BUSMGT 

714

BUSMGT 714
Economics for Managers
Week 8

Topic 8
Exchange Rates and Current Accounts

Week 8 Topic Topic 8’s key concepts

1. Current Account & Balance of Payments
• Exchange Rates, Current Accounts
• Interest Rates and Money Supply 2. Exchange rates
• Sloman et al, Chapters:
3. Floating exchange rates
– 27 the Balance of Payments and Exchange Rates 4. Depreciation and appreciation of a currency
(including Box 27.3)
5. Government Intervention
– 28 The Supply of Money (read Sections 28.3-28.5)
Exclude Box 28.4.
6. Who Benefits from currency depreciation and
appreciation?

1
 BUSMGT 714

Current Account and Balance of Payments Balance of Payments

1. What is the Current Account?
– The record of all payments for imports and exports of A positive and strong Balance of Payments
goods and services plus: indicates that:
– All income and all money transfers in and out of the
country. The net transfer of income and money to the
country from the rest of the world is positive.
2. What is the Balance of Payments (BOP)?

– It is the overall balance of the current account.

– It is positive or negative or zero and it shows the
magnitude of surplus or deficit.

The Exchange Rate NZ exchange rate against some currencies

The exchange rate is the rate at which one

currency trades for another in the currency market.
It is shown as such:

NZD 0.67 USD

NZD 0.93 AUD

NZD 4.51 CNY Yuan Renminbi

2
 BUSMGT 714

NZ exchange rate against the USD since 2013 NZ exchange rate against the USD since 2000

NZ exchange rate against the USD since 1972 One NZ$ buys:

NZ$ exchange Rate to US$

NZ$ exchange Rate to AU$

3
 BUSMGT 714

One NZ$ buys The Exchange Rate Market

NZ$ Exchange Rate to Indian
Rupee
NZ$ Exchange Rate to CNY
The currency trade market is characterised by:
(Yuan Renminbi)
• 1 NZ$ = 45.33
Rupees • Competition
• Information
• Several buyers and sellers of the currency.

Exchange rates can change several times a

day.

The Exchange Rate Market Demand and Supply of Currencies

Exchange Rates are determined by the interaction 1. The demand for a currency is downward sloping
of: ________________ and _______________ of in relation to the Exchange Rate.
The Demand Supply
the currency.
2. The supply for a currency is upward sloping in
relation to the Exchange Rate.
The result of market forces is the equilibrium price,
the (Exchange Rate).

4
 BUSMGT 714

Determination of the rate of exchange Determination of the rate of exchange
If a currency’s exchange rate is temporarily above the equilibrium rate:

1.6 1.6
1.4 S Of NZD by NZ 1.4
S by NZ
USD price of NZD

USD price of NZD

1.2 1.2
1 1
Excess supply
0.8 0.8 of NZD leads to
0.6 0.6 a depreciation.

0.4 0.4
0.2 D for NZD by USA 0.2
D by USA
0 0
Q of NZD QD QS Q of NZD

Determination of the rate of exchange Changes in Exchange Rates

If a currency’s exchange rate is temporarily below the equilibrium rate:

1.6 • Floating exchange rates

1.4
S by NZ

– Shifts in currency demand and supply

USD price of NZD

1.2
1
Shortage of
– Appreciation and depreciation
0.8 NZD leads to an – Causes of a currency’s depreciation
0.6 appreciation.

0.4
0.2
D by USA
0
QS QD Q of NZD

5
 BUSMGT 714

Floating exchange rates: movement  Floating exchange rates: movement 
to a new equilibrium to a new equilibrium
1.10 1.10
1.05
S1 1.05 S1
USD price of NZD

USD price of NZD

1.00 1.00
S2
0.95 0.95
0.90 0.90
0.85 0.85
0.80 0.80
0.75 D1 0.75
D1
0.70 0.70
Q of NZD Q of NZD

Floating exchange rates: movement  Changes in Exchange Rates

to a new equilibrium
1.10 Causes of a currency’s depreciation:
1.05 S1
• Fall in interest rate.
USD price of NZD

1.00
S2
0.95 • Increase in inflation rate.
0.90
• Rise in aggregate demand (increased imports).
0.85
• Inward investment less attractive.
0.80
D1 • Speculation against depreciation (expectation of
0.75
D2 depreciation).
0.70
Q of NZD

6
 BUSMGT 714

Causes of a depreciation (assume no changes abroad)
Who benefits from changes in exchange rates?
• fall in interest rate
• change in inflation rate
• rise in aggregate demand • Who benefits from a depreciation of the NZD?
1 • inward investment less attractive
•
British Pound price of NZD

0.9 speculation against depreciation S1

0.8 • NZ Exporters (e.g. Farmers in NZ)
0.7 S2
0.6
0.5 • Foreign Investors in NZ
0.4
0.3
0.2 • Consumers in countries buying NZ products
0.1
D2 D1
0
• Tourists to NZ
Q of NZD

Who benefits from changes in exchange rates? Is there a link between exchange rates and
inflation?
• Who benefits from an appreciation of the NZD?
• YES
• NZ importers (consumers)
• The depreciation of a currency causes Inflation, since
imports become more expensive domestically (e.g. cost
of imported petrol)
• NZ travelers overseas

• NZ investors investing overseas

7
 BUSMGT 714

Exchange Rates and the Balance of Payments Government intervention: Reducing short-term
fluctuations:

• Changes in interest rates.

• Government intervention: reducing short-term Increase interest rates to appreciate the NZD
fluctuations, for greater economic stability or to
encourage exports for greater aggregate
demand: • Intervention using currency reserves.
Sell USD reserves to appreciate the NZD

Increasing the Prime Interest Rate to  Increasing the Prime Interest Rate to

appreciate the NZD: movement to a  appreciate the NZD: movement to a
new equilibrium new equilibrium
1.10
1.05 S2 • More people abroad would deposit their money
in NZ to take advantage of the higher interest
USD price of NZD

1.00
S1
0.95 rate (demand for the NZD will increase).
0.90
0.85
D2
• More NZ residents would be (more) likely to
0.80 deposit their money in NZ banks (the supply of
0.75 the NZD in the foreign exchange market will
D1
0.70 decrease as not spent).
Q of NZD • Result: NZD appreciates against
other currencies.

8
 BUSMGT 714

Buying NZD (Selling USD reserves) to  Buying NZD (Selling USD reserves) to

appreciate the NZD:  appreciate the NZD: movement to a
movement to a new equilibrium new equilibrium
1.10
1.05 S2 • Reserve Bank increases the demand for NZD in
the process of selling USD in NZ (demand for
USD price of NZD

1.00
S1
0.95 the NZD will increase). (Bigger effect).
0.90 • The Reserve Bank keeps the NZD exchanged
0.85 for USD, as a reserve (the supply of the NZD in
D2
0.80 the foreign exchange market will decrease
0.75 compared to before the USD reserve sale).
D1
0.70 • Result: NZD appreciates against USD.
Q of NZD

Should exchange rate policies and macro-

economic policies by coordinated?

Yes, because as we saw they are inter-linked.

e.g. exchange rates influence aggregated

demand and inflation, and vice versa