MCD 2090 Macroeconomics (Week 11)

Tutorial 11: International trade and exchange rates (Chapter 14)

Section A – Homework
1. What is the relationship between the current account, the capital account, the financial
account and the balance of payments?

2. Use the information in the following table to prepare a balance of payments account like the
one shown in Table 14.1. Assume the balance on the capital account is zero. All values are in
billions of dollars.

3. If the exchange rate between the Japanese yen and the Australian dollar expressed in terms
of yen per dollar is ¥110 = $1, what is the exchange rate when expressed in terms of dollars
per yen?

4. Explain the relationship between the current account deficit and net foreign investment.

5. Look again at how we arrived at the equation S = I + NX + NPI. Suppose that we define
national income as being equal to Y + TR, where TR equals government transfer payments, and
we define government spending as being equal to G + TR. Show that after making these
adjustments we end up with the same saving and investment equation.

6. What happens to national saving when the government runs a budget surplus?

Section B
7. Graph the demand for and supply of Australian dollars for euros and label each axis. Show
graphically and explain the effect of an increase in interest rates in Europe by the European
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Central Bank (ECB) on the demand for and supply of dollars and the resulting change in the
exchange rate of euros for Australian dollars. Assume that interest rates in Australia have not
changed.

8. Graph the demand for and supply of Australian dollars for euros and label each axis. Show
graphically and explain the effect of an increase in Australian government budget deficits that
increase Australian interest rates on the demand for and supply of dollars and the resulting
change in the exchange rate of euros for Australian dollars. Why might the change in the
exchange rate lead to a current account deficit?

9. Watch the following video on free trade agreements of Australia.

https://www.youtube.com/watch?v=VWDlNsOxkFg

10. A news article recently had the headline: ‘Export demand for education may rise on
falling dollar’.
a. What does the headline mean when it refers to a ‘falling dollar’?
b. Why would the dollar’s drop increase the demand for the export of Australian education?

11. Why does monetary policy have a greater effect on aggregate demand in an open economy
than in a closed economy?

12. Why does fiscal policy have a smaller impact in an open economy than in a closed economy?

13. If investment spending in Australia has been strong, why would this reduce apprehension
about the size of the current account deficit? What does the current account deficit have to
do with investment spending?

14. In 2010 China introduced some flexibility into its exchange rate determination and allowed
the value of the yuan to appreciate somewhat. According to a news article at the time:
Economists at China International Capital Corp., or CICC, say the companies that will suffer
the most from a stronger yuan are textile and apparel makers and office equipment
producers.…That could mean a sting for [overseas] clothing retailers… that buy a lot from
China.i
a. Does a ‘stronger yuan’ mean that the yuan will exchange for more or fewer dollars?
b. How can both Chinese companies, such as apparel makers, and Australia clothing retailers
such as Kmart, Target and Big W be hurt by a stronger yuan?
c. What effect will a stronger yuan be likely to have on the Chinese current account? What
effect is it likely to have on the Australian current account?

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15. Suppose that interest rates in Australia rise relative to those in other countries.
a. How will this policy affect real GDP in the short run if Australia is a closed economy?
b. How will this policy affect real GDP in the short run if Australia is an open economy?
c. How will your answer to part b change if interest rates also rise in the countries that are the
major trading partners of Australia?

When answering questions based on articles, please note the following steps;
Step 1: Read all the questions from the article.
Step 2: Number all the paragraphs in the article
Step 3: Browse through the article and match the questions and the paragraphs
Step 4: Write the answers to the questions
(Do not try to understand each and every word in the article)

16. Read the article and answer the following questions

i. According to the article, what is the likely outcome on the Australian dollar as results of
Brexit?

ii. According to the article, what is the predicted response of RBA to Brexit?

iii. What would you expect to happen to the value of the Australian dollar, the current account
and the flows of investment to and from Australia with the above mentioned response of RBA?

THE AGE 29 JUNE 2016

Brexit tipped to push $A higher, RBA to cut rate
by Mark Mulligan
The fallout from Brexit could make the Australian dollar even more alluring to investors, say
leading economists and fixed income experts, adding to already intense pressure on the RBA
to cut the cash rate to 1.5 per cent and lower.
They say the shrinking pool of triple-A rated sovereign credits, Australia’s relatively high
interest rates and doubts about further US interest rate increases would continue to draw foreign
money into Australian government bonds and other assets, pushing the Aussie higher against
the US dollar.
Jamieson Coote Bonds executive director Charlie Jamieson said rather than its conventional
status as a commodity-linked risk asset, the Aussie had become ‘somewhat of a flight-to-
quality currency’ amid recent Brexit-related volatility. This was largely due to the country’s
relatively high interest rates and triple-A rating by the three main credit rating agencies. The
downgrade this week of the UK’s AAA sovereign debt rating by Standard & Poor’s, and by
Moody’s, made Australia stand out even more, he said.

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‘Name a country other than Australia with low political risks, a AAA credit rating and a
positive yield,’ asked Citi currency strategist Todd Elmer. ‘It’s tough, isn’t it? It is too soon to
catch the falling knife, but when the dust settles, the Australian dollar may be among the
outperformers,’ he said.
Saul Eslake, one of Australia’s best-known economists, says this, coupled with the likely
impact of Brexit on US and Japanese monetary policy, could derail Australia’s export- and
services-led transition away from investment in resources-related investment.
‘If, as seems likely, the Brexit outcome and the turmoil it’s prompted does prompt the US
Federal Reserve to defer yet again raising rates, and if it prompts the Bank of Japan to move
Japanese rates even further into negative territory, that’s likely to bring upward pressure on the
Australian dollar,’ he said.
‘This would be unhelpful in terms of the transition the Australian economy is trying to make
away from mining investment-led growth to growth led by more diverse array of sources of
economic activity.
‘And if that is the case, then we’ll almost certainly see the Reserve Bank respond to that by
cutting interest rates further.’
Source: Mark Mulligan (2016), ‘Brexit tipped to push $A higher, RBA to cut rates’, The Age,
Fairfax Media, 29 June at <www.theage.com.au>, viewed 22 November 2016.

i
Jason Dean, Norihiko Shirouzu, Clare Ansberry and Kersten Zhang, (2010), ‘Yuan impact: General
manufacturing’, The Wall Street Journal, 21 June, at <http://blogs.wsj.com>, viewed 19 February 2014.

16. Complete Post-class homework after watching the video.

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