Topic14_B_FX_AAP_B&W6

Topic14_B_FX_AAP_B&W6 - The Euro US$/Euro(EXUSEU...

Info iconThis preview shows page 1. Sign up to view the full content.

View Full Document Right Arrow Icon
This is the end of the preview. Sign up to access the rest of the document.

Unformatted text preview: The Euro; US$/Euro (EXUSEU) 1.6 1.5 1.4 1.3 Open Economy Macroeconomics II 1.2 1.1 1.0 0.9 Market Exchange rates (FX), enom Real Exchange rates (RFX), e PPP, Flexible exchange rates, Fixed exchange rates, The Euro 9 7 -0 8 -0 Ja n Ja n 6 -0 -0 Ja n Ja n Ja n 4 5 -0 -0 -0 Ja n Ja n 2 3 1 -0 Ja n Ja n Ja n Ja n -9 -0 -0 0 9 0.8 The Japanese Yen; Yen/US$ (EXJPUS) 375 325 275 225 175 125 9 7 n-0 Ja Ja Ja Ja n-0 5 n-0 n-0 3 1 Ja 5 7 9 n-0 n-9 n-9 n-9 Ja Ja Ja 3 1 9 n-8 n-9 n-9 Ja Ja Ja 7 n-8 5 Ja Ja n-8 3 n-8 Ja 7 1 9 n-8 n-7 n-7 Ja Ja Ja 1 n-7 n-7 n-7 Ja Ja Ja 5 3 75 Topic 14-B (Text: 13.1, 13.2, 13.5; Article: 7) 1 8 Exchange Rates The British Pound; US$/Pound (EXUSUK) 2.8 2.6 • Nominal exchange rate (enom): Number of foreign currency units that can be purchased with one unit of domestic currency 2.2 2.0 1.8 1.6 1.4 1.2 Ja n Ja n -0 -0 9 7 5 1 3 -0 -0 Ja n Ja n 7 9 -0 -9 Ja n Ja n -9 Ja n 1 5 3 -9 -9 -9 Ja n Ja n Ja n 9 5 7 -8 -8 -8 Ja n Ja n Ja n Ja n -8 -8 3 1 9 Ja n 5 7 -7 -7 -7 3 -7 Ja n Ja n Ja n Ja n -7 1 1.0 Ja n Usually nominal exchange rates are expressed in terms of US $ 2.4 There are exceptions The Mexican Peso; Peso/US$ (EXMXUS) Example: on 11/15/2000, one $US bought 14.0 108.7 Japanese Yen (¥) ¥/$ (¥ 1.17 Euros (€) €/$ (€ 12.0 10.0 More recently: 8.0 99.5 ¥/$, 0.7576 €/$ or 1.32 $/€ (preferred quote) $/€ 6.0 4.0 Exchange Rates (cnt.) cnt.) 8 6 9 N ov -0 7 ov -0 ov -0 N N 5 4 ov -0 ov -0 N N 2 3 1 ov -0 ov -0 N N N ov -0 0 9 ov -0 ov -9 N N 7 8 ov -9 N N ov -9 6 5 ov -9 ov -9 N N 4 ov -9 N ov -9 3 2.0 N 2 PRC Yuan (Remnimbi); Yuan/US$ (EXCHUS) 9.0 8.0 • enom $ appreciates (foreign currency/$) 7.0 6.0 Takes more FC to buy $1 $1 buys more FC 5.0 4.0 3.0 • enom $ depreciates (fc/$) (fc/$) 2.0 1.0 Ja n-8 1 Ja n-8 Ja 2 n-8 Ja 3 n-8 Ja 4 n-8 5 Ja n-8 Ja 6 n-8 Ja 7 n-8 Ja 8 n-8 9 Ja n-9 Ja 0 n-9 Ja 1 n-9 Ja 2 n-9 Ja 3 n-9 4 Ja n-9 Ja 5 n-9 Ja 6 n-9 Ja 7 n-9 8 Ja n-9 Ja 9 n-0 Ja 0 n-0 Ja 1 n-0 2 Ja n-0 Ja 3 n-0 Ja 4 n-0 Ja 5 n-0 6 Ja n-0 Ja 7 n-0 Ja 8 n-0 9 Takes less FC to buy $1 $1 buys less FC The Hong Kong $; HK$/US$ (EXHKUS) 8.5 8.0 • Use “currency appreciates” and appreciates” “currency depreciates” depreciates” 7.5 7.0 6.5 not “increase” and “decrease” increase” decrease” 6.0 5.5 Ja n-8 1 Ja n-8 Ja 2 n-8 Ja 3 n-8 Ja 4 n-8 5 Ja n-8 Ja 6 n-8 Ja 7 n-8 Ja 8 n-8 9 Ja n-9 Ja 0 n-9 Ja 1 n-9 Ja 2 n-9 Ja 3 n-9 4 Ja n-9 Ja 5 n-9 Ja 6 n-9 Ja 7 n-9 8 Ja n-9 Ja 9 n-0 Ja 0 n-0 Ja 1 n-0 2 Ja n-0 Ja 3 n-0 Ja 4 n-0 Ja 5 n-0 6 Ja n-0 Ja 7 n-0 Ja 8 n-0 9 5.0 3 10 1 1 The Korean Won; Won/US$ (EXKOUS) Real Exchange Rates 1,800 1,600 • Why care about the real exchange rate? 1,400 An in the RFX improves the purchasing RFX power of a country’s citizens, because they can country’ buy more foreign goods in exchange for a given amount of domestic production However, the higher the RFX the lower the net RFX exports (NX), since U.S. produced goods would be more expensive abroad enom appreciation or depreciation will not have the same impact if it just offsets inflation differences 1,200 1,000 800 A pr -8 A1 pr -8 A2 pr -8 A3 pr -8 A4 pr -8 A5 pr -8 A6 pr -8 A7 pr -8 A8 pr -8 A9 pr -9 A0 pr -9 A1 pr -9 A2 pr -9 A3 pr -9 A4 pr -9 A5 pr -9 A6 pr -9 A7 pr -9 A8 pr -9 A9 pr -0 A0 pr -0 A1 pr -0 A2 