International Finance
27 c h a p t e r
BALANCE OF PAYMENTS
The record of all of the international financial transactions of a nation over a year is called the balance of payments. The balance of payments is a statement that records all the exchanges requiring an outflow of funds to foreign nations or an inflow of funds from other nations. Just as an examination of gross domestic product accounts gives us some idea of the economic health and vitality of a nation, the balance of payments provides information about a nation’s world trade position. The balance of payments is divided into three main sections: the current account, the capital account, and an “error term” called the statistical discrepancy. These are highlighted in Exhibit 1 on page 604. Let’s look at each of these components, beginning with the current account, which is made up of imports and exports of goods and services.
THE CURRENT ACCOUNT Export Goods and the Current Account A current account is a record of a country’s imports and exports of goods and services, net investment income, and net transfers. Any time a foreign buyer purchases a good from a U.S. producer, the foreign buyer must pay the U.S. producer for the good.
Usually, the foreign buyer must pay for the good in U.S. dollars, because the producer wants to pay his workers’ wages and other input costs with dollars.
This requires the foreign buyer to exchange units of her currency at a foreign exchange dealer for U.S.
dollars. Because the United States gains claims for foreign goods by obtaining foreign currency in exchange for the dollars needed to buy exports, all exports of U.S. goods abroad are considered a credit, or plus (1), item in the U.S. balance of payments.
Those foreign currencies are later exchangeable for goods and services made in the country that purchased the U.S. exports.
Import Goods and the Current Account When a U.S. consumer buys an imported good, however, the reverse is true: The U.S. importer must pay the foreign producer, usually in that nation’s currency. Typically, the U.S. buyer will go to a foreign exchange dealer and exchange dollars for units 602 CHAPTER TWENTY-SEVEN | International Finance The Balance of Payments s e c t i o n 27.1 _ What is the balance of payments?
_ What are the three main components of the balance of payments?
_ What is the balance of trade?
According to hotel and motel records, San Francisco has roughly 4 million visitors annually. This number does not take into account people who stayed with friends or families or people who visited the city for the day only.
When a foreign tourist rides a cable car in San Francisco, how does that affect the current account? Tourism provides the United States with foreign currency, which is included in exports.
© Jan Butchofsky-Houser / CORBIS of that foreign currency. Imports are thus a debit (–) item in the balance of payments, because the dollars sold to buy the foreign currency add to foreign claims for foreign goods, which are later exchangeable for U.S. goods and services. U.S. imports, then, provide the means by which foreigners can buy U.S.
exports.
Services and the Current Account While imports and exports of goods are the largest components of the balance of payments, they are not the only ones. Nations import and export services as well. A particularly important service is tourism. When U.S. tourists go abroad, they are buying foreign-produced services in addition to those purchased by citizens there. Those services include the use of hotels, sightseeing tours, restaurants, and so forth. In the current account, these services are included in imports. On the other hand, foreign tourism in the United States provides us with foreign currencies and claims against foreigners, so they are included in exports. Airline and shipping services also affect the balance of payments.
When someone from Italy flies American Airlines, that person is making a payment to a U.S.
company. Because the flow of international financial claims is the same, this payment is treated just like a U.S. export in the balance of payments. If an American flies on Alitalia, however, Italians acquire claims against the United States, and so it is included as a debit (import) item in the U.S. balanceof- payments accounts.
Net Transfer Payments and Net Investment Income Other items that affect the current account are private and government grants and gifts to and from other countries. When the U.S. gives foreign aid to another country, a debit occurs in the U.S. balance of payments because the aid gives foreigners added claims against the United States in the form of dollars.
Private gifts, such as individuals sending money to relatives or friends in foreign countries, shows up in the current account as debit items as well. Because the United States usually sends more humanitarian and military aid to foreigners than it receives, net transfers are usually in deficit.
There is also net investment income in the current account—U.S. investors hold foreign assets and foreign investors hold U.S. assets. In 2000, investment income paid to foreigners exceeded investment received from foreigners by $15 billion.
The Current Account Balance The balance on the current account is the net amount of credits or debits after adding up all transactions of goods (merchandise imports and exports), services, and transfer payments (e.g., foreign aid and gifts). If the sum of credits exceeds the sum of debits, the nation is said to run a balance-ofpayments surplus on the current account. If debits exceed credits, however, the nation is running a balance-of-payments deficit on the current account.
