S products causes the value price of US goods relative to the value price of

S products causes the value price of us goods

This preview shows page 45 - 51 out of 61 pages.

An increase in relative demand of U.S. products causes the value (price) of U.S. goods relative to the value (price) of foreign goods to rise. ¡ A real appreciation of the value of U.S. goods: P US rises relative to $ / € EU E P ´ ¡ The real appreciation of the value of U.S. goods makes U.S. exports more expensive and imports into the U.S. less expensive (thereby reducing the relative quantity demanded of U.S. products). ¡ A decrease in relative demand of U.S. products causes a real depreciation of the value of U.S. goods. 45
Image of page 45
The Real Exchange Rate Approach to Exchange Rates (cont.) A change in relative supply of U.S. products ¡ An increase in relative supply of U.S. products (caused by an increase in U.S. productivity for example) causes the price/cost of U.S. goods relative to the price/cost of foreign goods to fall. ¡ A real depreciation of the value of U.S. goods: P US falls relative to $ / € EU E P ´ ¡ The real depreciation of the value of U.S. goods makes U.S. exports less expensive and imports into the U.S. more expensive (thereby increasing relative quantity demanded to match increased relative quantity supplied). ¡ A decrease in relative supply of U.S. products causes a real appreciation of the value of U.S. goods. 46
Image of page 46
Determination of the Long-Run Real Exchange Rate 47Suppose the supply of long run output in the US economy is equal to Y1USand the supply of long run output in the EU is equal to Y1EU.
Image of page 47
Determination of the Long-Run Real Exchange Rate 48 The equilibrium long- run RER is at point 1 Suppose gasoline prices fall making US cars more attractive Shift in RD to the right Causing the RER to fall
Image of page 48
The Real Exchange Rate Approach to Exchange Rates (cont.) The real exchange rate is a more general approach to explain exchange rates. Both monetary factors and real factors influence nominal exchange rates: 1a. Increases in monetary levels lead to temporary inflation and changes in expectations about inflation. 1b. Increases in monetary growth rates lead to persistent inflation and changes in expectations about inflation. 2a. Increases in relative demand of domestic products lead to a real appreciation. 2b. Increases in relative supply of domestic products lead to a real depreciation. 49
Image of page 49
The Real Exchange Rate Approach to Exchange Rates (cont.) What are the effects on the nominal exchange rate? US $ / € US EU EU P E q P = ´ When only monetary factors change and PPP holds, we have the same predictions as before. ¡ No changes in the real exchange rate occurs. When factors influencing real output change, the real exchange rate changes. ¡ With an increase in relative demand of domestic products, the real exchange rate adjusts leading to corresponding change in nominal exchange rates.
Image of page 50
Image of page 51

You've reached the end of your free preview.

Want to read all 61 pages?

  • Left Quote Icon

    Student Picture

  • Left Quote Icon

    Student Picture

  • Left Quote Icon

    Student Picture