1. Copyright © 2004 South-Western Mods 42-44 The Open Economy: FOREX Models, Graphs, and Practice

2. Copyright © 2004 South-Western Understanding Exchange Rates Foreign Exchange Market Exchange Rates Appreciate Depreciate US $JP ¥€ $1.00198.30.77 ¥10.01011.0078 €1.001.3127.91

3. Copyright © 2004 South-Western Quick Review Guide of Exchange Rate Features Appreciation: When a currency appreciates, it gains in value in relation to another currency. It would take less of that currency to “buy” the other currency. We say that the appreciated currency has strengthened. Because of that appreciation, the goods of that country would cost more for other countries to buy, so exports of the appreciated currency’s country would decline. Appreciation of your currency is good if you are traveling, but bad if you are an exporter of goods.

4. Copyright © 2004 South-Western Quick Review Guide of Exchange Rate Features Depreciation: When a currency depreciates, it loses in value in relation to another currency. It would take more of that currency to “buy” the other currency. We say that the depreciated currency has weakened. Because of that depreciation, the goods of that country would cost less for other countries to buy, so exports of the depreciated currency’s country would increase. Depreciation of your currency is bad if you are traveling, but good if you are an exporter of goods.

5. Copyright © 2004 South-Western FOREX follows laws of supply & demand Equilibrium Exchange Rate The Equilibrium Exchange Rate Graph

6. Copyright © 2004 South-Western The steps for FOREX analysis 1.Draw 2 FOREX graphs (S & D graphs) 2.For X axes: One for Q of 1 country’s currency—Q D One for Q of other country’s currency--Q € 3.For Y axes, always put the country’s currency that you’ve drawn the graph for as the denominator. In other words, “what goes below (in the X axis), goes below” (in the Y axis denominator).

7. Copyright © 2004 South-Western The steps for FOREX analysis 3.Draw in S & D curves on each FOREX graph 4.Look at the problem or scenario Think: “Who is wanting to buy what?” On the graph for the country that will be doing the buying, shift supply to show increase in supply of their currency. On the graph for the country where things will be bought, shift demand to show increase in demand for their currency 5.Read the new Ep for appreciation or depreciation

8. Copyright © 2004 South-Western Wksht Practice FOREX Wksht Capital Flows Wksht Monetary and Fiscal Policy and Exchange Rates Wksht

9. Copyright © 2004 South-Western Inflation and Real Exchange Rates Nominal Exchange Rates Real Exchange Rates

10. Copyright © 2004 South-Western Exchange Rate Policy Governments have more power to influence nominal exchange rates than other prices Exchange rates are important to countries where exports and imports are a large fraction of GDP

11. Copyright © 2004 South-Western Exchange Rate Regimes Exchange Rate Regimes Exchange Rate Regime Fixed Exchange Rate Floating Exchange Rate "Managed" & "Target Zone"

12. Copyright © 2004 South-Western How Can an Exchange Rate Be Held Fixed? How Can an Exchange Rate Be Held Fixed? Exchange Market Intervention Foreign Exchange Reserves Foreign Exchange Controls

13. Copyright © 2004 South-Western The Exchange Rate Regime Dilemma The Exchange Rate Regime Dilemma The Case for Fixed Exchange Rates Facilitates trade by creating certainty about the exchange rate Acts as a check on inflationary policies

14. Copyright © 2004 South-Western The Exchange Rate Regime Dilemma The Exchange Rate Regime Dilemma The Case against Fixed Exchange Rates Requires large foreign currency reserves May divert monetary policy Distorts incentives Opportunity for corruption

15. Copyright © 2004 South-Western Purchasing Power Parity The notion that a dollar should buy the same amount in all countries. In the long run, the exchange rate between two countries should move towards the rate that equalizes the prices of an identical basket of goods and services in each country. The Economist mag’s Big Mac Index: Our "basket" is a McDonald's Big Mac, which is produced in about 120 countries.

16. Copyright © 2004 South-Western Big Mac Index—January 2014