TOPIC 3 - Key international prices Flashcards
direct exchange rate
units of national currency per one unit of foreign
currency
indirect exchange rate
units of foreign currency per one unit of national currency
Cross exchange rates
exchange rate between two currencies, which is set through their respective exchange rate with a third currency
Bilateral exchange rate
value of one currency with respect to another currency
nominal exchange rate
value of one currency with respect to another currency/other currencies without correction due to the different price evolution in the countries which use those currencies
real exchange rate
value of one currency with respect to another currency/other currencies with correction due to the different price evolution in the countries which use those currencies
effective exchange rates
value of one currency with respect to a basket of other currencies, each of them weighted by a weight factor coming from the importance of each partner in the trade activity of the country of interest
NEER
nominal effective exchange rate: product of bilateral exchange rates accounted by their trade weight
REER
real effective exchange rate
Fixed exchange rates
type of exchange rate regime in which a currency’s value is fixed or pegged by a monetary authority against the value of another currency, a basket of other currencies, or another measure of value, such as gold.
intermediate exchange regime
exchange rate regime that combines fixed and floating regime, such as a pegged rate with horizontal bands, it can fluctuate +- 1 % with respect to central rate
floating exchange rate
market determined exchange rate, no set trend by authorities (CB can intervene for short periods)
exchange rate flexibility
How floating the exchange rate is, completely fixed or floating.
higher exchange rate flexibility (upsides (4) and downsides (3))
(+) simple management
(+) avoiding attacks (lower reserves required)
(+) automatic stabalizer against shocks
(+) higher degree of autonomy to macroeconomic policy
(-) higher uncertainty
(-) barrier to economic integration
(-) not be used as foreign anchor (cannot maintain the exchange rate at a fixed level by selling and buying foreign currency)
Which exchange rate is suitable for developed, undeveloped and emerging countries?
developed - floating exchange rate
developing - fixed exchange rate (to gain credibility)
emerging - managed floating
to appreciate the currency (3)
- rising the interest rate
- cutting barriers to foreign investment
- FX market intervention (buying national currency
to depreciate the currency (3)
- lowering the interest rate
- building barriers to foreign investment
- FX market intervention (selling national currency
IMS
international monetary system
- one or more currencies play a key role and is used in international transactions
what is the exorbitant privilege
when a country issuing the global reserve currency gets an advantage
- way of financing economic growth cheaply
- when the situation is basically a monopoly in that role a country have enourmos advantage.
Triffin dilemma
The country issuing the global reserve currency must be willing to supply the world with an extra quantity of its currency to fulfill world demand for foreign exchange reserves (the liquidity problem).
However, to generate that additional supply, the central country must suffer an increasing current account deficit (= financial account surplus) (the adjustment problem)
But, for how long is going to be credible that country (i.e., the lenders will trust that country will be able to pay its increasing debt?) (the trust problem)
dilemma today
no liquidity problem, but adjustment problem and trust problem.
Short term interest rates
Mainly determined by monetary policy
Goal of monetary policy
- Macroeconomic
↳ Price stability
↳Output equal to natural output - Financial
↳ Stability in the financial banking system
Who controls the monetary policy
The Central bank, which is independent form politics and markets
Necessary conditions for conventional monetary policy to work
- Usual operation of the banking system
- Keeping the option to generate a negative real interest rate (ie. avoid liquidity trap)
Non-conventional monetary policy instruments
- Change in injecting liquidity
- Quantitative easing
- Qualitative easing
- Forward guidance
↳ measures often lead to depreciation
Risk of monetary policy
- CPI inflation
- Asset inflation
- Losses faced by the CB
- Increasing inequality
- Penalty for risk-averse savers
- Fiscal dominance
Long term interest rates
In the long term and through the cycles, real interest rate is determined by
the profitability of physical capital and the evolution of economic growth and productivity
Determination of interest rates for long-term bonds equation
R = r + λr + πê +λπ
Define variables in long-term interest rates bonds equation
R - interest rate for long-term bonds
Real components:
r - real interest rates
λr - real interest rate premium
Inflation components:
πê - expected inflation
λπ - inflation premium
Reasons for downward trend in long term interest rates (last 3 decades)
- ▽r - interest rate down:
Higher saving rates (due to income inequality, aging western population, and emerging countries) and lower investment - ▽λr interest rate premium:
Financial markets development and innovations (higher options for hedging risks) - ▽πê inflation:
Growing credibility of monetary policy, globalization pushes down prices and costs - ▽λπ inflation premium:
Lower volatility in the business cycle (steady production, monetary policy stabilization, integration in the world economy)