The Balance of Trade and the Balance of the Current Account The balance of payments of the United States for 2002 is presented in Exhibit 1. Notice that exports and imports of goods and services are by far the largest credits and debits. Notice also that U.S. exports of goods were $484 billion less than imports of goods. The import/export goods relationship is often called the balance of trade. The United States, therefore, experienced a balance-of-trade deficit that year of $484 billion. However, some of the $484 billion trade deficit was offset by credits from a $49 billion surplus in services. That leads to a $435 billion deficit in the balance of goods and services.
When $56 billion of net unilateral transfers (gifts and grants between the U.S. and foreigners) and $12 billion of investment income (net) from the United States is subtracted (the United States gave more to the foreigners than foreigners gave to the United States), the total deficit on the current account was $503 billion. Exhibit 2 shows the balance on the current account since 1975.
THE CAPITAL ACCOUNT How was this deficit on the current account financed?
Remember that U.S. credits give us the financial means to buy foreign goods and that our credits were $194 billion less than our debits from our imports and net unilateral transfers to foreign countries. This deficit on the current account balance is settled by movements of financial, or capital, assets. These transactions are recorded in the capital account, so that a current account deficit is financed by a capital account surplus. In short, the The Balance of Payments 603 604 CHAPTER TWENTY-SEVEN | International Finance Current Account 1. Exports of goods $683 2. Imports of goods 21167 3. Balance of trade (lines 1 1 2) 2484 4. Service exports 289 5. Service imports 2240 6. Balance on goods and services 2435 (lines 3 1 4 1 5) 7. Unilateral transfers (net) 256 8. Investment income (net) 212 9. Current account balance 2503 (lines 6 1 7 1 8) SOURCE: Bureau of Economic Analysis, Table 1.
Capital Account 10. U.S.-owned assets abroad $ 2156 11. Foreign owned assets in the 630 United States 12. Capital account balance 474 (lines 10 1 11) 13. Statistical discrepancy 29 14. Net Balance $0 (lines 9 1 12 1 13) U.S. Balance of Payments, 2002 (billions of dollars) SECTION 27.1 EXHIBIT 1 Type of Transaction 50 0 -50 -100 -150 -200 -250 -300 -350 -400 -450 1975 1977 1979 1981 1983 1985 1987 1989 1991 1993 1995 1997 1999 2001 2002 Surplus Balance of Trade (billions of dollars) Deficit U.S. Balance of Trade on Goods, 1975–2002 SECTION 27.1 EXHIBIT 2 The United States has experienced trade deficits since 1975. The financial crisis in Asia led to a sharp increase in the trade deficit in the late 1990s.
capital account records the foreign purchases or assets in the U.S.(a monetary inflow) and U.S. purchases of assets abroad (a monetary outflow).
What Does the Capital Account Record?
Capital account transactions include items such as international bank loans, purchases of corporate securities, government bond purchases, and direct investments in foreign subsidiary companies. In 2002, the United States purchased foreign assets of $156 billion, which was a further debit because it provided foreigners with U.S. dollars. On the other hand, foreign investments in U.S. bonds, stocks, and other items totaled more than $630 billion. In addition, the United States and other governments buy and sell dollars. On net in 2002, foreign-owned assets in the United States made about $474 billion more than did U.S. assets abroad. On balance, then, there was a surplus (positive credit) in the capital account from capital movements of $474 billion, offsetting the $503 billion deficit on current account.
The Statistical Discrepancy In the final analysis, it is true that the balance-ofpayments account (current account minus capital account) must balance so that credits and debits are equal. Why is this so? Due to the reciprocal aspect of trade, every credit eventually creates a debit of equal magnitude. These errors are sometimes large and are entered into the balance of payments as the statistical discrepancy. Including the errors and omissions recorded as the statistical discrepancy, the balance of payments do balance. That is, the number of U.S. dollars demanded equals the number of U.S. dollars supplied when there is a balance of payments of zero.
Balance of Payments: A Useful Analogy In concept, the international balance of payments is similar to the personal financial transactions of individuals.
Each individual has a personal “balance of payments,” reflecting that person’s trading with other economic units: other individuals, corporations, or governments. People earn income or credits by “exporting” their labor service to other economic units, or by receiving investment income (a return on capital services). Against that, they “import” goods from other economic units; we call these imports consumption. This debit item is sometimes augmented by payments made to outsiders (e.g., banks) on loans and so forth. Fund transfers, such as gifts to children or charities, are other debit items (or credit items for recipients of the assistance).