pr -0 A3 pr -0 A4 pr -0 A5 pr -0 A6 pr -0 A7 pr -0 A8 pr -0 9 600 The Brazilian Real; Real/US$ (EXBZUS) 4.0 3.5 3.0 2.5 2.0 1.5 1.0 9 6 7 5 4 8 Ja n-0 Ja n-0 Ja n-0 Ja n-0 Ja n-0 Ja n-0 2 1 0 8 9 7 3 Ja n-0 Ja n-0 Ja n-0 Ja n-0 Ja n-9 Ja n-9 Ja n-9 6 Ja n-9 Ja n-9 5 0.5 11 15 Real Exchange Rates Real Exchange Rates • Nominal exchange rate (enom): In all the formulas we will use, e will be defined as foreign currency/$ foreign ¥/$, /$, £/$, M.Peso/$ etc. This is important, because the formulas change according to how the currency is quoted RFX (cnt.) cnt.) enom P For. Goods US PFor U .S . Goods • The real exchange rate is the number of real foreign goods someone gets in exchange for one domestic good It is sometimes referred to as the terms of trade terms This type of quote is called “European terms” terms” • An increase in RFX means the $ appreciates RFX in real terms real you can get more foreign goods/U.S. good more 12 Example #1 Real Exchange Rates • Real exchange rate (RFX): Nominal exchange rate doesn’t tell you about the purchasing power of doesn’ currency • Define the price of domestic goods relative to foreign goods as the real exchange rate RFX 16 fc / $$ / U .S . Goods For. Goods enom P US PFor U .S . Goods fc / For. Goods RFX enom P For. Goods US PFor U .S . Goods • What is RFX? RFX A hamburger costs $2 in the U.S. A hamburger costs 1,100 ¥ in Japan enom = 110 (yen/$) • Another way to think about it: RFX compares U.S. prices converted to foreign U.S. currency to foreign prices foreign • RFX appreciation of the $ (or the home currency) U.S. goods become more expensive abroad 14 17 2 2 Relative PPP Example #2 • Relative Purchasing Power Parity: • What is e? A Mercedes costs $56,000 in the U.S. The same Mercedes costs 30,000 € in Germany FX rate = 1.30 ($/€) ($/€ RFX enom P For. Goods US PFor U .S . Goods But price indices are not prices! When PPP is are written in terms of price indices, the implied e is arbitrary (its value has no economic meaning) RFX enom P P US enom Λ For PFor P US Now, relative PPP says: relative Whatever RFX is, it will remain the same! RFX Relative PPP also accounts for various “constant” constant” distortions Tariffs, taxes, transport costs, etc. 20 28 Relative PPP Example #3 • What would enom have to be for the prices to be the same? A Mercedes costs $56,000 in the U.S. The same Mercedes costs 30,000 € in Germany enom Λ (cnt.) cnt.) PFor P US • Empirical evidence suggests that relative PPP holds in the long run but not in the short run, probably because of trade restrictions transportation costs differing market conditions (markups) information costs, etc. non-tradables non- 22 Purchasing Power Parity Relative PPP • Purchasing Power Parity: Foreign and domestic (basket of) goods, should have the same price in terms of the same currency. Thus, real exchange rate should be 1 RFX 31 (cnt.) cnt.) • Most recent evidence from individual goods & services prices shows that there are large large & persistent price differences persistent Across cities in the same country Across countries These differences seems stable (see BigMac) BigMac) Relative prices return to these long-term differences longShort term variations seems to depend on FX FX movements enom P P US 1 enom For PFor P US Consistent with the proposition that relative relative PPP works well in the long run 25 32 3 3 Example #8 Big Mac Index Big Mac Index: April 1996 • China: April 2000 Big Mac=9.90yuan BigMac Deviations for Selected Countries Australia Britain Canada 125 e (yuan/$) = 8.35 yuan/$) Big Mac in China = 9.60 yuan Big Mac in US = $2.36 What is the implied PPP enom? Denmark Germany Hong Kong Japan Netherlands 75 Singapore South Korea Russia e(yuan.