Econ+102+lecture+25%2C+4-12-12+-+Foreign+exchange+markets copy

Econ+102+lecture+25%2C+4-12-12+-+Foreign+exchange+markets copy

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Lecture 25: Ch. 18 –  The foreign exchange market Econ 102, Winter 2012 4/12/2012 1 Required reading : Ch. 18: pp. 504 - 520
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Outline 1. The nominal exchange rate 2. Foreign exchange equilibrium a. Return to CA = - FA 3. Purchasing power parity 4. Floating vs fixing exchange rates 5. Monetary policy and foreign exchange markets 4/12/2012 2
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Exchange rates We now have models (trade) and measures (balance of payments) of international trade. So how does it get done? How do we exchange goods with people who use money other than our own? One currency is exchanged for another in the foreign exchange market (ForEx) For every pair of currencies, there is one such “market” The language here can get confusing. Consider the American market for yen: Q = ¥. You buy a certain quantity of yen 4/12/2012 3
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Exchange rates For example, the current exchange rate is P = $/¥ = $ 0.013. To buy one yen, pay $0.013 One dollar now buys about ¥77. Prior to the March earthquake & tsunami, it was around ¥82. After some major fluctuations, settled down to ¥77 è The dollar has depreciated relative to the yen since the earthquake. The same number of dollars buys fewer yen. May also say that the dollar has “weakened” vs. yen 4/12/2012 4
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Exchange rates This implies that (with stable prices within the US), Japanese goods have become more expensive for USers. A weaker dollar implies that there is lower demand in the US for imports A stronger yen implies that Japanese will want to import more goods (foreign currencies are cheaper) The central confusion of exchange rates: you can always flip every number and talk about the same thing! Labels are intensely important here. American yen market: Q = ¥, P = $/¥ Japanese dollar market: Q = $, P = ¥/$ Prices must be inverses of each other! 4/12/2012 5
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Exchange rates Let’s talk about the US (dollar) market for euro (this is the reverse of the textbook!) Demand: people who hold dollars and want to obtain euro (i.e., Americans who want European goods) When the exchange rate E = $/€ rises, the euro becomes more expensive, and therefore it takes more dollars to buy European goods. Americans will want to buy fewer European goods relative to US goods “a weaker dollar implies less imports”  As E ($/€) rises, quantity of euro demanded falls. A 4/12/2012 6
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Exchange rates Supply: people who hold euro and want to obtain dollars Just the reverse of the demand curve. In fact, the supply of euro to Americans (dollar-holders) is the demand curve of the European (euro-holding) market for dollars As the dollar weakens ($/€ rises), it takes fewer euro to buy one dollar. It takes fewer euro to buy any given US good
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This note was uploaded on 02/10/2012 for the course ECON 102 taught by Professor Rossana during the Winter '08 term at University of Michigan.

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