Econ182_glossary - SIMON FRASER UNIVERSITY Department of...

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SIMON FRASER UNIVERSITY Department of Economics Econ 345 Prof. Kasa International Finance Fall 2004 A Glossary of Terms and Concepts In International Finance 1. Asset Market Approach to Exchange Rate Determination: The view that the ex- change rate adjusts instantly to equilibrate the market for existing stocks of national assets. The exchange rate is therefore regarded as the price of a durable asset, as are stock market prices and gold, for example. As such, the key determinant of the exchange rate is current expectations of its future value, and changes in exchange rates represent revisions of these ex- pectations. Since unanticipated events are primarily responsible for movements in exchange rates, this approach implies that changes in exchange rates should be difficult to forecast. Although this may seem obvious now, given the experience of the past 30 years, until the 1970s most people viewed the exchange rate as equilibrating flows of goods and services. For example, in a ‘flow market approach’ an excess demand for foreign goods causes the domestic currency to depreciate. While this may have been a reasonable approach in an era of little or no capital mobility, it is a misleading view in today’s world of highly integrated capital markets. 2. Balance of Payments: An accounting record of all (observable) transactions between do- mestic and foreign residents that occur during a given period of time (usually a year). Trans- actions resulting in payments to foreigners (e.g., imports of goods or services) are entered as debit items and assigned negative values. Transactions which result in receipts from foreign- ers (e.g., the sale of an asset to pay for imports) are recorded as credit items and assigned positive values. In an accounting sense, the Balance of Payments is ‘always in balance’. In other words, the sum of all the components of the Balance of Payments must be zero. 3. Bretton Woods System: The system of fixed exchange rates that prevailed between the end of World War II and 1973. It was the result of an international conference held at Bretton Woods, New Hampshire, in 1944. Under this agreement countries fixed the value of their currencies vis-a-vis the U.S. dollar, while the U.S. government was obliged to maintain a constant price of gold in terms of dollars ($35 per ounce). In essence then, the value of all currencies was fixed in terms of gold. In contrast to a gold standard, however, U.S. dollars were used as reserves (in addition to gold) by central banks when settling their accounts. This system gave a lot of power to U.S. policymakers since dollars were the reserve currency . The abuse of this power was a contributing factor to the system’s collapse. Excessive U.S. monetary growth in the late 1960s led speculators to believe that the dollar would need to be devalued in terms of gold. This led to massive gold losses by central banks as they attempted to defend the existing dollar price of gold, and eventually forced Nixon to sever the dollar’s link to gold in 1971. This was the beginning of the end for the Bretton Woods System. The
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