$) = 8.28 Yuan still undervalued 25 89 990 991 992 993 994 995 996 997 998 999 000 001 002 003 004 005 006 007 008 009 010 2 2 2 2 2 2 2 2 2 2 2 1 1 1 1 1 1 1 1 1 1 19 -25 -75 33 Example #8 Example #6 Big Mac Index: April 1996 • China: • If domestic inflation = 2% foreign inflation = 8% enom depreciation = 10% e (yuan/$) = 8.35 yuan/$) Big Mac in China = 9.60 yuan Big Mac in US = $2.36 What is the implied PPP enom? PPP enom = 9.60 yuan/$2.36 = 4.07 (yuan/$) (yuan/$) what has happened to RFX? what RFX • enom% = RFX% + (for – $) % RFX 53 enom P For. Goods US Pfor U .S . Goods 43 Real Exchange Rates Example #8 (cnt.) cnt.) • Italy (lira/cents) Germany(DM/$) Nominal Real Nominal Real 1/72 589 16.16 3.21 2.05 1/80 812 13.26 1.74 1.43 • Are the Italian goods becoming cheaper? • How about German goods? RFX 54 enom P For. Goods US Pfor U .S . Goods 52 Big Mac Index: April 1996 • China: e (yuan/$) = 8.35 yuan/$) Big Mac in China = 9.60 yuan Big Mac in US = $2.36 What is the implied PPP enom? PPP enom = 9.60 yuan/$2.36 = 4.07 (yuan/$) (yuan/$) Actual rate 8.35 (yuan/$) (yuan/$) Yuan is undervalued, $ overvalued (necessarily) % over or under valuation = (ppp rate – actual rate)/actual rate (ppp = (4.07 – 8.35)/8.35 = -51% 55 Yuan undervalued by 51% 4 4 Flexible Exchange Rates Fixed Exchange Rates • In flexible-exchange-rate systems, exchange flexible- exchangerates vary according to demand and supply An upward sloping supply curve and downward sloping demand curve for $ in the forex market determines enom • Demand for $ arises from foreigners’ foreigners’ demand for US goods and assets • Supply of $ arises from Americans’ demand Americans’ for foreign goods and assets 58 Flexible Exchange Rates Investors fear a devaluation Central bank reneges on its promise to “support” the currency support” They sell assets denominated in the overvalued currency This further supply of that currency, creating a BOP BOP crisis • Overvalued currency cannot be sustained devalue or make policy changes (hard to do in a timely way) Fixed Exchange Rates (cnt.) cnt.) • An in U.S. income causes in imports, which supply of U.S. $ in foreign exchange market $ depreciates $ appreciates $ appreciates • Expected future depreciation of the $ demand for $s $ depreciates now now 61 (cnt.) cnt.) • If RFX is overvalued, RFX is too high RFX overvalued RFX • If enom is fixed, then P must be reduced • An in quality of U.S. goods foreign demand for $s • An in the attractiveness of investment in the U.S. the demand for $s (cnt.) cnt.) • When a central bank buys back its own currency to support a fixed exchange rate, its foreign reserves -- balance of payments (BOP) deficit • Speculative run: RFX ~ enom PHome PFor Phome is the only variable the central bank controls (indirectly) Implies of money supply and deflation Under fixed exchange rates, a central bank cannot have an independent monetary policy Countries DO NOT engineer deflation to bring their currencies in line! 59 62 Flexible vs Fixed Exchange Rates Fixed Exchange Rate • The value of the nominal exchange rate is officially set by the government (central bank) in fixed exchange rate regimes • If officially fixed exchange rate > market exchange rate (fundamental value), the currency is overvalued • Ways to deal with overvaluation: Change official value to