International Economics What Determines Exchange Rate ? 16/11/61 Session 19 What Determines Exchange Rate ? Aj. Noom (anuphak@gmail.com) tel. 0835426434

Movements of Exchange Rate 1. Long-term Trends The movement of exchange rate over the entire period. 2. Medium-term Trends The movement of exchange rate over periods of several years. These are sometimes counter to the longer trends. 3. Short-term Variability The movement of exchange rate over short periods. These are the exchange rates from month to month (and indeed, from day to day , hour to hour, and even minute to minute.)

Exchange Rates in the Short-run This depends on the demands and supplies of assets denominated in different currencies. 1. The basic return on the bond itself (the interest rate) 2. The expected gain and loss on the currency exchanges

The Role of Interest Rates Malaysia What happen to Malaysia currency ? Bond Interest = 5% The value of “Malaysia” currency will depreciate. Thai Exchange Money Bond Interest = 10 % High Demand for the “Thai” currency will occur. The amount of “Thai” currency will be reduced from the system. The value of “Thai” currency will appreciate. ( i.e. from 1 dollar/25 baht to 1 dollar/24)

The Role of the Expected Future Spot Exchange Rate** Current Spot Rate Expected Future Spot Rate Singapore 1 USD / 25 SGD Singapore $ 1 USD / 30 SGD High Demand for the “Singapore” currency will occur. Hong Kong 1 USD / 25 HKD Hong Kong 1 USD/ 20 HKD The amount of “Singapore” currency will be reduced from the system. The value of “Singapore” currency will appreciate. ( i.e. from “1 USD /25 SGD” to “1 USD/24 SGD”)

Exchange Rates in the Long-run Price Level (i.e., + transport cost, tariff, bribe, and etc) Suppose : $1 = £1 (at the outset) U.S. U.K. = $1 Export > $1 Continue on the next slide Export = £1 > £1

U.S. Afterward U.K. $1 + XXX £1 + XXX £1 £1 + XXX Importing Price > £1 (Let’s say “£1 + XXX”) Bank $1 + XXX U.K. £1 + XXX £1 £1 + XXX

Thailand 75 baht/ $1AUS Australia U.S. 50 baht/ $1US Suppose : 25 Bath = Australia $1 = U.S. $1 (at the outset) 75 baht/ $1AUS Australia Thailand = Australia $1 75 Baht U.S. 50 Baht 50 baht/ $1US = U.S. $1

The market system will impact on the exchange rate. Inflation Rate U.S. Thai = $1 Export = 25 Baht = 50 Baht Inflation Thai people buy less = $2 The market system will impact on the exchange rate. Countries with relatively high inflation rates have currencies whose values tend to depreciate in the foreign exchange market. (i.e., from “1 dollar/25 baht” to “1 dollar/15 bath”)

The market system will impact on the exchange rate. U.S. Thai = $1 Export = 25 Baht = 12.5 Baht Deflation Thai people buy more = $ 0.5 The market system will impact on the exchange rate. Countries with relatively low inflation rates have currencies whose values tend to appreciate in the foreign exchange market. (i.e., from “1 dollar/25 baht” to “1 dollar/30 bath”)

15 baht /1 dollars 11 baht/1 dollars 10 baht/1 dollars The values of baht tend to depreciate.