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Econ1102_Week10

# Econ1102_Week10 - Week 10 Lectures 19 20 Open Economy...

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Week 10 Lectures 19 & 20 Open Economy Macroeconomics: Exchange Rates Reference: Bernanke, Olekalns and Frank - Chapter 16 Key Issues Nominal and real exchange rates Purchasing Power Parity (PPP) Supply and Demand Model of the Exchange Rate Fixed Exchange Rates

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2 Nominal Exchange Rate Rate at which two currencies can be traded for each other: bilateral exchange rate Units of foreign currency per \$A (RBA) 21 September 2010 US dollar 0.9456 Japanese yen 80.91 Euro 0.7223 Chinese renminbi 6.3389
3 Cross Rates We can use the exchange rate between the Australian and US dollars Australian dollar and Euro to infer the exchange rate between the Euro and the US dollar. \$US/\$A= 0.9456 Euro/\$A= 0.7223 Euro/\$US = US A A Euro \$ \$ \$ = 0.7223×1.0575 = 0.7638

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4 Quoting the Bilateral Exchange Rate Note that we expressed the exchange rate between US and Australian currencies in 2 ways: \$US/\$A = 0.9456 and as \$A/\$US = 1.0575 Exchange rates can be expressed as: Units of foreign currency per (one) unit of domestic currency; \$US/\$A = 0.9456, or Units of domestic currency per (one) unit of foreign currency; \$A/\$US = 1.0575
5 A Definition Let e denote the nominal exchange rate, and define it as: e = number of units of foreign currency that one unit of the domestic currency will buy If we treat Australia as the domestic (or home) country then: e = Yen/\$A or \$US/\$A A rise in e corresponds to an appreciation of the \$A A fall in e corresponds to a deprecation of the \$A

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6 Appreciation and Depreciation Appreciation: an increase in the value of a currency against other currencies 20 Sept 21 Sept \$US/\$A 0.9444 0.9456 Depreciation: a decline in the value of a currency against other currencies 17 Sept 20 Sept \$US/\$A 0.9448 0.9444
7 Monthly \$US/\$A and Trade Weighted Index (84-10) 0 0.2 0.4 0.6 0.8 1 1.2 31/01/1994 31/01/1995 31/01/1996 31/01/1997 31/01/1998 31/01/1999 31/01/2000 31/01/2001 31/01/2002 31/01/2003 31/01/2004 31/01/2005 31/01/2006 31/01/2007 31/01/2008 31/01/2009 31/01/2010 TWI \$US/\$A

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8 Real Exchange Rate Suppose we are interested in comparing the price of the same (or a very similar) good in two countries. Example Australian-made computer costs \$2,400 Japanese-made computer costs 242,000 yen Which computer is cheaper?
9 Convert to Common Currency Need nominal yen-dollar exchange rate e = Yen/\$A = 110 Convert \$A to Yen Price in yen = A Yen \$ × (price in dollars) Convert Yen to \$A Price in dollars = Yen A \$ ×(price in yen)

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10 Convert to \$A Price in dollars = Yen A \$ × (price in yen) e Yen A 1 \$ = Price in dollars
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Econ1102_Week10 - Week 10 Lectures 19 20 Open Economy...

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