fundamental value Limit or tax imports or capital outflows to supply of your currency in FX markets and fundamental value FX Buy back your currency by using foreign assets “Foreign reserves” reserves” 60 • Benefits of fixed rate system: Stability of FX rates makes trading of goods and assets FX easier and less costly Does nominal stability imply real stability? nominal real Improves monetary “discipline”: discipline” cannot expand money at will country inflation depends on “world” inflation world” • Drawbacks: Unstable system (always) Loss of independent control of monetary policy Need of coordinated response by countries coordinated Generally results in trade and cap movement restrictions 63 5 5 VERY & VERY VERY Fixed Exchange Rates VERY • Currency board The Euro –€ • The Baffling Sip + Greece (12): really really fixed; no central bank Belgium Spain Italy Austria Finland Portugal France Luxemburg Ireland Netherlands Germany Hong Kong • Dollarization Adopt the $ as the national currency Equador, Panama Equador, • Currency union same currency for different countries makes coordination easier and speculative attacks But, individual countries lose control of policy Sovereign risk issues + Greece See the Euro discussion 64 E.U. Membership 68 The ‘EURO’ area EURO’ • Current Members (15): France, Germany, Italy, Belgium, Luxemburg, Netherlands (Benelux), Austria, Denmark, Finland, Greece, Ireland, Denmark, Portugal, Spain, Sweden, U.K. Sweden, • New Members: Cyprus, Czech Republic, Estonia, Hungary, Latvia, Lithuania, Malta, Poland, Slovakia, Slovenia, • Current Applicant Countries: Bulgaria, Romania, Turkey 66 EU Membership 69 Benefits of the Euro • Who is in the EU? Original 6: Belgium, France, Germany, Italy, Luxemburg, Netherlands Later (9): Austria, Denmark, Finland, Greece, Ireland, Denmark Portugal, Spain, Sweden, U.K. Sweden U.K. Recent (10): Czech Republic, Poland, Cyprus, Estonia, Latvia, Lithuania, Hungary, Malta, Slovenia, Slovak Republic, Latest (2): Bulgaria, Romania In Line: Croatia, Turkey • The latest wave mostly was looking for political security 67 • Benefits: Reduction in transaction costs Reduction in information costs Greater competition leading to greater efficiency Greater integration among the European financial markets and greater investment efficiency Inflation discipline likely through the independence of the European Central Bank Fiscal discipline as a requirement to enter and stay in the system Increase the pressure of structural reforms in Europe 70 6 6 Costs of the Euro • Costs: The system of fixed exchange rates eliminates the use of exchange rate adjustments as a policy tool in the presence of asymmetric shocks Individual countries cannot use monetary policy to deal with country-specific shocks country Europe may not be an optimal currency area because: Likelihood of asymmetric or country-specific shocks country Limited labor mobility Structural labor market rigidities Limited ability to use fiscal policy as a stabilization tool in the absence of monetary independence Absence of a system of fiscal redistribution to insure against regional/national shocks Sovereign risk –national bankruptcy possible 71 Glossary enom e P PFor for S I NX Nominal exchange rate Real exchange rate (RFX) -- when fixed Domestic price level Foreign price level Domestic inflation rate Foreign inflation rate Saving Investment Net exports (= S - I) 72 THE END 73 7 7 ...
View Full Document

{[ snackBarMessage ]}

Ask a homework question - tutors are online