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Short-Run Exchange Rate Determination

Part I Factors Determining Rates. In the Short Run, the price of foreign exchange rises when1. The foreign interest rate rises relative to ours. Why might this be?(Mobile, investment funds follow the higher rates. As they change countries, they bid up currency values.). Short-run Exchange R

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Short-Run Exchange Rate Determination

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    1. Short-Run Exchange Rate Determination Issues in Global Trade & Finance Prof. Bryson

    2. Part I Factors Determining Rates

    3. In the Short Run, the price of foreign exchange rises when 1. The foreign interest rate rises relative to ours. Why might this be? (Mobile, investment funds follow the higher rates. As they change countries, they bid up currency values.) Short-run Exchange Rate Determination

    4. The price of foreign exchange also rises when 2. The expected future spot exchange rate rises. How come? (If you expect you will have to pay more for the Euros you will need later because you expect the Euro/Dollar rate to rise, why not buy now before it does? Thus, the increased demand for Euros will bid the price up now.) Short-run Exchange Rate Determination

    5. How It Works Normally, returns on domestic and foreign government bonds tend to equality. Why? Differences cause investors to reposition their portfolios, affecting exchange and interest rates. Currency rates will rise when people buy in order to invest in foreign, short-term funds.

    6. Determining Factors in Foreign Exchange Prices The role of expectations is extremely important in forecasting the future. Lacking other information, what is the universal law of forecasting? We extrapolate recent change into the future. Lacking other information, the future will look like the present. The bandwagon effect.

    7. Determining Factors in Foreign Exchange Prices Once expectations are positive and buying goes on, we can begin a process of destabilizing speculation. Friedman and bad speculation (buying high and selling low). Bad currency speculation can lead to overshooting, where speculation may go in the right direction, but move past the equilibrium point.

    8. Determining Factors in Foreign Exchange Prices Expectations can be based on various kind of news on, e.g., policies, trade data or performance, international political tensions and situations.

    9. Determining Factors in Foreign Exchange Prices An increase in money supply drives the interest rates down at first, then prices begin to rise (the “chasing dollars” thing, and currency values are driven down in the long run.

    10. Determining Factors in Foreign Exchange Prices When movements in exchange rates are not explainable as a function of the economic situation, they are referred to as speculative bubbles.

    11. Markets, Exchange, and Interest Rates Investing abroad has two steps. First, get the exchange (DM, F, €, ¥, £) Second, invest in foreign government bonds at high i rates

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