ECONOMICS 3150B

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ECONOMICS 3150B

• Fall 2008
• Professor Lazar
• Office N205J
• flazar_at_yorku.ca
• 736-5068

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Lecture 2 September 16
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Link to Lecture Notes

• http//dept.econ.yorku.ca/flazar/3150B08/index.
• htm

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National Income Accounts

• Y (C I G) CU
• Y lt (C I G) ? CU lt 0
• Domestic demand gt domestic production (case of
  US)
• CU ? net foreign wealth - CA (Capital account
  balance)
• CU lt 0, ? US borrows from foreigners ? CA gt 0
• Net foreign debt ?
• CU gt 0, ? Canada lends (invests) to (in)
  foreigners ? CA lt 0
• Net foreign debt ?

5
Changes in Net Foreign Wealth

• Consider case of US largest debtor country in
  history
• Net international investment position of US,
  2005 -2,238 B
• US owned assets abroad 11,576 B
• Foreign owned assets in US 13,815 B
• Net international investment position, 2006
  -2,540 B
• US owned assets abroad 13,755 B
• Foreign owned assets in US 16,295 B
• Changes in 2006
• Financial flows -833 B
• CU -722 B
• Net unilateral transfers -90 B
• Price changes 348 B
• Exchange rate changes 221 B
• US owned assets abroad largely denominated in
  foreign currencies
• Depreciation of US (decline in value relative
  to foreign currencies) results in increase in
  value of these assets in US

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Savings and the Current Account

• S SP SG Y C G I CU
• S gt 0 ? I CU gt 0
• Building up capital stock and/or acquiring
  foreign wealth (assets)
• S lt 0 ? I CU lt 0
• Building up foreign debt to finance investment,
  current consumption or government spending
• CU SP I SG
• If SG ?, CU also may ? (if SP and I do not
  change)
• Twin deficits CU lt 0 and SG lt 0

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Exchange Rate Markets

• Large Number of exchange rates
• Most important for Canada E US/Can
  E1/E
• As of 07/14/08 E 0.9948 E 1.0052
• Low _at_ 01/21/02 0.618
• High _at_ 11/07/07 1.103
• Depreciation (appreciation) ? E (? E )
• Exchange rates between Canadian dollar and other
  currencies e.g. Euro, pound, yen, peso, rupee,
  ruble, HK dollar, yuan, etc.
• Direct vs. cross exchange rates (07/14/08), e.g
  Can and Euro (Euros/C)
• Direct 0.6252
• Cross E(Euros/US) 0.99480.6284 0.6251

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Exchange Rate Markets

• Other exchange rates (as of 07/14/08) relative
  to C
• Australia 1.0225
• Britain 0.4988
• China Renminbi 6.8027
• Euro 0.6246
• India Rupee 42.5532
• Japan Yen 105.54
• Malaysia Ringgit 3.2113
• Mexico Peso 10.233
• Russia Ruble 23.01
• Singapore 1.3448
• Switzerland Franc 1.0098
• UAE Dirham 3.651

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Foreign Exchange Markets

• Participants
• Commercial banks
• Corporations
• Non-bank financial institutions
• Hedge funds
• Foreign exchange dealers
• Central banks
• Exchange rates spot, forward
• Rates move together
• Futures, options (call and put)
• Foreign exchange swaps spot sale of a currency
  combined with forward repurchase of same currency

10
Foreign Exchange Markets

• Key financial centres London, New York, Zurich,
  Tokyo, Frankfurt, Hong Kong, Singapore
• Dubai, Mumbai and Shanghai
• Daily volume of transactions US3.2 T/day
• London 1.4 T NY 664 B Zurich Tokyo 238 B
• Currency trading in Canada C60 B/day
• Interbank trading 43
• Currency trading between dealers and other
  financial institutions (MA and hedging
  activities) 40
• Trading with non-financial institutions
  (corporations) 17
• Foreign exchange swaps (hedging and carry
  trades) 56
• Conventional spot transactions 33
• Forward exchange transactions 12

