notes 3 - Exchange Rates and the Foreign Exchange Market:...

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Exchange Rates and the Foreign Exchange Market: An Asset Approach Viktoria Hnatkovska week 2 1
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Outline & What determines exchange rates? & Exchange rates in the short-run & Exchange rates in the long-run & Readings: Krugman and Obstfeld, Chapters 13-15. 2
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Exchange rates in the short-run & Exchange rate as an asset price & Interest parities & Forward premium puzzle & Money, interest rates and exchange rates Exchange rates in the long-run & & Purchasing power parity & Real exchange rates and productivity: Balassa-Samuelson 3
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Daily exchange rates: CAD, EUR, GBP per 1 USD 0.4 0.6 0.8 1 1.2 1.4 1.6 1/3/2000 5/3/2000 9/3/2000 1/3/2001 5/3/2001 9/3/2001 1/3/2002 5/3/2002 9/3/2002 1/3/2003 5/3/2003 9/3/2003 1/3/2004 5/3/2004 CAD (Canada Dollar) EUR (European Monetary Union Euro) GBP (United Kingdom Pound) 4
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Monthly ER: ARG, BRA, MEX, CHINA per 1 USD 0 2 4 6 8 10 12 14 1995M1 1995M7 1996M1 1996M7 1997M1 1997M7 1998M1 1998M7 1999M1 1999M7 2000M1 2000M7 2001M1 2001M7 2002M1 2002M7 2003M1 2003M7 2004M1 2004M7 2005M1 2005M7 2006M1 2006M7 2007M1 2007M7 Argentina Brazil China,P.R.: Mainland Mexico 5
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Monthly ER: RUS and THA per 1 USD 0 10 20 30 40 50 60 1995M1 1995M9 1996M5 1997M1 1997M9 1998M5 1999M1 1999M9 2000M5 2001M1 2001M9 2002M5 2003M1 2003M9 2004M5 2005M1 2005M9 2006M5 2007M1 Russia Thailand 6
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Monthly ER: KOR per 1 USD 0 200 400 600 800 1000 1200 1400 1600 1800 1995M1 1995M7 1996M1 1996M7 1997M1 1997M7 1998M1 1998M7 1999M1 1999M7 2000M1 2000M7 2001M1 2001M7 2002M1 2002M7 2003M1 2003M7 2004M1 2004M7 2005M1 2005M7 2006M1 2006M7 2007M1 2007M7 7
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Exchange rates in the short-run: an asset approach & Relate exchange rates to changes in the relative prices of goods & The foreign exchange market & The demand for currency and other assets & A model of foreign exchange markets & role of interest rates on currency deposits & role of expectations about the exchange rates 8
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Definitions Exchange rates are quoted as foreign currency per unit of domestic currency or domestic currency per unit of foreign currency. & How much can be exchanged for one dollar? = Y 102 = $1 & How much can be exchanged for one yen? $0 : 0098 = = Y 1 Exchange rate allows us to denominate and compare the prices of goods and services across countries in a common currency. How much does a Honda car cost? = Y 3 ; 000 ; 000 () = Y 3 ; 000 ; 000 ± $0 : 0098 = = Y 1 = $29 ; 400 9
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Definitions (cont.) De&nition 0.1 Depreciation is a decrease in the value of a currency relative to another cur- rency. & A depreciated currency is less valuable (less expensive) and therefore can be exchanged for (can buy) a smaller amount of foreign currency. $1 =EUR 1 = ) $1 : 20 1 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. & A depreciated currency is less valuable, and therefore it can buy fewer foreign produced goods that are denominated in foreign currency. & How much does a Honda cost? = Y3,000,000 = Y3,000,000 x $0.0098/= Y1 = $29,400 = Y3,000,000 x $0.0100/= Y1 = $30,000 & A depreciated currency means that imports are more expensive and domestically produced goods and exports are less expensive.
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This note was uploaded on 05/06/2010 for the course ECON Econ 365 taught by Professor Hnatkovska during the Spring '09 term at The University of British Columbia.

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notes 3 - Exchange Rates and the Foreign Exchange Market:...

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