Chapter 4: Exchange Rates II: The Asset Approach in the Short Run Flashcards
Asset Approach to Exchange Rates
Based on the idea that currencies are assets. The price of the asset is the spot exchange rate.
Fundamental Equation of the Asset Approach to Exchange Rates
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
FX Market Diagram
DR, FR
A graphical representations of home and foreign returns in the forex market
Nominal Rigidity
The assumption of sticky prices
Overshooting
When expectations cause a variable to change more than it would normally
Trilemma
You cannot have a fixed exchange rate, international capital mobility, and monetary policy autonomy all at the same time