ECO1011S Macroeconomics The exchange rate and balance of...

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ECO1011S: Macroeconomics The exchange rate and balance of payments Readings: M&F 13 (Sec 13.6, pp249-252) M&F 16 Leigh Neethling [email protected] Office hours Tuesday 10-11 Wednesday 10-11
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Introduction Globalisation Openness or integration into world economy SA is an OPEN economy Degree of openness not high or low 2
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International Trade & Financial Organisations International Trade Organisation (ITO) World Trade Organisation (WTO) International Monetary Fund (IMF) World Bank 3
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Why countries trade Absolute advantage Comparative Advantage 4
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Trade policies Import tariffs Import quotas Subsidies Non-tariff barriers Exchange controls Exchange rate policy 5
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The foreign exchange market The market in which one country’s currency is exchanged for another To put this in perspective: South Africa’s GDP in 2012 was a little over US$380 billion 6
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Source: BIS 2010 7
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8
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In the movies 9
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Exchange rates An exchange rate is the price at which you can exchange one currency for another Indirect method: how much foreign currency for one unit of local currency ($/R) Direct method: how much local currency for one unit of foreign currency (R/$) A rise in the direct exchange rate means an appreciation of the rand; a fall in the direct exchange rate means a depreciation of the rand This is the approach we usually use 10
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How much you pay for a dollar isn’t nearly as important as how much you can buy with your rands … but as with everything in life, psychology is sometimes important … 11
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How does the rand’s movement look compared to comparable currencies? Source: SARB QER Q1 2015 12
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Exchange rates of the rand QER Q2 2015, SARB 13
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Nominal vs real exchange rates Nomina l: price of one currency in terms of another currency Real : the price of SA goods and services relative to foreign goods and services Source: SARB QB June 2013 RER = E x (P SA /P F ) RER: real exchange rate E: nominal exchange rate P SA : prices in South Africa P F : prices in the foreign country The effective exchange rate represents a weighted average of the exchange rates for South Africa’s major trading partners 14
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Real exchange rate calculations Use 2012 prices Price of Big Mac in SA = R20 Price of Big Mac in USA = $4 Nominal direct E = $0.125/ZAR RER = X = = 0.625 Goods is SA are 62.5% the price of goods in the USA (SA goods are 37.5% cheaper than USA goods) 15
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Cross exchange rates “Crosses” Cross rates We can use two exchange rates to calculate a third $/ZAR: 0.0983 €/ZAR: 0.0736 16 3345 . 1 0736 . 0 0983 . 0 $ $ $ Euro Euro ZAR ZAR ZAR Euro ZAR
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Demand and supply in the forex market Demand South Africans want foreign currency to buy foreign goods and services and to invest in foreign assets Key determinants of supply 1. the exchange rate 2. SA demand for imports 3. interest rates in SA vs. other countries 4. the expected future exchange rate
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