EU Policies, Balance of Payments, and Exchange Rates

Posted on Jan 7, 2025 in Accounting and Finance

EU Policies

Regional Policy

Aims to reduce the differences between regions within member countries.

Social Policy

Coordinated through the European Social Fund (ESF) and is intended to support the employment of the unemployed.

Implemented through:

• Structural Funds: Cover the costs of infrastructure, social spending, and agricultural subsidies.
• The EAGGF Guarantee: Designed to maintain the income of farmers.
• The Cohesion Fund: Bridges the differences in prosperity between the countries of the EU.

Balance of Payments

The systematic record of economic transactions occurring during a given time among residents of a country and those in the rest of the world.

Recognizes revenues (in which scores the transactions that provide foreign exchange to the country making the balance) and payments (records transactions involving foreign exchange outflow). The balance is given by the difference between income and payments.

• It is structured in three blocks: capital, financial account, and current account. The current account consists of four groups:
  • The trade balance (includes imports and exports of goods).
  • The services account (includes exports and imports of tourism and others).
  • The income account (includes income obtained in other countries and labor income earned in the country other than the employee’s residence).
  • The transfer account (includes operations without compensation).

Foreign Exchange Market and the Exchange Rate

Currency markets are where you buy and sell foreign currency.

The exchange rate is the number of foreign currency units that are due for a national currency unit.

Depreciation and Appreciation of the Exchange Rate

The depreciation of the exchange rate means that you get fewer dollars for one euro. The appreciation of the exchange rate means that they give you more dollars for one euro.

Real Exchange Rate

Shows the rate at which goods can be exchanged from one country for another. A higher real exchange rate makes domestic goods more expensive relative to foreign goods. Real exchange rate (e) = P_n * t_c / P_ex

Demand for Euros

Comes from persons or entities wishing to exchange foreign currency for euros. Motivations to demand euros include exports, tourists wishing to visit Europe, and financial capital inflows (debt, actions, etc.). The variables that affect the demand for euros are:

• The real exchange rate: Depends on the nominal exchange rate (t_c) (if increased, exports are more expensive), domestic prices (P_n) (an increase will reduce demand for exports and euros), and foreign prices (P_ex) (an increase in exports will increase).
• The income of the foreign country: When foreign income increases, exports increase.
• The interest rate differential (i_n – i_ex): The inflow of capital in the short term depends on the remuneration of the assets in which such capital can be placed.

The demand curve depends on the euro exchange rate; if it decreases, there will be more euros. It moves to the right if foreign income increases, domestic prices decrease, foreign prices rise, or there is an increased rate differential.

Euro Supply

Comes from persons or entities wishing to exchange euros for foreign exchange. Motivations for the euro supply include imports, European tourists who wish to visit another European country, and financial outflows. Variables that affect the supply of euros:

• The real exchange rate: Depends on the nominal exchange rate (t_c) (if the nominal exchange rate increases, imports become cheaper), domestic prices (P_n) (an increase makes foreign products cheaper), and foreign prices (P_ex) (an increase makes foreign products more expensive).
• National income (y_n): When national income increases, imports increase.
• The interest rate differential (i_n – i_ex): The higher the differential output, the less attractive foreign capital will be, and the lower the supply of euros.

The supply curve shows the growing relationship between the quantity of euros and the exchange rate. It moves to the right when domestic revenue increases, domestic prices increase, foreign prices fall, or the interest rate differential is reduced.

Devaluation and Revaluation

A devaluation makes domestic products cheaper for foreigners, increasing national exports. A revaluation will reduce exports and increase imports.