The balance of payments and the exchange rate

Explain what a country's balance of payments records and name its three main accounts (current, capital, and financial), indicating in one sentence what each one records.

Indicate in which account of the balance of payments each transaction is recorded and whether it is a credit (inflow) or a debit (outflow) for Spain: a British tourist spends $2.000\ \text{€}$ on holiday in Valencia, a Spanish firm buys German machinery, a US fund buys shares in a Spanish bank, and a Spanish emigrant sends money to her family from Germany.

Arta's current account balance in one year: exports of goods, $40.000$ million euros; imports of goods, $55.000$ million; receipts from services (mainly tourism), $25.000$ million; payments for services, $10.000$ million; and net primary and secondary income (rents and transfers), $-2.000$ million.

1. a) Calculate the current account balance and state whether there is a surplus or deficit.
2. b) Explain what this result means and reason how it is financed (what happens in the financial account?).

Meridia's current account balance in one year, in billions of euros: exports of goods, $90.000$; imports of goods, $110.000$; receipts from services, $45.000$; payments for services, $25.000$; net primary income, $-5.000$; and net transfers, $-3.000$.

1. a) Calculate the current account balance and state whether there is a surplus or deficit.
2. b) Which sub-account partly offsets the deficit in the goods trade balance? Relate it to tourism.
3. c) Explain how that balance is financed (what should we expect in the financial account?).

Briga records, in one year, a current account surplus of $10.000$ million euros and a positive balance of $1.000$ million in the capital account.

1. a) Bearing in mind that the sum of the three accounts (current, capital and financial) must be zero except for errors and omissions, what must the balance of the financial account be?
2. b) Interpret that result: does Briga receive foreign capital or, on the contrary, does it accumulate assets in the rest of the world (buying companies, bonds or deposits abroad)?
3. c) Relate the case to a strongly exporting economy such as Germany.

The figure shows the euro market against the dollar: on the vertical axis, the exchange rate (dollars per euro) and, on the horizontal axis, the quantity of euros traded.

1. a) Read the equilibrium exchange rate from the graph.
2. b) Explain who demands euros and who supplies them in this market (think about exporters, importers, and tourists).

The exchange rate of the euro against the dollar is $1,15$ dollars per euro.

1. a) A Spanish tourist changes $200\ \text{€}$ for their trip to New York: how many dollars do they receive?
2. b) Explain in your own words what it means for the euro to "appreciate" against the dollar and how that tourist would notice it.

Explain the difference between a fixed exchange rate and a flexible exchange rate, and give an example of each system (the euro floats against the dollar; some countries peg their currency to the dollar and their central bank intervenes to keep it there).

The exchange rate of the euro against the dollar is $1,10$ dollars per euro.

1. a) How many dollars do you get when changing $500\ \text{€}$?
2. b) How many euros do you get when changing $770$ dollars?
3. c) If the rate changes to $1,20$ dollars per euro, has the euro appreciated or depreciated? Explain what this change means.

A winery in Briga sells wine to the United States at $10.000$ dollars per container. With the exchange rate at $1,00$ dollar per euro, each container yields $10.000\ \text{€}$; but the rate rises to $1,25$ dollars per euro.

1. a) Calculate how many euros it earns now per container.
2. b) Explain why the appreciation of the euro harms exporters and name two groups that benefit from it instead.

A Spanish company sells boxes of razor blades in the United States at $50\ \text{€}$ per box.

1. a) How many dollars does each box sell for if the exchange rate is $1,25$ dollars per euro? And if the euro depreciates to $1,05$ dollars per euro?
2. b) Explain why the depreciation improves the company's competitiveness in the American market.
3. c) Reason what happens, at the same time, to the cost in euros of the fuel the company imports and pays for in dollars.

An analyst states during a televised debate: "A $10\ \%$ depreciation of the euro against the dollar is excellent news for the entire Spanish economy: our exports will soar immediately, and we will correct our trade deficit without any adverse effects".

1. a) Analytically refute this statement by assessing the disparate impact of this depreciation on two companies: a La Rioja winery that produces using local grapes and sells to the United States, versus a Spanish shipping company whose vessels consume fuel priced in dollars and which has acquired its fleet through bank loans denominated in US currency.
2. b) Based on the price elasticity of demand for imports and exports, justify why in the short term Spain's trade balance usually deteriorates after a depreciation instead of improving ("J-curve" effect).
3. c) Predict the effect of this depreciation on the domestic general price level (cost-push or imported inflation) and explain what interest rate policy dilemma the European Central Bank would face if the depreciation coincides with GDP stagnation in the eurozone.

The Government of Meridia maintains that an ongoing current account deficit of $4\ \%$ of GDP over a decade is not a cause for concern, arguing that it "reflects the country's attractiveness in drawing funds from the rest of the world". However, the net international investment position (net external debt) already exceeds $75\ \%$ of its GDP.

1. a) Use the macroeconomic identity of the external balance ($Saving - Investment = Current\ account\ balance$) to refute the official view and explain what this structural deficit reveals about public and private saving patterns in Meridia.
2. b) Predict what financial and real consequences the country would suffer if an episode of global risk aversion is triggered and international markets abruptly cut off external financing (sudden stop).
3. c) Design a combination of two economic policy measures (one demand-side fiscal measure and one supply-side structural measure) to balance the external accounts in the medium term, justifying the adjustment costs and sacrifices that each will impose on the population.

International financial markets anticipate severe instability in Arta and trigger a massive sell-off of debt securities and listed equities, converting their proceeds into hard currencies to exit the country. Arta operates under a fixed exchange rate regime pegged to the benchmark currency.

1. a) Explain the pressure experienced by the domestic foreign exchange market and detail how this capital drain is reflected in the financial account's sub-balances and in the central bank's foreign exchange reserve position.
2. b) Evaluate the two orthodox intervention alternatives available to the central bank to keep the exchange rate pegged in the face of this speculative attack, identifying the critical operational limit of the first and the severe recessionary cost to the real economy of the second.
3. c) Predict the scenario in which the central bank is forced to give in and allow an abrupt devaluation: justify how this outcome would impact the solvency of Arta's banking system and corporate sector if they held liabilities denominated in foreign currency and assets in domestic currency (currency mismatch).