The relationship between the Current Account Balance and Exchange Rates

A nation’s balance of payments measures all economic transactions between that nation’s people and the people of all other nations. A country that spends more on imports than it earns from the sale of its exports is said to have a trade deficit. Such imbalances have become controversial topics of debate in political and economic circles, particularly over the last decade as the Chinese economy has emerged as the world’s largest exporter.

As goods and services flow from one country to another, the exchange rates of those countries’ currencies tend to fluctuate to promote balanced trade between the two nations. However, in some cases, most notably China, a country’s central bank will intervene in the market for its own currency to manage its exchange rate against that of a trading partner. When such interventions occur, the normal, moderating effect that rising and falling exchange rates has on trade flows is disrupted, and trade imbalances can become persistent.

This lesson will illustrate how trade flows should lead to appreciation and depreciation of currencies in a floating exchange rate system, and then explain how in the case of China, central bank policy aimed at buying large quantities of US government debt keeps the supply of Chinese currency high in the US and the demand for US dollars high in China. This means the dollar remains stronger than it otherwise might relative to the Chinese RMB, contributing to the persistent trade deficits the US exhibits in its trade with China.

 

Share this lesson!
Share

The Marshall-Lerner Condition

This video explains the Marshall-Lerner Condition for determining whether a depreciation of a nation’s currency will improve or worsen its current account balance. The MLC is an application of the total revenue test of price elasticity of demand, and applies to the sections of the Econ course on Balance of Payments and Exchange Rates.

After watching the video, read and respond to the discussion questions in the following blog post: The Marshall-Lerner Condition, the J-curve, and the US trade deficit

There is also an in-class research assignment to accompany this lesson. We will do this in my class with HL students over the next two class periods. Elasticity, exchange rates and the balance of payments – understanding the Marshall Lerner Condition

 

Share this lesson!
Share

The J-Curve – Illustrating the Marshall Lerner Condition

This video lesson is part two of a lesson on the Marshall-Lerner Condition and the J-curve. Before watching this video, make sure you have watched the lecture on the Marshall-Lerner Condition.

This lesson will explain how a depreciation of a nation’s currency is likely to affect the nation’s current account balance in the short-run and in the long-run depending on the price elasticity of demand for exports and imports.

After watching the video, read and respond to the discussion questions in the following blog post: The Marshall-Lerner Condition, the J-curve, and the US trade deficit

There is also an in-class research assignment to accompany this lesson. We will do this in my class with HL students over the next two class periods. Elasticity, exchange rates and the balance of payments – understanding the Marshall Lerner Condition

 

Share this lesson!
Share

Balance of Payments and Exchange Rates – AP Free Response Questions

This lesson presents worked solutions to three AP Free Response Questions on Balance of Payments and Exchange Rates. You may wish to download and attempt these questions yourself before watching the video. Here is the original quiz I gave my AP Macro students: AP Macro Balance of Payments Quiz

The original AP Questions and others can be found on the College Board Site: AP Macroeconomics – Sample questions and Scoring guidelines

The quiz covers the following questions:

  • 2011 Form B Question #2
  • 2008 Question #2
  • 2007 Form B Question #3

Share this lesson!
Share