country's international transactions, including the current account (trade in goods and services, incomes, current transfers) and capital account (financial flows). A country's current account surplus/deficit reflects its net lending to, or borrowing from, other countries.
• Current Account: Summarizes the flow of goods, services, income, and current transfers into and out of a country.
• Current Account as an Indicator for Competitiveness: Current account surpluses or deficits may not fully demonstrate national competitiveness (production or export capability) because numerous factors can affect the account.
• Theory of Optimum Currency Areas (OCA): The OCA theory suggests that certain criteria - factor mobility and economic similarity - influence whether countries benefit from using a common currency. Countries with asymmetric shock responses may benefit from independent currencies
• Economic Policy in an Open Economy: Monetary and fiscal policies in one country can impact other countries through trade flows, capital flows, exchange rates, and related mechanisms.
• Additional Exercises: These exercises provide examples of problems related to the concepts discussed above, including practical scenarios related to exchange rates, trade balances, and economic policies.