3 Determining the Exchange rate

3 Determining the Exchange rate - Crises and bandwagon...

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Determining Exchange rates
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Economic and Non-Economic Factors Short term: Interest rates and “news” that influences expectations about future exchange rates and interest rates. Longer term: Money and productivity and crises and bubbles.
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Determining Exchange Rates At its most basic, it’s supply and demand… transaction …but what are the big drivers of supply and demand?
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What sets the exchange rate? Transaction!! P $ (vs Yen) 100 Supply of $ Demand for $
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What sets the exchange rate? P $ (vs Yen) 100 Supply of $ Demand for $ 103
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Short term Interest rates – currency whose interest rate goes up: Spot rate goes up, forward rate goes down. Expected future spot rate: if the expected future spot rate goes up on $, the $ appreciates spot, depreciates forward.
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Unformatted text preview: Crises and bandwagon effects can swamp market mechanisms PPP and the exchange rate Law of one price --- absolute and relative PPP 1 barrel of oil = $40 in US 1 barrel of oil = Yen 4000 in Japan At what exchange rate does oil cost the same in US and Japan? Money and PPP Mv=PY M= Money supply V= velocity P= price level Y=output P= Mv/Y US M= 100, v=1, Y=50 barrels of oil P = 2 Japan M=1000, v=2, Y=10 P = 200 What determines exchange rates ? Long run PPP, law of one price Relative rates of inflation Relative interest rates Productivity growth Crises and government interventions...
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3 Determining the Exchange rate - Crises and bandwagon...

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