Explain How the International Trade Flows Should Initially Adjust in Response to the Changes in Inflation (Holding Exchange Rates Constant).

Topics: Inflation, United Kingdom, Money Pages: 2 (649 words) Published: July 10, 2011
Assignment #1: The International Financial Environment.

Explain how the international trade flows should initially adjust in response to the changes in inflation (holding exchange rates constant). Explain how the international capital flows should adjust in response to the changes in interest rates (holding exchange rates constant).

International trade flows are the exchange of goods and services for money between different countries. It is referred to as sales which cross juridical borders. Inflation is a rise in the general level of prices of goods and services in an economy over a period of time. When the price levels rises, each unit of currency buys fewer goods and services. Exchange rates between two currencies specify how much one currency is worth in terms of the other. When exchange rates are constant but inflation changes (rises in my example), international trade flows should increase. The prices of US exports would increase compared to British prices, causing a decline in British demand for US exports. The US demand for British goods would increase if US prices increase due to consumers using cheaper priced goods.

International capital flows are the financial side of international trade. In other words, when someone imports a good or service, the buyer gives the seller a monetary payment, just as in domestic transactions. Interest rates are the rates of exchanging one currency for another and the returns from borrowing in one currency. I believe if the exchange rates hold constant, then the capital flows coming from the US and going to the UK should decrease due to lower British interest rates and the capital flows from the UK to the US should increase.

Using the information provided, will Mesa expect the pound to appreciate or depreciate in the future? Explain.

According to the case study, since British inflation and interest rates are similar to the rates in the US, Mesa believes that the US balance-of-trade deficit from the trade...
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