Week 6

Currency Fluctuations
• When an exchange rate changes, the value of one currency will go up while the
value of the other currency will go down. When the value of a currency increases,
it is said to have appreciated. On the other hand, when the value of a currency
decreases, it is said to have depreciated.
• Appreciation
• when a currency becomes more valuable relative to another currency; a currency
appreciates when you need more of another currency to buy a single unit of a
currency
• Depreciation
• when the value of a currency decreases relative to another currency; a currency
depreciates when you need less of another currency to buy a single unit of a
currency.
Devaluation of a currency
• Devaluation of a currency is associated with countries having a fixed
exchange rate regime.
• Under the fixed rate regime, the central bank or the government
decides the value of the currency with respect to other foreign
currencies. The central bank or the government purchases or sells its
currencies to maintain the exchange rate.
• When the government or the central bank reduces the value of its
currency, then it is known as the devaluation of the currency. Under
this, the value of the domestic currency is deliberately reduced in
terms of other foreign currencies
Reasons responsible for currency devaluation
• Decline in exports: the decline in a country’s overall exports leads to a
decline in export revenues. This reduces the demand for the country’s
currency and leads to its depreciation.
• Large increase in imports: a large increase in the demand for imported
goods and services can lead to a trade deficit. Increase in the current
account deficit can lead to a net outflow of the currency which can
weaken the exchange rate leading to currency depreciation.
• Monetary policy of Central Bank: if the central bank reduces its policy
interest rates it can lead to the outflow of hot money such as foreign
portfolio investment etc. This can lead to the depreciation of domestic
currency.
Depreciation of a currency
• Depreciation of a currency is a phenomenon associated with
countries with floating exchange rate regime.
• In the floating exchange rate regimes, the value of a country’s
currency is determined by the market forces of demand and supply.
The exchange rate of the currency changes on daily basis as per the
demand and supply of that currency with respect to foreign
currencies.
• A currency depreciates with respect to foreign currency when the
supply of currency in the market increases while its demand fall
Balance of Payments
• The balance of payments (BOP) is the method countries use to monitor
all international monetary transactions in a specific period. The BOP is
usually calculated every quarter and every calendar year.
• All trades conducted by both the private and public sectors are accounted
for in the BOP to determine how much money is going in and out of a
country. If a country has received money, this is known as a credit, and if
a country has paid or given money, the transaction is counted as a debit.
• Theoretically, the BOP should be zero, meaning that assets (credits) and
liabilities (debits) should balance, but in practice, this is rarely the case.
Thus, the BOP can tell the observer if a country has a deficit or a surplus
and from which part of the economy the discrepancies are stemming.
• The balance of payments (BOP) is the record of all international financial
transactions made by the residents of a country.
• There are three main categories of the BOP: the current account, the capital
account, and the financial account.
• The current account is used to mark the inflow and outflow of goods and
services into a country.
• The capital account is where all international capital transfers are recorded.
• In the financial account, international monetary flows related to investment in
business, real estate, bonds, and stocks are documented.
• The current account should be balanced versus the combined capital and
financial accounts, leaving the BOP at zero, but this rarely occurs.
Current Account
• The current account is used to mark the inflow and outflow of goods and services into
a country. Earnings on investments, both public and private, are also put into the
current account
• Within the current account are credits and debits on the trade of merchandise, which
includes goods such as raw materials and manufactured goods that are bought, sold,
or given away (possibly in the form of aid). Services refer to receipts from tourism,
transportation (such as the levy that must be paid in Egypt when a ship passes
through the Suez Canal), engineering, business service fees (from lawyers or
management consulting, for example), and royalties from patents and copyrights
• Goods and services together make up a country's balance of trade (BOT). The BOT is
typically the biggest bulk of a country’s balance of payments, as it makes up total
imports and exports. If a country has a BOT deficit, it imports more than it exports,
and if it has a BOT surplus, it exports more than it imports
Capital Account
• The capital account is one of the accounts used in the balance of payments. It's used to record
international transfers between the residents in one country and those in other countries. The capital
account can reflect a country's financial health and stability. It can indicate how attractive a country is to
other countries that seek to invest internationally
• A country's capital account records all international capital transfers. The income and expenditures are
measured by the inflow and outflow of funds in the form of investments and loans.
A deficit shows more money is flowing out, while a surplus indicates more money is flowing in
• Along with non-financial and non-produced asset transactions, the capital account includes:
• Dealings such as debt forgiveness
• The transfer of goods and financial assets by migrants leaving or entering a country
• The transfer of ownership of fixed assets and of funds received for the sale or acquisition of fixed assets
• Gift and inheritance taxes
• Death levies, patents, copyrights, royalties
• Uninsured damage to fixed assets
• Complex transactions with both capital assets and financial claims may be recorded in both the capital and
current accounts.
Financial Account
• A financial account measures the increase or decrease in a country's ownership of international
assets.
• A country's financial account can be broken down into two sub-accounts. One is the domestic
ownership of foreign assets. The other is the foreign ownership of domestic assets
• The financial account deals with money related to:
• Foreign reserves
• Private investments in businesses, real estate, bonds, and stocks
• Government-owned assets such as special drawing rights at the International Monetary Fund
(IMF)
• Private sector assets held in other countries
• Local assets held by foreigners (government and private)
• Foreign direct investment
• Portfolio investment
Fiscal Consolidation
• Fiscal consolidation refers to policies implemented by national and
sub-national governments to reduce debt accumulation and minimize
deficits. This can be achieved through increasing revenue and
reducing expenditure. Fiscal consolidation means reducing the fiscal
deficit. It involves governments at different levels taking action to
reduce deficits and debt accumulation. The goal is not to eliminate
fiscal debt.
Is Monetary or Fiscal Policy Better?
• That depends on who you ask and the type of policy implemented.
When central banks lower interest rates by using monetary policy, the
cost of borrowing and investment becomes cheaper. This allows
consumers to assume more debt and make large purchases.
Businesses are also able to invest in their growth.
• Fiscal policy, on the other hand, helps increase
gross domestic product (GDP) through expansionary tools. This occurs
because demand for goods and services increases, which leads to a
rise in prices and output.
What Are the Common Goals of Monetary
and Fiscal Policy?
• Monetary and fiscal policy are two different tools that central banks
and governments use to influence the economy. Both are employed
to help bring stability to a country's economy. They often work best
when they are implemented together, where monetary policy shifts a
country's financial markets while fiscal policy affects how much
money people have in their pockets
• Both fiscal and monetary policy play a large role in managing the
economy and both have direct and indirect impacts on personal and
household finances. Fiscal policy involves tax and spending decisions
set by the government, and will impact individuals' tax bill or provide
them with employment from government projects. Monetary policy is
set by the central bank and can boost consumer spending through
lower interest rates that make borrowing cheaper on everything from
credit cards to mortgages