Intl Finance Exchange rates Flashcards
An exchange rate.
measures the value of one currency in
units of another currency
depreciation.
A decline in a currency’s value. When the British
pound depreciates against the U.S. dollar, this means that the U.S. dollar is strengthening
relative to the pound.
This means that it takes BR more pounds to buy same amt of US dollars
appreciation.
An increase in currency value
Ex
Br pound appreciates
So Br can buy more Us goods for same amt of pounds
exchange rates are determined by
supply and demand
Demand schedule
The U.S. demand for British pounds results partly from international trade, as U.S. firms
obtain British pounds to purchase British products. This demand schedule is downward
sloping because corporations and individuals in the United States would purchase more
British goods when the pound is worth less (since then it takes fewer dollars to obtain
the desired amount of pounds).
Supply schedule
British demand for U.S. dollars. British supply of pounds for sale, since pounds are supplied in the foreign exchange market in exchange for U.S. dollars When the pound’s valuation
is high, British consumers and firms are more willing to exchange their pounds
for dollars to purchase U.S. products or securities; hence they supply a greater number
of pounds to the market to be exchanged for dollars. Conversely, when the pound’s valuation
is low, the supply of pounds for sale (to be exchanged for dollars) is smaller,
reflecting less British desire to obtain U.S. goods.
Increase in Demand for country’s currency
P ^ , Q ^
The currency appreciates
Decrease in Demand for country’s currency
P down , Q down
Country’s currency depreciated
Increase in Supply for country’s currency
P down, Q up
The country’s currency depreciates
Decrease in Supply for country’s currency
P up, Q down
Country’s currency appreciates
U.S inflation goes up, what happens to D, S, Price
US demand goes up, British dont buy US goods so supply goes down, This pressures exchange rate Prices to go up
U.S interest rates goes up what happens to D, S, Price
Demand for pound drops b/c US investors favor US rates. it also attracts BR investors so supply increases. Thus, price increases
real interest rates
adjusted for inflation
U.S income increases, what happens to D, S, Price
Demand increases, supply stays the same. P increases.
fixed exchange rate system
exchange rates are either held constant or allowed to
fluctuate only within very narrow boundaries
devaluation
A central bank’s actions to devalue a currency in
a fixed exchange rate system
Revaluation
upward adjustment of
the exchange rate by the central ban
freely floating exchange rate system
exchange rate values are determined by market
forces without intervention by governments
freely floating exchange rate system- Advantages
country is more insulated from the inflation of other
countries. country is more insulated
from unemployment problems in other countries.
Exchange rate adjustments
serve as a form of protection against “exporting” economic problems to other countries
freely floating exchange rate system- Disadvantages
country that has problem of high inflation and unemployment will continue to have same issues
managed float or “dirty” float exchange rate system
allowed to fluctuate on a daily basis and there are no official boundaries but governments can and sometimes do intervene to prevent their
currencies from moving too far in a certain direction
pegged exchange rate
home currency’s value is pegged to one foreign currency or to an index of currencies.
Dollarization
replacement of a foreign currency with U.S. dollars
Fixed exchange rate advantages
- Exports and import international trade without worries of changes in currency.
Can make payments with protection against depreciation and obtain currency without rush of appreciation - Safe direct foreign investment
- Safe investment
Fixed exchange rates disadvantage - inflation
Us inflation ⬆️
US demand for UK good⬆️
UK has inflation cuz everyone buys from them
Fixed exchange system disadvantage unemployment shock
US unemployment ⬆️
US demand for UK good⬇️
UK production ⬇️
And unemployment ⬆️
Freely floating ER SYSTEM advantage
Inflation shock example
Us inflation ⬆️
US demand for UK good⬆️
UK does not buy from US SOO supply of pound ⬇️
Pound appreciates and now U.K. prices are higher in terms of dollar so
US Demand for U.K. GOODS ⬇️
UK has no inflation
Freely floating ER system disadvantage inflation
Us inflation ⬆️
US demand for UK good⬆️
UK does not buy from US SOO supply of pound ⬇️
Pound appreciates and now U.K. prices are higher in terms of dollar so
You need a greater number of dollars to buy the same number of pounds
US Demand for U.K. GOODS ⬇️
US Firms increase prices because raw materials are expensive now.
US inflation ⬆️⬆️⬆️⬆️
If ones country’s currency appreciates/depreciates the other country’s currency must do the
Opposite
Trade flows vs capital flows
Trade flows: inflation, tariffs
Capital flow: income and interest rates
Capital flows outbeats trades flows
Speculation thumb or rule
Invest in appreciation currency
Borrow in depreciation
To depreciate US $ Fed should
Exchange dollars for foreign currency
To appreciate US dollar FED should
Exchange foreign currency for US DOLLAR
Flooding the market with dollars
Weak home currency advtg and disadvgt
Adgt: exports increased, low unemployment
Dis: imports low inflation high
Strong home currency
Adgt: imports high, inflation low
Dis: exports are low, unemployment high
