Key Terms 229 SUMMARY actions; balance-of-payments accounts; and a psychological aspect. What actually determines exchange rates is wide and potentially complex, such that economists have not yet developed an accepted theory to explain them. Economists have been able to determine several parity relationships— that is, relationships of equivalence—among some of the various factors in exchange rate movements. These include interest rate parity and purchasing power parity. LO 8-4 Discuss financial forces governments can exert. Governments can restrict the exchange of their currency for other currencies, set tax rates, and, through monetary policy influence interest and inflation rates. Currency controls limit the amount of foreign currency purchases or exchanges made inside the country and may limit the firm’s ability to pay for imports and repatriate profits. Governments set currency exchange controls to reduce depletion of their foreign currency reserves. Differences in taxation and inflation rates can influence the firm greatly, so they must be monitored and predicted constantly. Taxes increase the firm’s costs, whether they are value-added taxes or income taxes. Inflation is a sustained price increase. It is measured by the consumer price index and accompanied by higher interest rates. LO 8-5 Explain the significance of the balance of payments to international business decisions. By monitoring balance of payments data, the firm can build a sense of a possible future. If a country is exporting more than it imports, there will be a high demand for its currency in other countries in order to pay for the exported goods. This demand might be expected, via supply and demand, to cause the currency to strengthen. Conversely, when a country imports more than it exports, the currency might be expected to weaken, either in the market or through government action. Faced with a trade deficit, a government might lean toward restrictive monetary or fiscal policies and introduce currency or trade controls. The BOP trend over time also helps managers predict what sort of changes in the economic environment might develop in the country and possibly affect their choice of strategic risks to take there. LO 8-1 Describe the international monetary system’s history. The gold standard operated to support trade until 1914. Currencies were pegged to gold and adjustments were made by the exchange of gold. Next followed a period of fixed rates under the Bretton Woods system, with the U.S. dollar exchangeable for gold. This pushed the United States into a persistent deficit and reduced gold in the U.S. reserves. The United States stopped the exchange of dollars for gold, and the dollar was allowed to float freely against other currencies on the open market. This began the period of floating exchange rates, which is where we are now. The IMF’s Smithsonian Agreement worked out the rules and exchange regimes for the floating system, ranging from free floats to dirty floats to pegged currencies. Meanwhile, the World Bank established the SDR (special drawing rights) as a reserve currency. LO 8-2 Describe today’s floating currency exchange rate system, including the IMF currency arrangements. Floating currency exchange rates are rates that are allowed to float against other currencies and are determined by market forces. The IMF now uses eight categories to describe the ways countries position their currencies in relationship to other currencies, characterized by their degree of flexibility. They are no separate legal tender, currency board arrangements, fixed peg, peg within a horizontal band, crawling peg, crawling band, managed float, and independent float. LO 8-3 Describe the factors that influence exchange rate movement. Since 1973, the relative values of floating currencies have been set by market forces, influenced by many factors. These factors include supply and demand forecasts for the two currencies; relative inflation in the two countries; relative productivity and unit labor cost changes; political developments, such as expected election results; expected government fiscal, monetary, and currency exchange market KEY TERMS arbitrage (p. 219) ask price (p. 218) balance of payments (BOP) (p. 226) Bank for International Settlements (BIS) (p. 215) bid price (p. 218) Bretton Woods system (p. 211) efficient market approach (p. 220) fiscal policies (p. 219)
Geringer_InternationalBusiness
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