Chapter 19
what determines exchange rates?
Objectives of the Chapter
In the short run, fluctuations in exchange rates can be related to demands for and supplies of asts denominated in different currencies—what we call “the ast market approach to exchange rates.” Here, we revisit the international financial investors and incorporate the impact of interest rate differentials and exchange rate expectations into the determination of the current spot exchange rate.
In the long run, purchasing power parity suggests that movements in exchange rates are determined by differences in countries’ inflation rates. The “monetary approach to exchange rates” explains inflation rates as functions of relative demands for and supplies of domestic and foreign monies. Linking the two, we get a model that ties exchange rates to “fundamentals” such as incomes and relative money supplies.
榴莲核
After studying Chapter 19 you should be able to explain
1. the impact of interest rates on the current exchange rate.
2. the impact of expectations about future spot rates on the current exchange rate.
3. what exchange rate overshooting is, and why it can occur.
4. how shortrun exchange rate movements can diverge from what would be predicted by market fundamentals.
5. the purchasing power parity hypothesis, in both its absolute and relative forms.学习型家庭
6. the quantity theory of money in a two-country world.
7. the difference between nominal and real exchange rates.肥臀套动
Important Concepts
Ast market approach Explains exchange rates in terms of demands and supplies
92年属什么的生肖to exchange rates: of all asts denominated in different currencies. The monetary
approach to exchange rates is a variant of this approach in which
only demands and supplies of the money ast are considered.
Bandwagon: 观澜湖高尔夫球场A situation in which investors expect the recent trend in exchange rates to extend into the future.
Law of one price: Asrts that a single commodity will have the same price everywhere once the prices are expresd in the same currency. This is another way of stating the purchasing power parity hypothesis. It ems to be true chiefly for commodities that are standardized and heavily traded internationally.
Monetary approach Seeks to explain exchange rates by focusing on the demands
to exchange rates: for and supplies of national monies.
Nominal bilateral exchange rate: The exchange rate we e quoted in foreign exchange markets.
Nominal effective exchange rate: The weighted-average exchange value of a country’s currency, where the weights reflect the importance of the other countries in the home country’s total international trade.
Overshooting: When the exchange rate is driven past its ultimate equilibrium rate (usually thought to be the PPP level), and then back to that rate later, during the adjustment of the macroeconomy to an exogenous shock. This effect is the conquence of goods prices that are sticky in the short run.
Purchasing power parity: In its absolute form, this hypothesis says that the exchange rate will equal the ratio of the domestic price level to the foreign price level, or e = P/Pf. (In its relative form, the hypothesis states that the difference over time in inflation rates will be offt by changes in the exchange rate over that period)] An approximation of relative purchasing power parity is [efuture – etoday] = [(inflation rate at home) minus (inflation rate in the foreign country]).
Quantity theory Theorizes that, in any country, the money supply is equal to the
of money: demand for money, which is directly proportional to the value of
nominal gross domestic product. This is symbolized as M = kPY.
Here, money’s only role is as a medium of exchange.
Real exchange rate: A way of measuring the price of foreign goods, not just in currency-adjusted terms, but also in price-level-adjusted terms. The real exchange rate on a currency at any moment in time is calculated as: [(foreign cost of home currency) x (P/Pf游戏原画设计) x (100)]. If purchasing power parity holds between the two countries, the real exchange rate will be 100. When the real exchange rate is above 100, the home currency is overvalued and the foreign currency is undervalued; when the real exchange rate is less than 100, the home currency is undervalued and the foreign currency is overvalued.
中国自然博物馆>影楼网络营销Speculative bubble: A lfconfirming upward or downward movement in a price (here, the exchange rate) that is out of line with the changes in the fundamental factors that determine the price of that object.
