25 The Open - 1 25-1 Exchange Rates Business Cycles and Macroeconomic Policy in the Open Economy Part 1 25-2 Agenda • Exchange Rates • How

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Unformatted text preview: 1 25-1 Exchange Rates, Business Cycles, and Macroeconomic Policy in the Open Economy, Part 1 25-2 Agenda • Exchange Rates • How Exchange Rates Are Determined ¾ A Supply-and-Demand Analysis 25-3 Exchange Rates • Nominal exchange rates: ¾ The nominal exchange rate indicates how much foreign currency can be obtained with one unit of the domestic currency. • For example, if the nominal exchange rate is 110 yen per dollar, one dollar can be exchanged for 110 yen. 25-4 Exchange Rates • Nominal exchange rates: ¾ Transactions between currencies take place in the foreign exchange market . ¾ Denote the nominal exchange rate (or simply, exchange rate) as e nom in units of the foreign currency per unit of domestic currency. 2 25-5 Exchange Rates • Nominal exchange rates: ¾ Under a flexible-exchange-rate system or floating-exchange-rate system, exchange rates are determined by supply and demand and may change every day. • This is the current system for major currencies 25-6 Exchange Rates • Nominal exchange rates: ¾ In the past, many currencies operated under a fixed-exchange-rate system, in which exchange rates were determined by governments. • The exchange rates were fixed because the central banks in those countries offered to buy or sell the currencies at the fixed exchange rate. • Though major currencies are in a flexible-exchange-rate system, some smaller countries fix their exchange rates. 25-7 Exchange Rates • Real exchange rates: ¾ The real exchange rate indicates how much of a foreign good can be obtained for one unit of a domestic good. • Suppose the nominal exchange rate is 110 yen per dollar, a hamburger costs 1100 yen in Japan and $2 in the U.S. – The price of a U.S. hamburger relative to a Japanese hamburger is 0.2 Japanese hamburgers per U.S. hamburger. • The real exchange rate is 0.2 yen per dollar. 25-8 Exchange Rates • Real exchange rates: ¾ The real exchange rate is the price of domestic goods relative to foreign goods, or e = e nom P/P For 3 25-9 Exchange Rates • Real exchange rates: ¾ Although countries produce many goods, and price indexes should be used to get P and P For , to simplify matters, assume that each country produces a unique good. ¾ If a country’s real exchange rate is rising, its goods are becoming more expensive relative to the goods of the other country. 25-10 Exchange Rates • Appreciation and depreciation: ¾ In a flexible-exchange-rate system: • When e nom falls, the domestic currency has become weaker and has undergone a nominal depreciation . • When e nom rises, the domestic currency has become stronger and has undergone a nominal appreciation . 25-11 Exchange Rates • Appreciation and depreciation: ¾ In a flexible-exchange-rate system: • When e falls, the domestic currency has become weaker and has undergone a real depreciation ....
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This note was uploaded on 07/29/2010 for the course UGBA 100b taught by Professor Wood during the Summer '10 term at University of California, Berkeley.

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25 The Open - 1 25-1 Exchange Rates Business Cycles and Macroeconomic Policy in the Open Economy Part 1 25-2 Agenda • Exchange Rates • How

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