Macro 6 Flashcards
What is currency market?
market where one currency is traded for another
What are foreign exchange reserves?
foreign currency holdings of central banks
What is the exchange rate?
rate at which one currency is traded for another
What do foreign country resident have ot buy domestic currency for? (EG why japan resident buy USD using Yen)
- buy domestic goods(buy us goods, exports by US)
- buy domestic assets (capital inflow domestically)
What might cause the shift in demand curve for dollars from Japan involving US goods?
- foreign country (Japan’s )real GDP rises
- foreign residents (Japan ) increase their fondness for US goods
- foreign country (Japan) price level rises, relative to US price level
What might cause the increase in demand curve for dollars from Japan involving US assets?
foreign country (japan) interest rate falls relative to US interest rate
foreign residents(japan) believe that the dollar will appreciate against the yen
What happens to domestic currency when foreign country experience RGDP growth?
domestic exports to foreign country increase
demand for domestic currency shift right
Domestic currency appreciates
What is hot money?
funds that can be moved from one type of asset to another at very short notice
What are the factors that affect hot money flows?
Changes in expectations and interest rates
What happens to price when traders expect domestic currency to depreciate?
For foreign investors, domestic assets less attractive , demand for domestic shift left
For domestic residents, foreign assets are more attractive, supply of domestic currency shift right
RESULT IN LARGE DECREASE IN PRICE OF DOMESTIC CURR TODAY
What is arbitrage?
buy an item in one market, sell it in another market for a higher price
Arbitrage removes ________________ in exchange rates
virtually all geographic differences
What happens when the exchange rate in New york is 95 yen and 105 yen per dollar in London?
demand for usd in new york shift right
sell yen for $ 100 in new york, and sell the 100 usd for higher yen of 10500 yen in London
Supply of USD in london shift right
usd depreciate in london until exchnage rate equal in 2 cities
usd apperciate in new york
What is used to predict what happens in the long run when there are different exchange rates?
purchasing power parity
What is PPP formula?
price level of good A in Yen in Japan/price level of good A in USD in US
How to tell how much something is undervalued?
(PPP- exchange rate )/ exchange rate *100
Why does PPP theory not hold exactly?
Transportation costs are not zero
Many goods and services (e.g. haircuts) are non-tradable
Barriers to trade may be present
Other determinants of exchange rate matter
How to calculate growth of ppp exchange rate (with japan in numerator for ppp)
japan inflation rate- us inflation rate
If gppp positive, usd appreciate against yen
PPP Theory predicts that countries with ________ X% per year _____ than US will see their currencies ____________ against the US dollar
inflation rates
higher
depreciate by X% per year
What does it mean by floating exchange rate?
allow demand and supply to operate freely in the currency market
What happens when you use fixed exchange rate?
central bank participates in the currency market to ensure that the exchange rate stays within 0.05HKD of the peg
What happens when you use managed exchange rates?
central bank also participates in currency markets
manage the value of the Singapore dollar against currencies of its major trading partners, but without explicit commitments
Why should we use fixed / managed exchange rates?
Preventing or slowing down appreciation helps exporters and those competing against imports
Preventing or slowing down depreciation helps import-using industries and consumers
Keeping the exchange rate stable reduces the risk for doing international business transactions
Pegging one’s currency to USD ties one’s monetary policy to that of the Fed, gaining credibility to fight inflation
How does central bank prevent appreciation, if there is excess demand for domestic currency?
maintain the peg, central bank must sell domestic reserve by shortage each month at the exchange rate at excess demand
buys the equiv amount of usd
central bank accumulates foreign exchange reserves
What happens when traders expect depreciation in domestic currency?
Supply of the domestic currency shifts right
Demand for domestic currency shifts left
Excess supply widens
Even faster depletion of reserves!
What options does a country if foreign exchange reserve runs out?
Allow the domestic currency to float
Devalue domestic currency: lower peg to sustainable level
Impose capital control
Borrow from IMF : lender of last resort, imf impose stringent condition
How did panic spread to other asian countries?
Investors started to wonder if banks and companies in nearby countries were similarly vulnerable!
bank run developing into a banking panic
What lessons could be learnt from the asian financial crises?
The need for ample foreign exchange reserves
The need to monitor private sector borrowing in foreign currency
How do exchange rate movement provide source of demand shock?
currency depreciation lead ot net export increase
AE increase
Y* increase
exchange rate channel makes _______impact on output _________ in an open economy than in a closed one
How does that occur?
monetary policy’s
more powerful
interest rate decrease causes domestic assets less attractive, foreign asset more attractive, currency depreciate, NX increase
What is the trilemma?
free capital mobility, exchange rate movement, monetary authority
What is the difference between bilateral and overall trade balance?
- bilateral: measured against one otehr country
- overall: measured against world
What is the currency market eqm?
quantity of domestic curr supplied (domestic purchase of foreign gns and assets)
quantity of domestic curr demanded(foreign purchase of domestic gns and assets)
What is the eqm condiiton if trade deficit?
Domestic trade deficit (domestic purchase foreign goods- foreign purchase of doemstic goods)
Domestic net financial inflow from foreign country (foreign purchase us asset- domestic purchase of foreign asset)
