Exchange rates Flashcards
What is a nominal exchange rate?
The rate at which currencies can be traded for each other. Rise or drop in value of currency is appreciation and depreciation respectively. So how much this foreign amount can buy in Australia.
How is the nominal exchange rate related to the traded weight index?
It is part of an average of all trading partners, which each partner weighted based on importance.
What is the difference between fixed and floating exchange rates?
Flexible exchange rate is determined by the supply and demand in the foreign market.
The fixed exchange rate is something set by the government (e.g. in terms of US dollars or gold).
What is the difference between a nominal and a real exchange rate?
Nominal currencies is the rate at which currencies can be traded for each other.
Real exchange rate is the value of the average domestic good relative to the price of average foreign goods or services. Increase in real exchange rate means that domestic goods become more expensive. Exports decrease, and imports increase. So how much can $1 AUD buy from other countries basically.
What assumption underlie the purchasing power parity theory of exchange rates?
The assumption is the law of one price, where basically you compare the same good and ignore transport costs. In comparing, that internationally traded commodity is worth the same everywhere. Using the PPP, you can thus determine the exchange rate as the commodity price should be the same.
Given purchasing power parity, what should happen to a country’s exchange rate if its inflation rate is higher than that of its neighbours.?
The country’s exchange rate should increase (2A=bB, B=2A/b insread of A/b). In other words, the currency depreciates relative to its neighbor’s.
Outline the limitations of the PPP theory of exchange rates.
- there are transport costs
- people simply might not want to buy your shit (Made in china vs made in Italy for a suit or something)
What factors determine the supply of dollars/demand for dollars in the international currency market?
Equilibrium exchange rate, or fundamental value of exchange rate, is the equivalence of supply and demand of the dollars in the foreign market. Preference on foreign goods (or increase in foreign GDP or real interest rate) means you want to trade your dollariedoos for foreign stuff, supplying it into the market and reducing its value. Likewise, preference for domestic goods (or increase in domestic GDP or interest rate) means foreign people want your goods, so they demand it more, and thus dollariedoos’ value increases.
