Chapter 12 - OPEN ECONOMY MACROECONOMICS Flashcards
What is Nominal Exchange Rate?
The rate at which a person can trade the currency of one country for the currency of another.
What is Appreciation?
The increase in the value of a currency as measured by the amount of foreign currency it can buy. Om nominal exchange rate = 60 sek / $1 CAD och sedan går den upp till 65 sek /$1 CAD då är det appreciation.
What is Depreciation?
The decrease in the value of a currency as measured by the amount of foreign currency it can buy.
What is Real Exchange Rate?
The rate at which a person can trade the goods and services of one country for the goods and services of another.
Like the nominal exchange rate, but we express the real exchange rate as units of the foreign item per unit of domestic item. The item is a good rather than a currency.
The real exchange rate is determined by the supply and demand for the foreign-currency exchange.
How is Real Exchange Rate calculated?
Real Exchange Rate = e × P/P*
Nominal exchange rate × Domestic Price/ Foreign Price
What is Purchasing -Power Parity?
The theory of exchange rates whereby a unit of any given currency should be able to buy the same quantity of goods in all countries.
What calculation must be true if the purchasing power of a dollar is equal in two countries?
For the purchasing power of a dollar to be the same in the two countries, it must be that:
1/P = e/P*
e = P*/P
the nominal exchange rate between the currencies of two countries must reflect the different price levels in those countries.
What are some limitations of PPP?
PPP provides a simple model of how exchange rates are determined.
Exchange rates do not, however, always move to ensure that a dollar has the same real value in all countries all the time.
For example, imagine that haircuts are more expensive in Paris than in New York. International travelers might avoid getting their haircuts in Paris, and some haircutters might move from New York to Paris. Yet such arbitrage would be too limited to eliminate the differences in prices. Thus, the deviation from purchasing-power parity might persist, and a dollar (or euro) would continue to buy less of a haircut in Paris than in New York.
The second reason that purchasing-power parity does not always hold is that even tradable goods are not always perfect substitutes when they are produced in different countries. For example, some consumers prefer Swedish cars, and others prefer American cars. Moreover, consumer tastes can change over time. If Swedish cars suddenly become more popular, the increase in demand will drive up the price of Swedish cars compared to American cars. Despite this difference in prices in the two markets, there might be no opportunity for profitable arbitrage because consumers do not view the two cars as equivalent.
What does Perfect capital mobility mean?
Perfect capital mobility means Canadians have full access to world financial markets.
The implication of perfect capital mobility for a small open economy like Canada’s is that the real interest rate in Canada should equal the real interest rate prevailing in world financial markets.
r=rw
What is Interest Rate Parity?
Interest rate parity is a theory of interest rate determination whereby the real interest rate on comparable financial assets should be the same in all economies with full access to world financial markets.
