1 Chapter 3 Exchange Rates and the Foreign Exchange Market: An Asset Approach 3-2 Preview • The basics of exchange rates • Exchange rates and the prices of goods • The foreign exchange markets • The demand of currency and other assets • A model of foreign exchange markets – role of interest rates on currency deposits – role of expectations of exchange rates
2 3-3 Key question • how are (floating) exchange rates determined ? • from simple model to ... • short run (prices are given, ...) • partial model; i.e. only foreign exchange market 3-4 3.1. Exchange rates (p. 65) • definition? price of one currency in terms of another • importance? (allow us to compare the prices of g&s of ≠ countries) strong influence on the CA and other variables • quotations (Table 3-1) * direct or American domestic currency per unit of foreign currency price of the foreign currency in terms of dollars USD 0.009421 per yen * indirect or European foreign currency per unit of domestic currency price of dollars in terms of foreign currency JPY 106.15 per dollar
3 3-5 Exchange rates (2) • ∆ in exchange rate depreciation/appreciation ; relative prices ! • consequences of depreciation/appreciation (of home currency) exports imports depr. appr. (See Box entitled ‘Exchange rates, auto prices, and currency wars’ on p. 69) cheaper more expensive more expensive cheaper 3-6 Depreciation and Appreciation • Depreciation is a decrease in the value of a currency relative to another currency. – A depreciated currency is less valuable (less expensive) and therefore can be exchanged for (can buy) a smaller amount of foreign currency. – $1/ € → $1.20/ € means that the dollar has depreciated relative to the euro. It now takes $1.20 to buy one euro, so that the dollar is less valuable. – The euro has appreciated relative to the dollar: it is now more valuable.
4 3-7 Depreciation and Appreciation (cont.) • Appreciation is an increase in the value of a currency relative to another currency. – An appreciated currency is more valuable (more expensive) and therefore can be exchanged for (can buy) a larger amount of foreign currency. – $1/ € → $0.90/ € means that the dollar has appreciated relative to the euro. It now takes only $0.90 to buy one euro, so that the dollar is more valuable. – The euro has depreciated relative to the dollar: it is now less valuable. 3-8 Depreciation and Appreciation (cont.) • A depreciated currency is less valuable, and therefore it can buy fewer foreign produced goods that are denominated in foreign currency. – A Nissan costs ¥2,500,000 x $0.01027/¥ = $25,672.50 – Less expensive than $27,962.50 at $0.011185/¥ • A depreciated currency means that imports are more expensive and domestically produced goods and exports are less expensive. • A depreciated currency lowers the price of exports relative to the price of imports.
5 3-9 Depreciation and Appreciation (cont.) • An appreciated currency is more valuable, and therefore it can buy more foreign produced goods that are denominated in foreign currency.
You've reached the end of your free preview.
Want to read all 51 pages?
- Fall '18
- Leo van hove
- Exchange Rate, Foreign exchange market, United States dollar