Lecture_20___Fall_2007 - Lecture 20 1 of Professor David...

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Unformatted text preview: Lecture 20 1 of Professor David Lee AEM 230 / ECON 230 Alternative Views on Foreign Exchange Rate Determination Elasticity approach Concern about inherent instability of foreign exchange rate Chronic trade deficits thought to lead to an inherent tendency toward currency depreciation. Problem solved by Marshall-Lerner condition for market stability: to improve a countrys trade balance, sum of elasticities of foreign demand for domestic currency (e.g., exports) and domestic demand for foreign currency (e.g., imports) must be > 1.0: X + M > 1 A real devaluation will yield a stable outcome if Marshall- Lerner condition is met. Lecture 20 2 of Professor David Lee AEM 230 / ECON 230 Lecture 20 3 of Professor David Lee AEM 230 / ECON 230 Alternative Views on Foreign Exchange Rate Determination Balance of payments or absorption approach Given: GNP = Y = C + I + G + (X M) Net exports (BOP) = Y C I G = Domestic money income total domestic expenditures (absorption) Approach recognizes that a countrys macroeconomic policies can have unequal effects on income and expenditures. A currency devaluation will improve a countrys trade balance only if national output increases relative to absorption. Refocused interest on trade balance and on government policies which affect BOP. Also focuses on equilibrium exchange rate the exchange rate that reconciles national balances (unemployment and inflation) and external (current account) balance. Lecture 20 4 of...
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This note was uploaded on 02/19/2008 for the course AEM 2300 taught by Professor Lee,d.r. during the Fall '06 term at Cornell University (Engineering School).

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Lecture_20___Fall_2007 - Lecture 20 1 of Professor David...

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