week4 - Money Interest Rates and Exchange Rates Viktoria...

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Money, Interest Rates and Exchange Rates Viktoria Hnatkovska week 4 1
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Overview Interest rate parity conditions suggest the factors important in determination of exchange rates: interest rates at home and foreign countries expectations of future exchange rate What determines interest rates and expectations? Step 1: de±ne money demand and money supply. The equilibrium on the money market will determine interest rates Step 2: determine how the developments in the monetary market a/ect prices of coun- try²s products. Step 3: combine the knowledge about equilibrium interest rates and output prices to determine their e/ects on people²s expectations about future exchange rates. Step 4: use interest parity conditions to study exchange rates. 2
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What is Money? Money as a Medium of Exchange - generally accepted means of payment. Without money - transactions would take place through barter trade. Barter trade - the direct trade of goods and services for other goods and services. Money eliminates the search costs associated with barter system. Money as a Unit of Account (i.e. a widely recognized measure of value). In particular, prices of goods, services, and assets are all expressed in terms of money. easy comparison of prices for di/erent commodities. Money as a Store of Value - because money can be used to transfer some purchasing power from the present into the future, it is also an asset, or store of value . Which of these properties of money is the most important? Because money is used as a medium of exchange, it automatically makes money the most liquid of all assets. What does it mean to be liquid? 3
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So, What is Money? Money includes widely accepted means of payment that can be transferred between owners at low cost: currency in circulation bank deposits on which checks can be drawn (checking deposits, debit card accounts, etc.) Money supply When we speak of money supply we refer to the monetary aggregates that the country±s Central Bank calls M1. households. The Central Bank controls the quantity of money that circulates in an economy, the money supply. In the U.S., the central banking system is the Federal Reserve System. The Federal Reserve
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week4 - Money Interest Rates and Exchange Rates Viktoria...

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