Exchange Rate Determination Lecture 4 Exchange Rate Determination

Chapter 15 exchange rate determination 15.1 Introduction 15.2 Purchasing-Power Parity Theory 15.3 Monetary Approach to the Balance of Payments and Exchange Rates 15.4 Asset Market Model and Exchange Rates 15.5 Exchange Rate Dynamics

15.1 Introduction Traditional exchange rate Modern exchange rate -Based on trade flows -Explain exchange rate in the long run Modern exchange rate -Based on international financial flows -Seek to explain the short-run volatility

15.2 Purchasing-Power Parity Theory 15.2a Absolute Purchasing-Power Parity Theory 15.2b Relative Purchasing-Power Parity Theory 15.2c Empirical Tests of Purchasing-Power Parity

15.2a Absolute Purchasing-Power Parity Theory Postulates that the equilibrium exchange rate between two currencies is equal to the ratio of the price levels in the two nations. R=P/P* Law of one price

15.2b Relative Purchasing-Power Parity Theory Postulates that the change in the exchange rate over a period of time should be proportional to the relative change in the price levels in the two nations over the same time period.

15.2c Empirical Tests of Purchasing-Power Parity Why do deviations from PPP die out so slowly?

15.3 Monetary Approach to the Balance of Payments and Exchange Rates 15.3a Monetary Approach Under Fixed Exchange Rates 15.3b Monetary Approach Under Flexible Exchange Rates 15.3c Monetary Approach to Exchange Rate Determination 15.3d Expectations, Interest Differentials, and Exchange Rates

15.3a Monetary Approach Under Fixed Exchange Rates Demand for money Supply of money

15.3b Monetary Approach Under Flexible Exchange Rates Under a managed floating exchange rate system

FIGURE 15-2 Relative Money Supplies and Exchange Rates.

15.3c Monetary Approach to Exchange Rate Determination