Chapter 17

Chapter 17 - 9/22/2010 :9; i,“ 0 Exchange rate: price of...

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Unformatted text preview: 9/22/2010 :9; i,“ 0 Exchange rate: price of one currency‘ in terms of r a Foreign exchange market: the financial market where exchange rates are determined 0 Spot transaction: immediate (two-day) exchange of bank deposits — Spot exchange rate 0 Forward transaction: the exchange of bank deposits at some specified future date — Forward exchange rate Foreign Exchange II o Appreciation: a currency rises in value relative to another currency 0 Depreciation: a currency falls in value relative to another currency 0 When a country’s currency appreciates, the country’s goods abroad become more expensive and foreign goods in that country become less expensive and vice versa 0 Over—the—counter market mainly banks FIGURE 1 Exchange Rates, 1990“- 2008 no 100 ‘ ;;'--:. . a _ Bfitlshpotmd 07% u u ,. ., emu '- me use 0.50 1990 20430 2010 1990 2000 2019 _. Japanese yen 1990 2000 2010 1590 2000 2010 Source: Federal Reserve: www.federalreserve.gov/releasesfhlofhist. 9/22/2010 9/22/2010 f": '33 603% in _ _ l ; XChange Rates In Run <52“? 9 0 Law of one price V“. o mega qLEy rchasjflg Power Parity ’u _ \ \: mammgwgfw / assumptions: — All goods are identical in both countries — Trade barriers and transportation costs are low - Many goods and services are not traded across borders 7 3 a = Z— . r) ’1 .-’ {i 5 «— :mg a; rad-re; Egg Cal/loo; d 8.52 = 55.311516 'a rat. '=;§ii»‘€ A "a ' \ ‘ < m -‘ __ "-1 ', ‘1" g.- ‘- " f1“ EV, EX. * r”: TG‘; M glib} an Jigjpgsvm w Edges-lint v.1: iv“. vs? an . 4 .v ~— , l ,, a 21*: W; V ' , ’M a «:2: a r“: g: 3 2c: 1. w l I? Him a or (a-- \w 1; Factors that Affect Exchange Rates in the Long Run [ __.._ r'\ l . é‘a r i .t? {A wear Cain/Uggt‘; leg; / “talisman Relative price levels u - : 1‘ fig; '0“ ‘- an” .: , 1N5 is“; l_;d:__: ‘1 i, ._ goods \omslam {V awai'iifi Productivity (rail/\i‘lxéi XV” m. . ,t ¥ . i‘e;§‘=.,2r‘§‘fi’i mg“; 3‘ ' ‘ g“ I I h . q, of E \ ,n, i. chQQQ .9 low logo-co ~—> \O m é»- has“ - k \1/ r If" 3“ M :2"? 5:" "I Eu ‘ , L. 9/22/2010 “17? - Véxa‘iflfién P if“ 2 “gr-r \V‘ fisz «DJ/‘- “ i“ "H" m " f ' I? ‘ I“: ""~"‘""'* i " ' ‘--" W” a '\ LJW‘ 1 «J'ng f? we; we 01? fl ? , E 1e :1 was my ‘3‘- ’ ' ' - e m {'1' ‘?‘ I”? ma; 2-; -- = 9 FIGURE 2 Purchasing Power Parity, United States/United Kingdom, 1973—2008 (Index: March 1973 = 100.) Index 250 Reiafive Price 200 7; Leveis (mum:an 3 r 150 axcizange Sate £2253} 19'?3 1983 1993 2006 Source: ftp.bls.gov/pub/special/requests/cpi/cpiai.txt. Summary Table 1 Factors That Affect. Exchange Rates in the Lang Bun qufl‘w‘d Wan-an...— Exchange Rates in the Short A Supply and Demand Analysis 0 An exchange rate is the price of dOmestic assets in terms of foreign assets 0 Supply curve for domestic assets — Assume amount of domestic assets is fixed (supply curve is vertical) 0 Demand curve for domestic assets — Most important determinant is the relative expected return of domestic assets — At iower current values of the dollar (everything else equal), the quantity demanded of dollar assets is higher 9/22/2010 9/22/2010 Explaining Changes in Exchange Rates 0 Shifts in the demand for domestic assets — Domestic interest rate I? "4??? D jimmafi‘ ii — Foreign interest rate 4‘57 3,; D if; — Expected future exchange rate ii“ :7 5’? E} 5;: FIGURE 4 Response to an Increase in the Domestic Interest Rate, I'D Exchange Rate, EI (euros/$) Quantity of Doiiar Assets 9/22/2010 FIGURE 