Chapter 4: Exchange Rates II: The Asset Approach in the Short Run

Question 1

Asset Approach to Exchange Rates

Answer 1

Based on the idea that currencies are assets. The price of the asset is the spot exchange rate.

Question 2

Fundamental Equation of the Asset Approach to Exchange Rates

Answer 2

UIP Equation:
i(h) = i(f) + (E(e) - E)/E
interest rate on dollar deposits, aka the dollar rate of return on dollar deposits, equals the expected dollar rate of return on euro deposits, which is the interest rate on euro deposits plus the expected rate of depreciation of the dollar

Question 3

FX Market Diagram

Answer 3

DR, FR

A graphical representations of home and foreign returns in the forex market

Question 4

Nominal Rigidity

Answer 4

The assumption of sticky prices

Question 5

Overshooting

Answer 5

When expectations cause a variable to change more than it would normally

Question 6

Trilemma

Answer 6

You cannot have a fixed exchange rate, international capital mobility, and monetary policy autonomy all at the same time