9,THE EXCHANGE RATE AND THE BALANCE OF PAYMENTS,The dollar, the yen, and the euro are three of the worlds monies. In October 2000, one U.S. dollar bought 1.17 euros. From 2000 through 2008, the dollar sank against the euro and by July 2008 one U.S. dollar bought only 0.63 euros. Why did the dollar fall against the euro? Should the United States do anything to stabilize the foreign exchange value of the dollar? The U.S. economy has become attractive to foreign investors. What determines the amount of international borrowing and lending?,The Foreign Exchange Market,To buy goods and services produced in another country we need money of that country. Foreign bank notes, coins, and bank deposits are called foreign currency. We get foreign currency in the foreign exchange market.,Trading Currencies We get foreign currency and foreigners get U.S dollars in the foreign exchange market. The foreign exchange market is the market in which the currency of one country is exchanged for the currency of another.,The Foreign Exchange Market,Exchange Rates The price at which one currency exchanges for another is called a foreign exchange rate. A fall in the value of one currency in terms of another currency is called currency depreciation. A rise in value of one currency in terms of another currency is called currency appreciation.,The Foreign Exchange Market,An Exchange Rate Is a Price An exchange rate is the pricethe price of one currency in terms of another. Like all prices, an exchange rate is determined in a marketthe foreign exchange market. The U.S. dollar is demanded and supplied by thousands of traders every hour of every day. With many traders and no restrictions, the foreign exchange market is a competitive market.,The Foreign Exchange Market,The Foreign Exchange Market,The Demand for One Money Is the Supply of Another Money When people who are holding one money want to exchange it for U.S. dollars, they demand U.S. dollars and they supply that other countrys money. So the factors that influence the demand for U.S. dollars also influence the supply of Canadian dollars, E.U. euros, U.K. pounds, and Japanese yen. And the factors that influence the demand for another countrys money also influence the supply of U.S. dollars.,Demand in the Foreign Exchange Market The quantity of U.S. dollars that traders plan to buy in the foreign exchange market during a given period depends on 1. The exchange rate 2. World demand for U.S. exports 3. Interest rates in the United States and other countries 4. The expected future exchange rate,The Foreign Exchange Market,The Law of Demand for Foreign Exchange The demand for dollars is a derived demand. People buy U.S. dollars so that they can buy U.S.-produced goods and services or U.S. assets. Other things remaining the same, the higher the exchange rate, the smaller is the quantity of U.S. dollars demanded in the foreign exchange market.,The Foreign Exchange Market,The exchange rate influences the quantity of U.S. dollars demanded for two reasons: Exports effect Expected profit effect Exports Effect The larger the value of U.S. exports, the greater is the quantity of U.S. dollars demanded on the foreign exchange market. The lower the exchange rate, the greater is the value of U.S. exports, so the greater is the quantity of U.S. dollars demanded.,The Foreign Exchange Market,Expected Profit Effect The larger the expected profit from holding U.S. dollars, the greater is the quantity of U.S. dollars demanded today. But expected profit depends on the exchange rate. The lower todays exchange rate, other things remaining the same, the larger is the expected profit from buying U.S. dollars and the greater is the quantity of U.S. dollars demanded today.,The Foreign Exchange Market,The Demand Curve for U.S. Dollars Figure 9.1 illustrates the demand curve for U.S. dollars on the foreign exchange market.,The Foreign Exchange Market,Supply in the Foreign Exchange Market The quantity of U.S. dollars supplied in the foreign exchange market is the amount that traders plan to sell during a given time period at a given exchange rate. This quantity depends on many factors but the main ones are 1. The exchange rate 2. U.S. demand for imports 3. Interest rates in the United States and other countries 4. The expected future exchange rate,The Foreign Exchange Market,The Law of Supply of Foreign Exchange Other things remaining the same, the higher the exchange rate, the greater is the quantity of U.S. dollars supplied in the foreign exchange market. The exchange rate influences the quantity of U.S. dollars supplied for two reasons: Imports effect Expected profit effect,The Foreign Exchange Market,Imports Effect The larger the value of U.S. imports, the larger is the quantity of U.S. dollars supplied on the foreign exchange market. The higher the exchange rate, the greater is the value of U.S. imports, so the greater is the quantity of U.S. dollars supplied.,The Foreign Exchange Market,Expected Profit E