As individuals, if our spending on consumption exceeds our income from exporting our labor and capital services, we have a “deficit” that must be financed by borrowing or selling assets. If we “export” more than we “import,” however, we can make new investments and/or increase our “reserves” (savings and investment holdings). Like nations, an individual who runs a deficit in daily transactions must make up for it through accommodating transactions (e.g., borrowing or reducing personal savings or investment holdings) to bring about an ultimate balance of credits and debits to his or her personal account.
The Balance of Payments 605 1. The balance of payments is the record of all the international financial transactions of a nation for any given year.
2. The balance of payments is made up of the current account, the capital account, as well as an “error term” called the statistical discrepancy.
3. The balance of trade refers strictly to the imports and exports of (merchandise) goods with other nations. If our imports of foreign goods are greater than our exports, we are said to have a balance of trade deficit.
1. What is the balance of payments?
2. Why must English purchasers of U.S. goods and services first exchange pounds for dollars?
3. How is it that our imports provide foreigners the means to buy U.S. exports?
4. What would have to be true for the United States to have a balance-of-trade deficit and a balanceof- payments surplus?
5. What would have to be true for the United States to have a balance-of-trade surplus and a current account deficit?
6. If there were no errors or omissions in the recorded balance-of-payments accounts, what should the statistical discrepancy equal?
7. A Nigerian family visiting Chicago enjoys a Chicago Cubs baseball game at Wrigley field.
How would that expense be recorded in the balance-of-payments accounts? Why?
s e c t i o n c h e c k THE NEED FOR FOREIGN CURRENCIES When a U.S. consumer buys goods from a seller in another country—who naturally wants to be paid in her own domestic currency—the U.S. consumer must first exchange U.S. dollars for the seller’s currency in order to pay for those goods. American importers must, therefore, constantly buy yen, euros, pesos, and other currencies in order to finance their purchases. Similarly, someone in another country buying U.S. goods must sell his domestic currency to obtain U.S. dollars to pay for those goods.
THE EXCHANGE RATE The price of a unit of one foreign currency in terms of another is called the exchange rate. If a U.S. importer has agreed to pay euros (the new currency of the European Union) to buy a cuckoo clock made in the Black Forest in Germany, she would then have to exchange U.S. dollars for euros. If it takes $1.00 to buy 1 euro, then the exchange rate is $1.00 per euro. From the German perspective, the exchange rate is 1 euro per U.S. dollar.
CHANGES IN EXCHANGE RATES AFFECT THE DOMESTIC DEMAND FOR FOREIGN GOODS Prices of goods in their currencies combine with exchange rates to determine the domestic price of foreign goods. Suppose the cuckoo clock sells for 100 euros in Germany. What is the price to U.S. consumers?
Let’s assume that tariffs and other transaction costs are zero. If the exchange rate is $1 5 1 euro, then the equivalent U.S. dollar price of the cuckoo clock is 100 euros times $1 per euro, or $100. If the exchange rate were to change to $2 5 1 euro, fewer clocks would be demanded in the United States. This is because the effective U.S. dollar price of the clocks would rise to $200 (100 euros 3 $2 per euro). The higher relative value of a euro compared to the dollar (or equivalently, the lower relative value of a dollar compared to the euro) would lead to a reduction in U.S. demand for German-made clocks.
THE DEMAND FOR A FOREIGN CURRENCY The demand for foreign currencies is a derived demand.
This is because the demand for a foreign currency derives directly from the demand for foreign goods and services or for foreign investment. The more foreign goods are demanded, the more of that foreign currency is needed to pay for those goods.
Such an increased demand for the currency will push up the exchange value of that currency relative to other currencies.
THE SUPPLY OF A FOREIGN CURRENCY Similarly, the supply of foreign currency is provided by foreigners who want to buy the exports of a particular nation. For example, the more that foreigners demand U.S. products, the more of their currencies they will supply in exchange for U.S. dollars, which they use to buy our products.
606 CHAPTER TWENTY-SEVEN | International Finance Exchange Rates s e c t i o n 27.2 _ What are exchange rates?
_ How are exchange rates determined?
_ How do exchange rates affect the demand for foreign goods?
With the introduction of the euro, it will be easy to compare prices for the same goods in different countries using this currency. For example, if you use mail order or shop on the Internet, it will be easier to spot the bargains between countries.
