1 Flashcards
nominal exchange rate d
rate at which the currency of one country can be exchanged for that of another
Sa|b
amount of currency A that can currently (on the spot) be bought with 1 unit of currency B,
(direct method of quotation)
what is the indirect method of quotation of the exchange rate
from perspective of country A (home) can quote the rate in terms of the amount of currency B needed to buy 1 unit of currency A,
($1.36 needed to buy £1)
what is the effective nominal exchange rate
average of a country’s bilateral exchange rates (all previously mentioned ways of quoting ER) with an index with weights often given by trade shares (how much the country trades with different countries)
what are spot rates (S)
exchange rates for currency exchanges on the spot (for immediate delivery)
what are forward rates (F)
exchange rates for currency exchanges that will occur at a future (forward) date,
typically 30,90,180,360 days in future
depreciation d
depreciation is a decrease in the value of a currency relative to another currency
appreciation d
appreciation is an increase in the value of a currency relative to another currency
S£|$=0.72 –> S£|$=0.75,
has the £ depreciated or appreciated
£ has depreciated relative to the $, now takes more £s to buy $1, ($ appreciated relative to £)
why did the pound fall relative to the euro during the financial crisis
sterling more exposed than the euro because of the city
why did the pound fall relative to the dollar during the financial crisis
dollar is seen as safest currency so people go to it in times of economic uncertainty
what does a depreciated currency mean
imports are more expensive,
domestically produced goods and exports are less expensive
what is the double impact of exchange rate movements
on trade flows (cheaper/more expensive),
on CPI inflation
what is worldwide daily volume of foreign exchange transactions
about $5 trillion
what is the largest financial market in the world
foreign exchange markets
what do surveys of FX market participants suggest that 95+% of currency transactions motivated by
speculation
arbitrage and
international capital movements
rather than importing/exporting goods
arbitrage d
simultaneous buying and selling of securities, currency or commodities in different markets or derivative forms in order to take advantage of differing prices for the same asset
most transactions (85% spot deals) exchange foreign currencies for __ ______
US dollar
who are the participants in foreign exchange markets
commercial banks and other depository institutions,
non-bank financial institutions (hedge funds and insurance),
other businesses involved in international trade,
central banks
rate of return d
percentage change in value that an asset offers during a time period
liquidity d
ease of using the asset to buy goods/services
what are rates of return that investors expect determined by
interest rate that the asset will earn,
expectations about appreciation or depreciation,
risk
what is the asset approach to exchange rates *
exchange rate is the rate (price) of one currency against another,
an asset since a form of wealth,
its value today depends crucially on its future expected value,
forward-looking variable: any news that might change its future price must have an impact on its price today
what is the currency exchange rate st
a forward-looking variable
if markets are efficient what should st (current exchange rate) reflect
all publicly available info about current and expected future: domestic interest rates foreign interest rates risk premia and about the future long-run sustainable exchange rate st+N
what is the real exchange rate *
Qt,
price of domestic goods relative to foreign goods
equation for Qt (real exchange rate)
Qt = (StP*t)/Pt, log version qt = st + p*t - pt, qt: measure of competitiveness qt up: real depreciation increases competitiveness (48/123)
money market (MM) equilibrium *
log version mt-pt = φyt - ηit + εt, Mt/Pt = L(Yt,it,...) lhs supply of real money balances rhs demand of real money balances, mt, pt, yt the logs of Mt, Pt, Yt, φ,η>0 parameters and εt a zero-mean mdt shock
what will happen in the short run when there is a permanent increase in lnmt (money),
mt-pt = φyt - ηit + εt
it down,
yt up,
why? price stickiness, pt adjusts slowly over time,
unanticipated announcements (news) from central banks about current and future policy can have an important impact on st,
long run all values back to long run
what is the key national accounts macro identity
Y = C+I+G+CA,
CA: current account
all else being equal what must qt up or st up (depreciation) mean
yt up, such that the output market is in equilibrium,
requires output to also increase, st up so yt up
yt=at+δqt+gt = at+δ(st+p*t-pt)+gt
FOREX market equilibrium *
it = i*t + Etst+1 - st + pt
what is the AA schedule equation *
mt-pt=φyt - η(i*t+Etst+1-st+pt) + εt,
comes from MM equilibrium and FOREX market equilibrium
what is the basic idea of the asset approach to exchange rates
given perfect capital mobility, exchange rates should move to equalise the returns on equivalent assets denominated in different currencies
