12 Exchange Rate, International Trade and Capital Flow Flashcards
Nominal exchange rate
Rate which 2 currencies can be traded for each other
Number of FOREIGN currency for 1 LOCAL currency (2.38rm for 1SGD)
-denominator is LOCAL
currency
- analyze denominator (supply of local, not foreign)
Appreciation - exchange rate becomes higher/lower?
(opposite is depreciate)
Higher
$1 = 0.5pounds
now $1 = 0.6pounds
Flexible vs fixed exchange rate
Flexible - varies w demand & supply, not controlled by govt
Fixed - set by govt policy
Higher exchange rate, larger/smaller qty of dollars SUPPLIED?
Higher exchange rate, LARGER qty of dollars supplied
Upward sloping
US$1 can exchange for more Yen
-foreign goods are cheaper
eg US$ local currency
Yen foreign currency
Who can demand?
Who can supply?
Demand - anyone who holds Yen can demand US$ (by exchanging)
Supply - anyone who holds US$
Higher exchange rate, larger/smaller qty of dollars DEMANDED?
Lower
Negative slope
Higher exchange rate - 1US$ exchange for more Yen, Jap consumers need to fork out more Yen to get 1US$ - US products more ex from Jap pov - lower demand
Supply is determined by 3 factors: (look at local pov)
(Same for demand but look at foreigner pov)
Higher supply:
1. Higher preference
2. Higher local real GDP - consumers richer
3. Higher interest rate
Strong currency means can exchange for more/less of foreign currency
MORE
Strong currency:
- Reduce net exports - products are viewed expensive to foreigners
- Attract inflow of foreign funds for investment since strong currency
Tighter US monetary policy lead to higher/ lower interest rate? How will it affect demand and supply?
Tighter policy - reduce money supply - higher interest rate - assets more attractive - demand increase, supply decrease
Local currency will appreciate
*Want to make local currency stronger: tighten money supply (dec) - raising real interest rate
When real interest rate increase, local currency increase or dec?
real interest rate inc - local currency inc - demand dec since foreigners find it ex - net export dec
Fixed exchange rate system, govt may adjust:
Devaluation: reduce fixed rate
Revaluation: increase fixed rate
What is real exchange rate
Price of avg domestic good relative to price of avg comparable foreign good when prices expressed in common currency
price of domestic good / price of foreign good in US$
eg prices of candy:
1SGD but 1rm (cheaper in msia)
1 SGD but 3rm (same price, not much point buying in msia)
To convert foreign price Pf to price P
Pf / e (nominal exchange rate)
If relative price is >1
Domestic product is more ex
eg 1.09 (REAL exchange rate)
- US (domestic) computer costs 9% more ex than Jap (foreign)
If real exchange rate is high, domestic goods are cheaper/more expensive relative to foreign goods
If real exchange rate is high, domestic goods are MORE EXPENSIVE relative to foreign goods
-Net exports lower because will want to buy from foreign country instead
Purchasing Power Parity (PPP)
Nominal exchange rates are determined by price differential between economies
-Long run: country with signficant inflation will tend to depreciate (currency will become weaker)
Law of one price
Transportation costs are small and no trade restrictions, price of internationally traded commodity must be same in all locations
Trade balance is the same as net exports (NX)
Trade surplus: positive/ negative trade balance?
Export > or < imports?
Trade surplus: positive trade balance
Export > imports (sell more than buy)
Trade deficit: negative trade balance
Imports > exports
Net capital inflow (KI)
Capital INflow - capital OUTflow
Diff from import/export (this is produced goods and services)
Capital is purchase of existing assets - land, buildings, deposits, shares, bonds
NX + KI = ?
Trade balance (NX)
Net Capital Inflow (KI)
0
2 roles of international capital flows
- Trade imbalances
surplus - net capital outflow
deficit - net capital inflow - Efficient allocation of savings
International capital flow graph x and y axis
x: net capital inflow (KI)
y: domestic real interest rate
upward sloping
KI < 0 - net capital outflow
KI > 0 - net capital inflow (higher)
Increase in riskiness of domestic products increase/decrease capital inflow
Increase in riskiness of domestic products DECREASE capital inflow
More risky - foreigners less willing to buy asset - net capital inflow dec - Curve shifts left
Y = C + I + G + NX
I = Y - C - G - NX
National savings, S = (Y-C-G)
S - NX = I
NX + KI =0
NX = -KI
S + KI = I