© Dave G. Houser / Corbis Images DETERMINING EXCHANGE RATES We know that the demand for foreign currencies is derived from the demand for foreign goods, but how does that affect the exchange rate? Just as in the product market, the answer lies with the forces of supply and demand. In this case, it is the supply of and demand for a foreign currency that determine the equilibrium price (exchange rate) of that currency.
THE DEMAND CURVE FOR A FOREIGN CURRENCY As Exhibit 1 shows, the demand curve for a foreign currency—the euro, for example—is downward sloping, just as it is in product markets. In this case, however, the demand curve has a negative slope because as the price of the euro falls relative to the dollar, European products become relatively more inexpensive to U.S. consumers, who therefore buy more European goods. To do so, the quantity of euros demanded by U.S. consumers will increase to buy more European goods as the price of the euro falls. This is why the demand for foreign currencies is considered to be a derived demand.
THE SUPPLY CURVE FOR FOREIGN CURRENCY The supply curve for a foreign currency is upward sloping, just as it is in product markets. In this case, as the price, or value, of the euro increases relative to the dollar, U.S. products will become relatively less expensive to European buyers, who will thus increase the quantity of dollars they demand. Europeans will, therefore, increase the quantity of euros supplied to the U.S. by buying more U.S. products.
Hence, the supply curve is upward sloping.
Exchange Rates 607 Why is a strong dollar (i.e., exchange rate for foreign currencies is low) a mixed blessing?
A strong dollar will lower the price of imports and make trips to foreign countries less expensive. Lower prices on foreign goods also help keep inflation in check and make investments in foreign financial markets (foreign stocks and bonds) relatively cheaper. However, it makes U.S. exports more expensive. Consequently, foreigners will buy fewer U.S.
goods and services. The net effect is a fall in exports and a rise in imports—net exports fall. Note that some Americans are helped (vacationers going to foreign countries and those preferring foreign goods), while others are harmed (producers of U.S.
exports, operators of hotels dependent on foreign visitors in the United States). A stronger dollar also makes it more difficult for foreign investors to invest in the United States.
EXCHANGE RATES USING WHAT YOU'VE LEARNED A Q Dollar Price of Euros Quantity of Euros 0 $1.40 $1.20 $1.00 Excess Supply of Euros Excess Demand for Euros Demand for Euros (U.S. purchases of European goods and services) Supply of Euros (U.S. sales of goods and services to Europeans) Equilibrium in the Foreign Exchange Market SECTION 27.2 EXHIBIT 1 Suppose the foreign exchange market is in equilibrium at 1 euro 5 $1.20. At any price higher than $1.20, there will be a surplus of euros.
At any price lower than $1.20, there will be a shortage of euros.
608 CHAPTER TWENTY-SEVEN | International Finance Its leaders are divided and its economies are distressed, but Europe stands tall in one respect. The euro, its toddler currency, is growing into a cheeky rival to the dollar, one of the most visible symbols of America’s power in the world.
After a hapless debut in January 1999, marked by a long, stomach-churning slide in its value, the euro has made up virtually all the ground it lost against the dollar. It now trades at an exchange rate of about $1.15 per euro, only three cents shy of its value on the first day of trading.
More important, the euro has gained stature as a safe haven for investors and governments.
The dollar remains the world’s default currency—the lingua franca of oil traders and bond dealers, and the bedrock of foreign reserves held by central banks from Brussels to Baghdad.
But the euro is gaining ground, both as an attractive currency in which to issue bonds and as an alternative to the dollar for national foreign exchange reserves, notably in southeast Asian countries with predominantly Muslim populations.
With the United States piling up vast deficits, economists say the euro has a chance to consolidate its gains. “U.S. federal finances are coming under increased strain,” said Niall C. Ferguson, a senior research fellow at Oxford. “Money that had been invested in dollar-denominated assets is shifting to euro assets. For the euro to become a little brother to the dollar seems perfectly plausible.” Such a role would vindicate the guardians of the euro, who watch over it from the European Central Bank’s glass-and-steel tower in Frankfurt. They have always had grand ambitions for the currency, viewing it as an alternative to the dollar and an instrument to drive Europe’s integration.
Yet an almighty euro carries risks for champions of a united Europe. It could supply fresh ammunition to opponents of the monetary union in Britain, Sweden and prospective members.
It could also open fissures between existing members that depend on exports and stand to suffer from a currency that rises too far, too fast. Last week, three euro countries—Germany, Italy and the Netherlands—reported that they were on the brink of recession.
