Wk14_17Nov_Ch19_PPP

Wk14_17Nov_Ch19_PPP - Week 14 (Nov. 17, 2011) Chapter 19:...

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Chapter 19: What Determines Exchange Rates? Week 14 (Nov. 17, 2011)
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Reminder Our Goal: Understand the Behavior of Exchanges Two types of forces: Those that explain the short-run behavior Those that explain the long-run trend
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Forces Dominant in Short Run Tuesday: Asset Market Approach e d/f best explained by the D and S of assets denominated in different currencies Approach built around U-IRP U-IRP links together: i d , i f , e d/f , and e d/f Thus, changes in i d , i f , or e d/f impact e d/f ex ex
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Consider Following Changes* Rise in Variable Effect on i d e d/f i f e d/f e d/f e d/f *On your own ex
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Start W/ FLOATING EXCHANGE RATE Test Yourself e d/f S f Equi-Value D f Quantity of f.c.
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Rise in i d e d/f S0 f S1 f e’ d/f e d/f D0 f D1 f Quantity of f.c. Appreciation of d.c.
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Rise in i f e d/f S1 f S0 f e’ d/f e d/f D1 f D0 f Quantity of f.c Depreciation of d.c.
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Rise in e d/f expect collapse of currency E d/f S1 f S0 f e’ d/f e d/f D1’ f D0 f Quantity of f.c. Depreciation of d.c./ Self-fulfilling ex
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expect collapse of currency Summary of Effects
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Forces Dominant in Long Run Main assumption: Economic fundamentals become dominant in the long run; they are ‘anchor’ for long-term trends Two key propositions: international trade places pressure on prices and exchange rates across countries Expressed in three (related) theories Exchange Rates are Largely Monetary Phenomena
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Law of One Price (LOP) If a product is freely and heavily traded, it should have the same price everywhere, once the prices in different places are expressed in a common currency. Suppose prices differ initially:
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This note was uploaded on 01/28/2012 for the course ECN 306 taught by Professor Croucher during the Fall '08 term at ASU.

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Wk14_17Nov_Ch19_PPP - Week 14 (Nov. 17, 2011) Chapter 19:...

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