B16 Flashcards
Price levels and the exchange rate in the long run
What is the law of one price
The idea that in a competative market, identical goods must be sold at the same price if expressed in the same currency, supposing the abscense of transportation costs and price discrimination, otherwise there is an arbitrage oppertunity
What is the theory of purchasing power parity
that the exchange rate between two countries reflects the ratio between the two countries price levels on an all encompassing basket of goods
What is the diference between the law of one price and PPP
The law of one price applies to singular products whole PPP applies to a basket of goods
What is absolute and relative PPP
absolute PPP states that the exchange rate reflects the relative prices of a basket of goods which leads to relative PPP which claims that changes in the exchange rate reflects Price changes in the agregate basket
Is the monetary aproach to the exchange rate short run or long run
long run as it is based on price changes that are not effected by money supply in the short run
What does the monetary aproach to the exchange rate imply
That the exchange rate which is the relative price of currencies money is fully determined in the long run by the relative supplies of those moneys and the relative real demand for them. (shifts in interest rate only effects to the extent they effect money demand)
In the monetary aproach to the exchange rate an increase in interest rate depreciates the currency
Yes, by lowering the demand for its money, the oposite of the currency aproach when demand would increase becouse you earne more on currency deposits
How can people predict the interest rate difference between two countries if relatice PPP holds
By predicting the relative inflation rates expected over the relevant time horizon, how the comaprative money supply will change. Depreciation = expected inf currency - expected inf other currency
How does inflation effect the interest rate
More inflation means higher interest rate in the long run, called the fisher effect
Does PPP and the law of one price reflect imperical findings
No, prices seam to varry based on location even in aggregate terms
What are the three main reasons for PPP not reflecting reality
The exhistance of trae barriers, monopolistic or oligopolistic markets and becouse the inflation data reported are based on diferent baskets of goods
What is the real exchange rate
The difference between a basket of common purchases in one country compared with another contries basket, keeping the baskets adapted to the preferences
What is a real depreciation of a currency
When the native currency prices on foreign goods rise aka when the native goods basket is considered less valuable then the foreign
What happens to the exchange rate if demand for a countries goods increase
it apreciates