“If it goes much beyond $1.25, we’ve got a problem,” said Daniel Gros, director of the Center for European Policy Studies, a research group in Brussels.
The introduction of euro notes and coins here last year was striking for how smooth the process seemed. After a noisy buildup, the German mark, the French franc and the Italian lira faded into history like quaint relics. In the financial markets, where the euro had traded as a virtual currency since 1999, the transition was equally seamless, with investors showing prompt acceptance of the new currency. . . .
[Barry] Eichengreen [professor of economics at the University of California, Berkeley] said there was no reason the euro’s influence would not eventually match the dollar’s. The euro zone already has 300 million people; it would have more than 450 million if Britain, Sweden and the countries of Central Europe adopted the currency.
Most are eager to do so, believing it will help their populations.
But the price of belonging to a monetary union—obeying strict fiscal rules and one-size-fits-all interest rates—has made some Central Europeans relieved that they will not be allowed to adopt the euro until at least 2007.
“It would be so easy to sell the concept of the euro if there weren’t these tough requirements,” the prime minister of Hungary, Peter Medgyessy, said recently in an interview at a conference in Munich. “That is why we should be very cautious about setting a date for joining the euro zone.” Among Western Europeans, feelings are even more ambivalent.
Sweden, which is scheduled to hold a referendum on joining the monetary union in September, has historically been pro-Europe. But in recent polls, public sentiment has swung narrowly against the euro.
Part of the problem is that Swedes fear a strong euro would cripple their exports. They also point to neighboring Germany, which has limped through four years with the euro, in part because the tight monetary policy of the European bank is arguably ill suited to its faltering economy.
The same arguments are heard in Britain, where the chancellor of the exchequer, Gordon Brown, is to deliver a judgment next month on whether the country has met five economic conditions for entry to the union. His verdict is widely expected to be “not yet.” Mr. Brown’s obdurate resistance has revived rumors of a rift between him and Prime Minister Tony Blair, who favors the euro. The two men issued a statement on Friday denying that they were at loggerheads. In one respect, the rise of the euro should remove a barrier for Britain. Because the pound, like the dollar, has lost value against the euro, the danger of converting it into euros at an inflated rate has been mitigated.
“If you lock in the pound at too strong a rate, you run into some of the same problems Germany did,” said David Walton, the chief European economist at Goldman Sachs in London.
Still, Mr. Walton said Britain’s reluctance to join the union was driven less by economics than by politics—springing from inchoate but deeply held notions of sovereignty and national identity.
Ultimately, the success of the euro will also depend on politics.
That is why the currency’s creators seem quite satisfied with its rebound. While they recognize it is mostly a reflection of the dollar’s weakness, they relish the chance to erase the memory of its stumbling start.
SOURCE: Mark Landler, “Euro Beginning to Flex Its Economic Muscles,” The New York Times, May 18, 2003, p. 17. © 2003 New York Times Company.
EURO BEGINNING TO FLEX ITS ECONOMIC MUSCLES In The NEWS EQUILIBRIUM IN THE FOREIGN EXCHANGE MARKET Equilibrium is reached where the demand and supply curves for a given currency intersect. In Exhibit 1, the equilibrium price of a euro is $1.20. As in the product market, if the dollar price of euros is higher than the equilibrium price, an excess quantity of euros will be supplied at that price, or a surplus of euros will exist. Competition among euro sellers will push the price of euros down toward equilibrium.
Likewise, if the dollar price of euros is lower than the equilibrium price, an excess quantity of euros will be demanded at that price, or a shortage of euros will occur. Competition among euro buyers will push the price of euros up toward equilibrium.
Equilibrium Changes in the Foreign Exchange Market 609 On January 1, 1999, the euro became the currency in 11 countries: Belgium, Germany, Spain, France, Ireland, Italy, Luxembourg, the Netherlands, Austria, Portugal, and Finland.
If the euro becomes relatively less expensive in terms of dollars (it now costs less to buy a euro), what will happen to the U.S. demand for European goods? If the price of the euro falls relative to the dollar, European products become relatively less expensive to U.S. consumers, who will tend to buy more European goods.
© AP Photo / Bob Edme 1. The price of a unit of one foreign currency in terms of another is called the exchange rate.
2. The exchange rate for a currency is determined by the supply of and demand for that currency in the foreign exchange market.
3. If the dollar appreciates in value relative to foreign currencies, foreign goods become more inexpensive to U.S. consumers, increasing U.S. demand for foreign goods.
