Lecture 5 2019 post.pptx - Lecture 5 Long Run Monetary Model of Exchange Rate Part 2 Evidence for PPP in the Long Run and Short Run Foreign country is

Lecture 5 2019 post.pptx - Lecture 5 Long Run Monetary...

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Lecture 5 Long Run Monetary Model of Exchange Rate Part 2
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2 FIGURE 3-2 Evidence for PPP in the Long Run and Short Run Foreign country is USA, PPP: - * = E/E
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3 Evidence for PPP in the Long Run and Short Run FIGURE 3-3 APPLICATION
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US - ( * + )
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Actual and PPP yen/dollar nominal exchange rate 1980- 2011(using relative export price indices) Actual exchange rate
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Monetary approach to exchange rate Three ingredients: 1. Money demand function 2. Quantity Theory of Money QTM 3. Purchasing power parity PPP
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Money demand and money market equilibrium Assume: Money supply is M 1 and is controlled by the central bank Demand for money (Simple version) Real money demand: Money mkt equil income Real constant A money real for Demand Y L P M d ($) income Nominal constant A ($) money for Demand PY L M d
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Quantity Theory of Money QTM Given Y at full-employment level, money supply M, and the demand for money, the price level adjusts to clear the money market
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“Simple” monetary model of exchange rate With equilibrium P determined in each country, they are linked the exchange rate via PPP Simple Monetary Model
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“Simple” monetary model of exchange rate Exchange rate is driven by relative money supply (M/M*) and relative real income (Y/Y*) A country whose relative money supply will see its currency depreciate A country whose relative real income will see its currency appreciate
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“Dynamic” version of simple monetary model Relative PPP = ) )
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12 Exchange Rate Forecasts: Simple Monetary Model An in the growth rate of the domestic money supply FIGURE 3-6
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Evidence for the Monetary Approach Inflation Rates and Money Growth Rates, 1975–2005
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Evidence for the Monetary Approach Money Growth Rates and the Exchange Rate, 1975–2005
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Application Money Demand in Hyperinflations 15
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General Money Demand Function Two motives for demand for money: 1) Transaction demand (as medium of exchange) f (nominal GDP, PY + )
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  • Fall '15
  • DR.CLEMENT
  • Inflation, Balassa Samuelson Effect,  Real money demand

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