what is the covered interest parity condition (CIP) *
page 1 notes
1+it = Ft/St(1+it),
it = it + ft - st (after taking logs)
where * denoted foreign
what is the case when the covered interest parity (CIP) holds (page 1 notes)
the foreign exchange market is in equilibrium,
it should be true for any currencies that are freely traded in a world of perfect capital mobility
what does it mean if in the CIP equation: ft-st=it-it, it-it>0 (<0), ft-st>0 (<0)
domestic currency is selling at a forward discount (premium)
what is the uncovered interest parity condition (UIP) *
uncovered version of cip,
1+it = (St+1/St)(1+it)
it = it + Etst+1 - st (after logs)
what does it mean in UIP equation: it=it+Etst+1-st, it-it>0 (<0), Etst+1-st>0 (<0)
domestic currency is expected to depreciate (appreciate)
what do both the cip and uip assume
perfect capital mobility
what is the augmented UIP *
it = i*t + Etst+1 - st + ρt,
when ρt>0 (<0), ρt denoted the risk premium (discount) associated with holding domestic currency denominated assets
with the augmented UIP, what is the equation that shows how the spot exchange rate moves to equalise returns *
st = i*t - it + Etst+1 + ρt
what is the impact on the augmented UIP on the impact of "news" all else equal (st = i*t - it + Etst+1 + ρt) it up, i*t up, Etst+1 up, ρt up
st = i*t - it + Etst+1 + ρt, it up result in st down (appreciation, i*t up result in st down (depreciation), Etst+1 up result in st up, ρt up result in st up
by rewriting the augmented UIP for t+1 and t+2 etc what is the current exchange rate st equal too
st=Etst+n + EtΣi*t+n - EtΣit+n + EtΣρt+n (45/123),
essentially shows how the current exchange rate is a forward looking variable
if markets are efficient, st should reflect all publicly available info about current and expected future…
domestic interest rates, foreign interest rates, risk premia, & about the expected future long-run sustainable exchange rate st+n (all this got from rewriting for t+1, t+2 etc, 45/123)
what is a carry trade investment strategy
consists of borrowing in low-interest rate currency (funding currency),
buying high-interest rate currency (investment currency)
what are factors contributing to the depreciation of sterling since 2007
negative news about relative UK prospects (UK economy hit harder than trading partners due to relatively large debts and large financial sector),
higher relative inflation (lowers competitiveness unless currency depreciates),
rise in risk premia on sterling assets
what is the output market equilibrium condition *
yt=at+δqt+gt = at+δ(st+p*t-pt)+gt, yt: log output, qt=st+p*t-pt: real exchange rate, gt: government spending, at: autonomous spending independent of yt & qt, δ>0 parameter,
when does at go up (output market equilibrium condition yt=at+δqt+gt = at+δ(st+p*t-pt)+gt),
at: autonomous spending
autonomous consumption, investment or exports up,
autonomous imports down and taxes down
what is the IS-LM model
IS: combination of i (interest rates) and y (output) such that output market in equilibrium,
LM: combinations of i and y such that money market in equilibrium,
equilibrium jointly determines i and y
what does it mean if qt up in output market equilibrium equation DD,
yt=at+δqt+gt = at+δ(st+p*t-pt)+gt,
qt up, depreciation, home goods cheaper so increase output
what does dd show
all combinations of nominal exchange rates and real output levels that are compatible with equilibrium in the output market
what is the output market DD equation
yt=at+δqt+gt = at+δ(st+p*t-pt)+gt,
what is the impact of a temporary fiscal policy shock
adjustment starts in OM where gt increases,
this increases income and increases demand for money (ED for money) since demand for money depends positively on income,
equilibrium in MM re-established by rise in i,
nominal appreciation of home currency spills over to OM via a worsening of current account
what is the key distinction between gt and mt shocks
both expansionary cause rise in output,
monetary results in currency depreciation and improvement in CA,
fiscal produces currency appreciation and worsening of CA
what is the impact of a permanent fiscal policy shock
LR OM equil condition: ybar=abar+δqbar+gbar,
g increases permanently, ED for output by gov appreciates currency, which reduces exports and increases imports,
due to output being determined on the supply side in the long run (ybar=abar+δqbar+gbar) ybar independent of g so g rise must crowd out the CA (see above)
(q down, appreciation)
what is the ceteris paribus impact on the current account (CA=EX-IM) of a depreciation of domestic currency if all measured in domestic
CA down = EX - IM down,
does not affect volume of imp or exp but makes imp more expensive
who talked about the nominal exchange rate, the UIP, and PPP
Baillie (2008)
what was the original paper bringing in uip, money demand, DD curve, real exchange rate
Dornbusch (1976)
what kind of shocks does a flexible exchange rate and fixed ER insulate an economy from
flexible protects from real shocks to AD,
fixed ER insulates economy from money supply and demand shocks,
source and nature of shock (temp or permanent)
