Week 6 - CH-5-1 (2).pdf - Chapter 5 International Monetary...

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International Monetary Systems Chapter 5
International Monetary Systems Up to now, only examined closed economies Trade and financial links between countries are increasingly important Today’s lecture: exchange rate determination in a two-country model
Model Two countries a and b OLG model endowment in each country consist of same good People are indifferent to origin of goods
Model superscripts a and b identify parameters and variables of each country changes in money stock used to purchase goods for government free international trade in goods
Model Monies of two countries traded at exchange rate e t Exchange rate e t : units of country b money that can be purchased with one unit of country a money If country a is USA and b is Switzerland: e t Swiss Franc US Dollar
Options available to an owner of 1 unit of country a money Option A Option B Keep country a money Buy goods Trade for e t units of country b money Buy goods t a e t t b
Options available to an owner of 1 unit of country b money Option A Option B Trade for 1/ e t units of country a money Buy goods Keep country b money Buy goods t b t a e t
Monetary Equilibrium Three possible cases. Two of them lead to a disequilibrium: t a e t t b t a e t t b t a e t t b
Monetary Equilibrium Three possible cases. Two of them lead to a disequilibrium: If , everyone prefers country a money, but owners of country a money will not want to trade for country b money t a e t t b t a e t t b t a e t t b
Monetary Equilibrium Three possible cases. Two of them lead to a disequilibrium: If , everyone prefers country a money, but owners of country a money will not want to trade for country b money If , everyone prefers country b money, but owners of country b money will not want to trade for country a money t a e t t b t a e t t b t a e t t b
Monetary Equilibrium Three possible cases. Two of them lead to a disequilibrium: If , everyone prefers country a money, but owners of country a money will not want to trade for country b money If , everyone prefers country b money, but owners of country b money will not want to trade for country a money If , money owners are indifferent which money to use t a e t t b t a e t t b t a e t t b
Monetary Equilibrium Both monies have positive value in last case only In equilibrium it must be that a a b t t t t t b t e e 
Foreign Currency Controls
Foreign Currency Controls Citizens of each country permitted to hold over time only money of own country Monetary sectors of two countries completely separated Trade not prohibited

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