11
Foreign Exchange Markets

• Each transaction involves two currencies, so
  market shares calculated out of 200
• US 86
• Euro- trades 27
• Yen- trades 13
• Pound- 12
• Emerging market currencies- 19
• Emerging market currencies-Euro 4

12
Foreign Exchange Markets

• Forward exchange rate
• Over-the-counter transactions between bank and
  customers whereby bank agrees to buy or sell
  specified amount of currency at an agreed rate
  (forward rate) for delivery at specified future
  date (as of December 20, 2007)
• 1 month 0.9939
• 1 year 0.9917
• 5 years 1.0032
• Futures Transactions on an exchange
• Closing dates for contracts, usually end of each
  quarter
• Fixed value for each contract
• Options Transactions on an exchange
• Rights to buy/sell currencies at pre-specified
  exchange rate at future point in time (usually
  available with monthly closing dates)

13
Revaluations of Exchange Rates and Impacts on
Relative Prices

• Prices of comparable Canadian and US goods
  expressed in same currency
• PCE PUS
• ? PCE/PUS
• Depreciation (appreciation) ?? ? ( ? )
• Example Bombardier selling Q400 to Horizon Air
• Price set in C or US?
• Set in US (US 30 M) no foreign exchange risk
  for Horizon Air
• Delivery in 6 months
• _at_ current E Bombardier will receive C 30.2 M
• If C depreciates by 5 (E 0.945), Bombardier
  will receive C 31.7M
• If C appreciates by 5 (E 1.045), Bombardier
  will receive C 28.7M
• Implications for profit margins, pricing?

14
Revaluations of Exchange Rates and Impacts on
Relative Prices

• Depreciation of spot rate of C increases C
  price of foreign goods and services, unless
  foreign prices reduced
• US price of US good/service US100 (PUS), with
  E0.9948, C price of this good/service PUS / E
  C100.52
• Depreciation of C i.e. E decreases to 0.9451
  (5 depreciation in the value of the C relative
  to the US), C price of this US good/service
  (US price unchanged at US100) at new exchange
  rate is C105.81

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Revaluations of Exchange Rates and Impacts on
Relative Prices

• Depreciation of the spot rate for the C also
  reduces foreign currency price of Canadian goods
  and services, unless C price increased
• C price of Canadian good/service C100 (PC),
  with E0.9948, US price of this good/service
  PC E US99.48
• Depreciation of C i.e. E decreases to 0.9451,
  US price of this Canadian good/service (C price
  unchanged at C100) at new exchange rate is
  US94.51

16
Revaluations of Exchange Rates and Impacts on
Relative Prices

• Ceteris paribus, competitive position of
  Canadian-based companies improves vis a vis
  foreign competitors when C depreciates and
  deteriorates when C appreciates as long as
  Canadian companies do not use many US or foreign
  produced/priced parts, components, services
• Depreciation may lead to higher rate of inflation
  (prices of imported goods and services), and
  increase in wage demands
• Foreign suppliers may improve quality,
  productivity to maintain competitive position
• Foreign suppliers may reduce profit margins to
  maintain prices in C
• Canadian suppliers may become lax (X-inefficient)
  and less innovative

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Aggregate Demand

• EX (exports of goods and services)
• Determinants of D real income, relative prices
• Income of major trading partners US in
  particular
• Relative prices prices of Canadian produced
  goods and services relative to price of competing
  foreign produced goods and services
• PC E/PUS E exchange rate between C and US
  defined as US/C
• Non-price competitiveness of Canadian companies
• Trade barriers tariffs, transportation costs
• Real vs. nominal

18
Aggregate Demand

• IM (imports of goods and services)
• GDP in Canada
• Relative prices prices of Canadian produced
  goods and services relative to price of competing
  foreign produced goods and services
• Non-price competitiveness of Canadian companies
• Trade barriers
• Real vs. nominal