economics question (1 Viewer)

[lawrence.h]

"briefly explain the relationship between the current account and the capital and financial account under a floating exchange rate system. 3 marks"

(My answer, so far)

The current account deficit must equal the capital and financial account surplus. The two accounts add up to zero. This balance will occur when the supply of Australian dollars equals the demand for Australian dollars.


I don't really know what to say after that. Would that get three marks? Because I don't really understand why the floating exchange rate system matters. Can someone explain to me why this would be different under a pegged exchange rate?

 

[runnable]

You can add:

Net income section is usually composed largely of dividends, profits and interest payments to overseas investors and their investment will be recorded on the Financial account. Thus a large surplus on the Financial account leads to an increase in net income deficit on the current account.

 

[reynoldson]

Yeah, then the foreign liabilities associated with the capital inflow from the surplus on the C+F account, 'all foreign investment has to make a return for its owner' or whatever the quote was, but the net income account represents the liabilities of our foreign debt

 

[BackCountrySnow]

ok, well.
Under a floating exchange system, the exchange rate is determined through demand and supply.

so:

demand = supply

Since exports, income from overseas and foreign capital flowing in must be exchanged to $A:
demand = exports (X) + Income inflow (Y credit) + Capital inflow (K credit)

Since imports, income going overseas and capital flowing out of Australia must be exchanged to foreign currency:
Supply = Imports (X) + Income outflow (Y debit) + Capital outflow (K debit)

so rearranged:

M - X + Y debits - Y credits = k inflow - k outflow

which happens to be:

current account = Capital and financial account.


So under a pegged exchange rate demand will not equal supply. Therefore
M - X + Y debits - Y credits =/= k inflow - k outflow

EDIT:
one connection is that capital inflow in the K&FA will be recorded as foreign liabilities in Net income.

 

[lawrence.h]

why will demand of equal supply under a peter exchange rate system? Even with a pegged rate imports still need to be converted into Australian dollars and exports need to be converted to foreign currency. So I don't really understand why it makes a difference.

lol, yah I have the explanation in my book for what was written above, but thanks anyway. It's just what was written in the book isn't make me understand whyyy the floating exchange rate....
Oh wait...
Maybe I understand now.
Aha! Yes I do, thankyou BackCountrySnow for reiterating that for me.

 

[lawrence.h]

why will demand of equal supply under a peter exchange rate system? Even with a pegged rate imports still need to be converted into Australian dollars and exports need to be converted to foreign currency. So I don't really understand why it makes a difference.

lol, yah I have the explanation in my book for what was written above, but thanks anyway. It's just what was written in the book isn't make me understand whyyy the floating exchange rate....
Oh wait...
Maybe I understand now.
Aha! Yes I do, thankyou BackCountrySnow for reiterating that for me.

lol, sorry for typos. I'm on my iPod touch so I don't turn on the computer and get distracted.
So instead I'm wasting my time on my iPod...lol

 

[BackCountrySnow]

Not bad for a troll aye?