Foreign Exchange Rates: Determination and Changes

Slides:



Advertisements
Similar presentations
Copyright ©2004, South-Western College Publishing International Economics By Robert J. Carbaugh 9th Edition Chapter 13: Exchange-Rate Determination.
Advertisements

Ch. 16: Output and the Exchange Rate in the Short Run.
FIN 40500: International Finance Nominal Rigidities and Exchange Rate Volatility.
Chapter 19 The Foreign Exchange Market. © 2004 Pearson Addison-Wesley. All rights reserved 19-2 Foreign Exchange Rates.
International Investment Theory of FOREX J.D. Han King’s University College 13-1.
Unit 7 Foreign Exchange Rate Determination. I. What determines the exchange rates?
14-1 Money, Interest Rates, and Exchange Rates Chapter 14.
Chapter 18 Exchange Rate Theories. Copyright © 2007 Pearson Addison-Wesley. All rights reserved Topics to be Covered The Asset Approach The Monetary.
Determination of FX Rate: Financial Investment Theory J.D. Han King’s College UWO.
Exchange Rate Determination (1) International Investment/Arbitrage J.D. Han King’s University College 13-1.
Economics 282 University of Alberta
AKA the “FOREX”. The Foreign Exchange Market Goods produced within a country must be paid for with that country’s currency International transactions.
Exchange Rates. Foreign Exchange Market Currencies are bought and sold on a foreign exchange market. The demand for a currency is a function of three.
Macroeconomic fluctuations, and the traditional Keynesian theory Nikolina Kosteletou 1 Keynesian theories: open economy National and Kapodistrian University.
Chapter 17 Basic Theories of the Balance of Payments.
International Trade and Finance: Exchange Rate Policy
1 International Economics Exchange Rate Changes and Current Account Reactions.
Copyright © 2006 Pearson Addison-Wesley. All rights reserved Chapter 15 Price Levels and the Exchange Rate in the Long Run.
International Economics
Principles of Macroeconomics: Ch. 18 Second Canadian Edition Chapter 18 A Macroeconomic Theory of the Open Economy © 2002 by Nelson, a division of Thomson.
1 Ch. 14: Money, Interest Rates, and Exchange Rates.
Chapter 7 The Foreign Exchange Market. Copyright © 2001 Addison Wesley Longman TM 7- 2 The Foreign Exchange Market Definitions: 1.Spot exchange rate 2.Forward.
Chapter 13 The Foreign Exchange Market. 2 Chapter Preview We develop a modern view of exchange rate determination that explains recent behavior in the.
OPEN ECONOMY MACRO AND THE EXCHANGE RATE (1) Up to now, we have ignored the exchange rate: i.e. the price of foreign currency in terms of domestic currency.
Fundamental Analysis Classical vs. Keynesian. Similarities Both the classical approach and the Keynesian approach are macro models and, hence, examine.
Session 23 Internal and External Balance with Fixed Exchange Rates.
Exchange Rate Regimes Because governments set quantity of money, they have significant influence on exchange rates, which in turn is important to net.
Copyright © 2006 Pearson Addison-Wesley. All rights reserved Introduction We saw how a single country can use monetary, fiscal, and exchange rate.
Price and Output and Macroeconomic Policies in an Open Economy.
1 Exchange Rate Dynamics(I) Dr. J. D. Han King’s College U.W. O.
1 Exchange Rate Determination(2) Trade Approach Dr. J. D. Han King’s College U.W. O.
1 Exchange Rate Determination(4) Real Factor Approach Dr. J. D. Han King’s College U.W. O.
19-1 Foreign Exchange Rates The Foreign Exchange Market Definitions: 1.Spot exchange rate 2.Forward exchange rate 3.Appreciation 4.Depreciation.
124 Aggregate Supply and Aggregate Demand. 125  What is the purpose of the aggregate supply-aggregate demand model?  What determines aggregate supply.
AP Review #1 – AD and AS. Draw a correctly labeled Aggregate Supply and Aggregate Demand graph that shows that the economy is currently experiencing a.
Output and the Exchange Rate in the Short Run
Exchange Rates, Business Cycles, and Macroeconomic Policy in the Open Economy: Fixed Exchange Rates Prof Mike Kennedy.
THE GLOBAL ECONOMY. FINANCING INTERNATIONAL TRADE Markets exist everywhere there is supply & demand There are markets where dollars can be exchanged for.
Exchange Rate Determination (1): Overview J.D. Han King’s University College 13-1.
Exchange Rate Dynamics(I) Dr. J. D. Han King’s College U.W. O.
1/38 FOREIGN EXCHANGE MARKET TOPIC 13. Chapter Preview We develop a modern view of exchange rate determination that explains the behavior of exchange.
Chapter 14. Money, Interest Rates, and Exchange Rates.
PRINCIPLES OF ECONOMICS Chapter 29 Exchange Rates and International Capital Flows PowerPoint Image Slideshow.
Exchange Rate Determination(2) Trade Approach
Aggregate Demand and Aggregate Supply
International Economics By Robert J. Carbaugh 9th Edition
Chapter 9 The Balance of Payments and Exchange Rates
Basic Theories of the Balance of Payments
Exchange Rate Theories
INTERNATIONAL FINANCE
Exchange Rate Determination(4) Real Factor Approach
Theories of the Current Account
International Economics By Robert J. Carbaugh 9th Edition
A Macroeconomic Theory of the Open Economy
Basic Theories of the Balance of Payments
The Foreign Exchange Market
Starter: Recap… Macro effects of a currency depreciation
M42: The Foreign Exchange Market
Exchange Rate Determination(3) Monetary Approach
International Economics
©2018 Jennifer P. Wissink, all rights reserved.
Equilibrium in the Aggregate Demand- Aggregate Supply Model
Ch. 12: U.S. Inflation, Unemployment and Business Cycles
MACROECONOMIC POLICY IN THE OPEN ECONOMY
The Foreign Exchange Market
ECO 401: International Economics
Foreign Exchange Rates
The Price Adjustment Mechanism with Flexible and Fixed Exchange Rates
AP ECONOMICS: April 18 Warm-up Using the LRAS-AS-AD Model and starting from equilibrium at full employ- ment, show the long-run impact on AD, AS, and.
Exchange Rate Dynamics(II)
Presentation transcript:

Foreign Exchange Rates: Determination and Changes J.D. Han King’s University College

Relationship between FOREX rates and Trade, or/and Capital Flows A third ‘Exogenous Variable’ affect both Trade/Capital Flows and FOREX rates. The two affect each other. We can apply Supply/Demand, and P/Q to FXrates/Trade or/and Capital Flows

Recall that Supply of FOREX comes from Exports(X) and Capital Inflows(CI): S(X, CI) Demand of FX comes from Imports(M) and Capital Outflows(CO): D(M, CO) Price of FX is FX Rates (E* or S*)

(The) FX rate is defined as How much domestic currency per one unit of foreign currency. - Direct or European Quotation eg) for Canada, U.S. $1 costs Cdn $1.01. Cdn 1.01/ U.S. 1 = 1.01 Eg) for China, U.S. $1 costs 7 Yuan 7 Yuan/ U.S. 1 = 7

Suppose that Exports rise rapidly: Is this due to a government’s manipulation of FX rate? Is this due to a change in a Exogenous Variable? eg) Japan of the 1980s China of the 2000s

In the Short-run, A change in FX rates affects Supply and Demand of FX such as X, M, CI, and CO. The economy will get out of equilibrium. However, eventually there will be adjustments back to equilibrium: FX rates and S/D change again.

When a government devaluate its currency? First, FX rates goes up; and exports go up as well: FX rates and X move in the same direction. Then, excess supply of FOREX will push E down and X down as well back to the equilibrium: FX rates and X eventually reverse the initial move. Still FX rates and X are moving in the same direction. D (M, CO) S (X, CI) E* E’ ES

In the Long-run, A change in a Third ‘Exogenous’ variable takes place. It affects Supply and Demand for FOREX via Trade/Capital Flows It affects Price of FOREX or FOREX rates In the process to equilibrium, FOREX rates and Trade/Capital Flows interact.

If a country has technical innovations, which improve the quality of exports. World demand for this country’s exports rise; More exports means the supply of FOREX rises, FX rate (E or S) falls. Note that X up and E down. FX rates and X are moving in the opposite direction over time. S (X, CI) S’ (X’, CI) D (M, CO) E’ E

In the above graph, FX rates go up and X increases. This movement is in line with market fundamentals.

Dynamic Path of changing FX rates Even changes due to Market Fundamentals can be clouded by Overshooting/Undershooting of FX rates. Overshooting/undershooting happens due to different adjustment speeds in the FX (rate) market(agile) and the Trade/Goods market(slow). *Note: the circled part is “Undershooting” below:

* The opposite is “Overshooting”

Some more advanced thoughts…… If we start from the equilibrium, a change in price has a impact on Q but only in the short-run. If there is a change in a underlying variable other than price, supply or demand will change and thus P and Q changes at the same time. Invariably, one exogenous changes of one direction will be followed by the changes of the opposite direction. They are offsetting each other. The degree of offsetting depends on parameters of the economic system. In the normal case, usually, the second is not so large as the first: no full offsetting impact. In extreme cases, there may be no offsetting or there may be a full offsetting.

(Key Question) 1. What causes exchange rates to fluctuate. 2 (Key Question) 1.What causes exchange rates to fluctuate? 2. How do you predict exchange rates (and their changes) in SR and LR respectively? 3. What is the ‘correct or equilibrium exchange rate’? 4.What are the benefits of having flexible exchange rates as opposed to not having ones (using the big country’s currency)?