1. What is an exchange rate?
2. When a U.S. dollar buys relatively more pounds in England, why does the cost of imports from England fall in the United States?
3. When a U.S. dollar buys relatively fewer yen, why does the cost of U.S. exports fall in Japan?
4. How does an increase in domestic demand for foreign goods and services increase the demand for those foreign currencies?
5. As euros get cheaper relative to U.S. dollars, why does the quantity of euros demanded by Americans increase? Why doesn’t the demand for euros increase as a result?
6. Who competes exchange rates down when they are above their equilibrium value? Who competes exchange rates up when they are below their equilibrium value?
s e c t i o n c h e c k Equilibrium Changes in the Foreign Exchange Market s e c t i o n 27.3 _ What factors cause the demand curve for a currency to shift? _ What factors cause the supply curve for a currency to shift?
DETERMINANTS IN THE FOREIGN EXCHANGE MARKET The equilibrium exchange rate of a currency changes many times daily. Sometimes, these changes can be quite significant. Any force that shifts either the demand for or supply of a currency will shift the equilibrium in the foreign exchange market, leading to a new exchange rate. Among factors are speculation and changes in consumer tastes for goods, income, relative real interest rates, and relative inflation rates.
INCREASED TASTES FOR FOREIGN GOODS Because the demand for foreign currencies is derived from the demand for foreign goods, any change in the demand for foreign goods will shift the demand schedule for foreign currency in the same direction. For example, if a cuckoo clock revolution sweeps through the United States, German producers would have reason to celebrate, knowing that many U.S. buyers will turn to Germany for their cuckoo clocks. However, because Germans will only accept payment in the form of euros, U.S.
consumers and retailers must convert their dollars into euros before they can purchase their clocks.
The increased taste for European goods in the United States would, therefore, lead to an increased demand for euros. As shown in Exhibit 1, this increased demand for euros shifts the demand curve to the right, resulting in a new, higher equilibrium dollar price of euros.
RELATIVE INCOME INCREASES OR REDUCTIONS IN U.S. TARIFFS Any change in the average income of U.S. consumers will also change the equilibrium exchange rate, ceteris paribus. If on the whole incomes increased in the United States, Americans would buy more goods, including imported goods, so more European goods would be bought. This increased demand for European goods would lead to an increased demand for euros, resulting in a higher exchange rate for the euro. A decrease in U.S. tariffs on European goods would tend to have the same effect as an increase in incomes by making European goods more affordable. As Exhibit 1 shows, this would again lead to an increased demand for European goods and a higher short-run equilibrium exchange rate for the euro.
CHANGES IN EUROPEAN TASTES, U.S.
TARIFF INCREASED TARIFFS, OR EUROPEAN INCOME INCREASES If European incomes rose, European tariffs on U.S.
goods fell, or European tastes for American goods increased, the supply of euros in the euro foreign exchange market would increase. Any of these changes would cause Europeans to demand more U.S. goods and therefore more U.S. dollars to purchase those goods. To obtain those added dollars, Europeans would have to exchange more of their euros, increasing the supply of euros on the euro foreign exchange market. As Exhibit 2 demonstrates, the effect of this would be a rightward shift in the euro supply curve, leading to a new equilibrium at a lower exchange rate for the euro.
HOW DO CHANGES IN RELATIVE INTEREST RATES AFFECT EXCHANGE RATES?
If interest rates in the United States were to increase relative to, say, European interest rates, other things equal, the rate of return on U.S. investments would increase relative to that on European investments.
European investors would thus increase their demand for U.S. investments and therefore offer euros for sale to buy dollars to buy U.S. investments, shifting the supply curve for euros to the right, from S1 to S2 in Exhibit 3 on page 612.
In this scenario, U.S. investors would also shift their investments away from Europe by decreasing their demand for euros relative to their demand for dollars, from D1 to D2 in Exhibit 3. A subsequent lower equilibrium price ($1.50) would result for the euro due to an increase in the U.S. interest rate.
That is, the euro would depreciate because euros can now buy fewer units of dollars than before. In 610 CHAPTER TWENTY-SEVEN | International Finance What impact will an increase in travel to Paris by U.S.
consumers have on the dollar price of euros? For a consumer to buy souvenirs at the Eiffel tower, she will need to exchange dollars for euros. This would increase the demand for euros and result in a new higher dollar price of euros.
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