Det of exchange rates (important stuff)

Question 1

Asset pricing theory of exchange rates

Answer 1

• currencies are financial assets
• value is determined by investors’ desire to hold it. desire depends on view of future assets’ worth

Question 2

Disequilibrium theory of exchange rates

Answer 2

• frictions in the economy cause goods prices to adjust slowly over time
• nominal exchange rates adjust quickly
• changes in nominal exchange rates propagate into changes in real exchange rates

Question 3

Describe the overshooting process

Answer 3

money supply increase–» exchange rate goes up one shot by same proportion, and then goes back down(appreciates back) slowly over time as prices react slowly upwards to reach the equilibrium price level

Question 4

Equilibrium theory of exchange rates

Answer 4

• markets clear: supply and demand are equated through gradual price adjustment
• attempts by CB to affect the real exchange rates through market intervention fail
• no simple relation between exchange rates change and trade deficit, competitiveness, employment, etc.
• morelong term than disequilibrium, in long run, exchange rate is primarily determined by fundamental economic factors

Question 5

What does central bank do and how

Answer 5

Determines/impacts:
- interest rates
- value of the currency
- inflation

How:
- prints money
- buys or sells local currency
- buys or sells foreign currency
- changes in fiscal and monetary regulations
- changes in interest rates

Question 6

Difference between sterilized/unsterilized intervention

Answer 6

Unsterilized may lead to inflation, sterilized takes into account the other currency in the intervention and offsets the inflation that could be created by the intervention

Question 7

With floating exch rates, how is exch rate determined

Answer 7

Through the laws of supply and demand

Question 8

How can nominal exchange rates be altered

Answer 8

by tightening or expanding the money shock

Question 9

In response to what does the real exchange rate mainly change

Answer 9

in response to economic fundamentals