5 Response to an Increase in the Foreign Interest Rate, 1"” Exchange Rate, Er (euros/3) Quanzity of Dollar Assets FIGURE 6 Response to an Increase in the Expected Future 'ExchangeRate, Eem Exchange Rate, E, (euroSJS) if! Quantity of Doilar Assets 9/22/2010 Summary Table 2 Factors That Shift the Demand Curve for Domestic Assets and Affect the Exchange Rate FIGURE 7 Effect of a Rise in the Domestic Interest Rate as a Result of an Increase in Expected Inflation Exchange Rate, 5: S {eumsm ? Quantity of Doiiar Assets 9/22/2010 Tau-é. L: Li ~i Application: Changes in the Equilibrium Exchange Rate 0 Changes in Interest Rates — When domestic real interest rates raise, the domestic currency appreciates. — When domestic interest rates rise due to an expected increase in inflation, the domestic currency depreciates. - Changes in the Money Supply — A higher domestic money supply causes the domestic currency to depreciate. ‘ . i u i‘ {\r’T‘ ’ \H- I? 13? L Ii 2:) “tax” u 13;: ) arr rt 3:2: as: r .r .r a; mg a? I“? (9 m ‘05; 09%S%t% , it we a? ‘3) "u ) ’\\ Tiia =5 \i: i) *rgr :51; Application: Changes in the Equilibrium Exchange Rate 0 Exchange Rate Overshooting 0 Monetary Neutrality ~— In the iong run, a one-time percentage rise in the money supply is matched by the same one- ‘ A S I time percentage rise in the price ievel w if 'i‘ grab s 3': o The exchange rate falls by more in the short re A :F‘Ci‘iw run than in the long run :2» if}; *3 pr; — Helps to explain why exchange rates exhibit so Q i ,A ,i a ' I [TV i134: W3 in {iti much voiatilaty r N UK ‘ FIGURE 8 Effect of a Rise in the Money Supply Exchange Rate, Et (eurosf5) Quantity of Dalia: Assets Application: The Dollar and Interest Rates 0 While there is a strong correspondence between real interest rates and the exchange rate, the relationship between nominal interest rates and exchange rate movements is not nearly as pronounced 9/22/2010 10 9/22/2010 FIGURE 9 Value of the Dollar and Interest Rates, 1973—2008 inmates! Rate (3%) $522; am 20 (index: Karat: i973:160} 1??) 15 156 10 325 E :" i I i ' g - . 4' g “a: ' f 2 g i = H Efiecfiver'” we Exchange R382 :3! 7-5 1974 1973 1982 1986 1990 i994 1998 2002 2005 Sources: Federal Reserve: www.fedEralresewagow'releases,’h10/summaryilndexn_m.bct; real interest rate from Figure 1 in Chapter 4. Application: The Subprime Crisis and the Dollar 0 During 2007 interest rates fell in the United States and remained unchanged in Europe. - The dollar depreciated 0 Starting in the summer of 2008 interest rated fell in Europe. 0 Increased demand for US, Treasuries “flight to quality" 2w”?i interele on US Oxé‘gélte mmth o The dollar appreciated lo é. / 3;: {ft 33:??? E) { : é f \ E “5": Z" : fag? “Masai/L)" E\ d gi/ D3: 2 F 52 MC»? 11 Cm \‘T Qeaxjaqw \Wfi wtov 0% . :i'é; - 5 S L“; m“: I“. .--;"“'§\ E943“ f; 3%: aggvasmfig thézfrn ,- ,- WW (3) bf". inlfiflfl-zzi my; 132:: by} ‘Eér'NCQ‘EYOVg ‘5. @138 ragga; ,«V, Whig”? w “a; ’ i k - 1‘3»? 1.} SEW-v 3:»: Q1 I (I? 9 2“: 35}, fl -4:;.' (E? 2;} gm 4; if: if: {N} I? ‘r i 5' .3 E? if X") m :5 ER ‘ F- . \, a u €503??? €195 Tag}??? “1%” am my! ».4' 4 M; :niar'} ‘ n g % LMFMJV». “a- Y?" KN JEN“ hf} 1' “1" fl“??? ...
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This note was uploaded on 02/21/2011 for the course ECON 2035 taught by Professor Stahl during the Spring '08 term at LSU.

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Chapter 17 - 9/22/2010 :9; i,“ 0 Exchange rate: price of...

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