Open Economy—International Trade and Finance

The balance of payments 国际收支 records all transactions between a country and the rest of the world, in two main accounts:

The four parts of the current account

• The current account 经常账户 tracks trade in goods and services (exports minus imports), plus income and transfers. A trade deficit makes it negative.
• The capital (financial) account 资本账户 tracks flows of financial assets – foreigners buying domestic assets, and residents buying foreign assets.

The two are mirror images: a current-account deficit is matched by a capital-account surplus (a country that imports more than it exports pays with assets, so foreign investment flows in). They sum to zero.

An exchange rate 汇率 is the price of one currency in terms of another. A currency appreciates 升值 when it gains value (buys more foreign currency) and depreciates 贬值 when it loses value. Always track which currency: if the US dollar appreciates against the euro, the euro depreciates against the dollar – the same event from two sides.

Worked example. Suppose $\$1=\text{€}0.90$, so $\text{€}1=\dfrac{1}{0.90}\approx\$1.11$. If the dollar then appreciates to $\$1=\text{€}1.00$, each dollar now buys more euros, while the euro has depreciated – it now buys only $\$1.00$ instead of $\$1.11$. The single event is an appreciation of the dollar and a depreciation of the euro.

A floating exchange rate set by the demand for and supply of a currency

Most currencies today are floating 浮动, set by supply and demand in the foreign-exchange market.

Each currency has its own supply-and-demand graph (price $=$ the exchange rate, quantity $=$ amount of that currency).

• Demand for a currency comes from foreigners wanting its goods, services, or assets.
• Supply of a currency comes from its own residents wanting foreign goods, services, or assets.

The equilibrium exchange rate is where they cross. A rightward shift in demand for a currency causes it to appreciate; a rightward shift in supply causes it to depreciate.

Exam skill: always draw the graph for the currency named in the question, label the axis with that currency's price, and shift the correct curve – mixing up the two currencies' graphs is the most common error.

Exchange rates respond to:

• Relative interest rates: a higher domestic real interest rate attracts foreign financial investment, raising demand for the currency and causing appreciation.
• Relative price levels/inflation: higher domestic inflation makes goods less competitive, lowering demand for the currency (depreciation).
• Relative incomes: higher domestic income raises imports, increasing the supply of domestic currency (depreciation).
• Tastes and expectations about future value.

Monetary policy has a strong link: expansionary monetary policy lowers interest rates, reduces demand for the currency, and causes depreciation (which then boosts net exports).

Exchange rates feed back into AD through net exports:

Appreciation makes exports dearer and imports cheaper; depreciation does the reverse

• A depreciation makes exports cheaper for foreigners and imports dearer, so net exports rise and AD shifts right.
• An appreciation makes exports dearer and imports cheaper, so net exports fall and AD shifts left.

Worked example. A US car priced at $\$30{,}000$ costs a European buyer $\text{€}27{,}000$ when $\$1=\text{€}0.90$. If the dollar depreciates to $\$1=\text{€}0.80$, the same car now costs only $\text{€}24{,}000$ – cheaper for foreigners, so US exports rise while imports (now dearer in dollars) fall, lifting net exports and shifting AD right.

This is how the foreign-exchange market and the AD-AS model connect – a currency change is a channel through which policy reaches output.

Money chases the highest real return, so capital flows 资本流动 respond to real interest rates:

• A higher domestic real interest rate attracts inflows of foreign financial capital – foreigners buy domestic bonds, raising currency demand and causing appreciation.
• A lower real rate causes outflows and depreciation.

This ties the whole course together: government borrowing raises the real interest rate (loanable funds), which attracts foreign capital, appreciates the currency, and reduces net exports – so a budget deficit can widen a trade deficit (the "twin deficits"). Tracing these linked effects across the loanable-funds, forex, and AD-AS graphs is the capstone skill of AP Macroeconomics.

• The current account and financial account are mirror images and sum to zero.
• Always draw the forex graph for the currency named, and label its price with that currency; one currency appreciating is the other depreciating.
• A depreciation raises net exports (exports cheaper); an appreciation lowers them.
• Higher domestic real interest rates attract capital inflows → currency appreciates → net exports fall.
• Link it all: a budget deficit raises the real rate, appreciates the currency, and can widen the trade deficit (twin deficits).