1. Ch. 29: Open Economy: Foreign Exchange

2. The Prices for International Transactions: Real and Nominal Exchange Rates
Rate you can trade one currency for another
80 yen per dollar or 1/80 = dollar per yen

3. “appreciation” or stronger: dollar buys……
more foreign currency
“depreciation” or weaker: dollar buys…..
less foreign currency

4. When exchange rate changes from 80 yen per dollar to 90 yen per dollar: the dollar has……
appreciated because …..
the dollar can now buy more yen
When exchange rate changes from 90 yen per dollar to 80 yen per dollar: the dollar has…..
depreciated because ……
the dollar can now buy less yen

5. FOREX: Who, What, Where, When, Why
Exchange rates are determined in the foreign exchange market
open to a wide range of different types of buyers and sellers
currency trading is continuous: 24 hours a day except weekends.
The spot exchange rate refers to the current exchange rate.
The forward exchange rate refers to an exchange rate that is quoted and traded today but for delivery and payment on a specific future date.
(*not responsible for this info*)

6. People may need to exchange currencies in a number of situations.
Example: travel to another country may buy foreign currency in a bank in their home country, where they may buy foreign currency cash, traveller's cheques or a travel-card.
From a local money changer they can only buy foreign cash
(*not responsible for this info*)

7. At the destination, the traveler can buy local currency at the airport, either from a dealer or through an ATM.
They can also buy local currency at their hotel, a local money changer, through an ATM, or at a bank branch.
When they purchase goods in a store and they do not have local currency, they can use a credit card, which will convert to the purchaser's home currency at its prevailing exchange rate.
If they have traveler's cheques or a travel card in the local currency, no currency exchange is necessary.
(*not responsible for this info*)

8. If a traveler has any foreign currency left over on their return home, may want to sell it, which they may do at their local bank or money changer.
The exchange rate as well as fees and charges can vary significantly on each of these transactions, and the exchange rate can vary from one day to the next.
(*not responsible for this info*)

9. A currency pair is the …..
quotation of the relative value of a currency unit against the unit of another currency in the foreign exchange market. (= e = nominal exchange rate)
The quotation EUR/USD means that 1 Euro is exchanged for US dollars.
USD
GBP
CAD
EUR
AUD
$1 US will buy:

10. An exchange rate index -
way of measuring the performance of a currency against a basket of other currencies.
US Dollar Index
For example, the US dollar index measures the US dollar against 6 main currencies.

11. Real and Nominal Exchange Rates working together
Real Exchange Rate
Rate you can trade goods/services of one country for that of another
Ex: for every case of American beer you can buy, you would get 2/3 case of German beer
Real and Nominal Exchange Rates working together
Ex: American rice = $100/bushel Japanese rice = 16,000 yen/bushel
What is the real exchange rate? = nominal x domestic P / foreign P
e x P / P*
use to convert prices into a common currency

12. e x P / P*
(80 yen/$) x ($100/bushel US rice)
(16,000yen/bushel Japanese rice) =
8,000 yen / per bushel US rice
16,000 yen/per bushel Japanese rice
= ½ bushel Japanese rice per bushel of American rice

13. Real Exchange Rate = key determinant of how much a country imports or exports
Use the Price of basket of goods for both US price (P) and foreign price (P*) and the nominal exchange rates (e)
Measures the price of a basket of goods domestically relative the price of foreign goods

14. Finding the nominal exchange rate:
e = P* / P (-assuming there is purchasing power parity)
Convert foreign price of good to US $:
P*/ e

15. Purchasing Power Parity
Purchasing power of the dollar is = to that of other currencies
According to the theory: The ( e ) between two countries must reflect the different price levels in those countries
( e ) change when PL changes
**When increase MS, PL increases = value decreases = depreciate vs. other currencies

16. If Britain pursues tighter MS and less inflation than the US, then the value of the Pound will appreciate vs. the US $ If the US pursues easy MS and allows more inflation than Britain, then the value of the US$ will depreciate vs. the Pound

17. Purchasing Power Parity does not always hold true
Many goods are not easily traded
Not always perfect substitutes

18. Case Study: Increasing Openness of the US Economy
Transportation (ships/jets)
Telecommunications
Technology – change in kinds of goods (easily transported)
Govt. policies – more free trade : NAFTA, GATT

19. Case Study: Are US Trade Deficits a National Problem?
Trade deficit a problem? Maybe a symptom of the problem …= reduce national savings …. = not providing for future

20. FOREX Market Demand curve = Demand for US $ …comes from
Foreign Demand for :
US exports
US financial investments (savings)
Speculation
Ex : if D for US goods increases, shift D for US $ to right = appreciate
Ex: if Int. Rates in US increase, shift D for US $ to right = appreciate …..why? ..
Higher int rates = incentive for foreigners to buy US $ to save (bonds) ….= higher return on their financial investments

21. Supply curve = Supply of US $...comes from:
Americans buy imports
US buy foreign financial investments (savings)
Speculation
If US imports (M) increase = increase Supply of US $ = Supply shifts right = depreciate
If Foreign int. rates increase = increase Supply of US $ = Supply shifts right = depreciate..why…
If foreign int rates increase = incentive for Americans to supply $ to buy foreign bonds (savings

22. US $ US consumers change tastes to prefer European goods …..result?
US increase Supply of Dollars …..to buy Euros…..
US increase D for Euros…to buy European goods
Euro
US $
D for Euro
S of $

23. Results? Pe P of Dollar in Euros Dollars per Euro
P of Euros in Dollars
Results?
Q of Euros

24. US $ -Europe increases S of Euros to buy Dollars Euro
-Europeans increase relative incomes…..result?
-Europe increases S of Euros to buy Dollars
-Europe increases D of Dollars to buy US goods
US $
Euro
S of Euro
D for $

25. Results? Pe P of Dollar in Euros Dollars per Euro
P of Euros in Dollars
Results?
Q of Euros