Test 1 Flashcards
Law of One Price
P = E x PF - In 2 different countries 1 good will be the same amount after currency exchange
Absolute PPP
The tendency for similar goods to sell for similar prices
provides a link between prices and exchange rates.
More of a price level not changes in prices. Does not hold
E = P/PF
Relative PPP
It says that the appreciation or depreciation of
the currency in terms of another has to be equal to
the inflation differential between the two.
E^ = P^ - PF^
Equation for inflation/exchange rate
inflation A - inflation B = (forward rate - today rate) / today rate
Relative price changes becomes less important over the long run
true
relative price changes can change the exchange rate without changing the price level
true
Empirical Evidence rejects Absolute PPP and
Relative PPP.
Evidence is even worse in the short-run than in the long-
run.
true
Lessons from the graph:
1-Exchange rates are much more volatile than inflation
differentials.
2-Deviations from PPP are much more apparent for
monthly data than for annual data.
If the percentage change in the exchange rate is equal to the inflation differential between two countries, then relative PPP holds
true
the law of one price applies to non-traded goods because of arbitrage
false
what causes permanent deviations from PPP
trade barriers / transport cost / non-traded goods that are included in price index
what causes temporary deviations from PPP
relative price changes and different speed of adjustments in prices and exchanges rates
what factors that can cause the appearance of deviations from PPP even though none really exists
PPP are indexes and trade timing
Merchandise
trade commodities
current account
Services
of factors of production. Also includes tourism, royalties,
Transportation costs, insurance premiums
current account
Income
Dividends, interest
current account
Unilateral Transfers
Gifts, foreign aid
current account
Direct Investment.
Private financial transactions that result in the ownership
Of 10% or more of a business firm
capital account
Security Purchases.
Private sector net purchases of equity and debt securities
capital account
Bank Claims and Liabilities
capital account
US Government Assets Abroad.
change in the US official reserve assets. All assets that can be used to settle debts between countries. (gold, IMF reserve position, foreign currency, etc)
capital account
Foreign Official Assets in the US
capital account
Direct quote for currencies
As the price of the foreign currency in terms of dollars
Indirect quote for currencies
As the price of dollars in terms of the foreign currency (indirect)
