| | | | | | in income is unique to us; it is not part of a worldwide boom. If other countries' incomes are increasing at the same time, then our exports should also increase, making uncertain the net effect on our balance of payments and exchange rate. | | | | | | | | | 3. Interest rate. When our interest rate is higher, foreigners are more interested in buying our financial assets, so they demand more of our dollars on the foreign exchange market. This demand creates capital inflows, a balance of payments surplus, and upward pressure on the exchange rate. Two caveats concerning capital inflows are important. First, the result depends on the interest rate increase not being part of a worldwide pattern. If interest rates throughout the world rise, the fact that our interest rate is higher should not entice foreigr ers to switch to our bonds. Second, the relevant difference in interest rates is the difference in real interest rates, not nominal interest rates; investors are concerned with real returns. For more on this topic, see chapter 18. | | | | | | | | | 4. Price level. A rise in our price level increases the price of our exports and the price of import-competing goods and services, so our exports fall and our imports rise. As a result, the demand for our dollars decreases, and the supply of our dollars increases, creating a balance of payments deficit and downward pressure on the exchange rate. Again, such effects occur only if there is no equivalent price increase in the rest of the world. | | | | | | | | | 5. Expectations. If foreigners expect the value of the dollar to rise, they can reap a capital gain by buying our bonds and then selling them again after the exchange rate has risen. This speculation creates an inflow of capital, a balance of payments surplus, and upward pressure on the exchange rate. Such speculative funds are available in large amounts and can be moved very quickly from one currency to another. Indeed, speculative activity is the primary determinant of exchange rates in the short run. Daily volume on the foreign exchange market is about $1 trillion, the bulk of which is speculative. | | | | | | | | | To summarize, several factors influence activity in the foreign exchange market. The balance of payments summarizes this activity, telling us whether the market is in disequilibrium, in what direction, and by how much, allowing us to predict economic forces for change (see chapter 16). | | | | | | | | | 15.3
The International Economic Accounts | | | | | | | | | Knowledge of the balance of payments is all that is needed for analysis of the economic forces that automatically are set in motion whenever there is a disequilibrium in the international sector of the economy. Often, however, analysts are interested in the source of any disequilibrium in the international sector, that is, the relative contributions to an equilibrium position of the various components of the demand for and supply of dollars on the foreign exchange market. Consequently, the balance of payments is broken down into several subsidiary measures, which together are referred to as the international accounts or the balance of payments accounts. | | | | |
