1 / 42

10. Foreign Exchange

10. Foreign Exchange. The basics Long run / PPP Short run / Demand & Supply Gov’t intervention. Exchange rates (XR). Price of one countries currency in terms of another Impacts Relative prices of imports/exports Attractiveness of domestic vs. foreign assets. Two ways to quote XR.

akio
Download Presentation

10. Foreign Exchange

An Image/Link below is provided (as is) to download presentation Download Policy: Content on the Website is provided to you AS IS for your information and personal use and may not be sold / licensed / shared on other websites without getting consent from its author. Content is provided to you AS IS for your information and personal use only. Download presentation by click this link. While downloading, if for some reason you are not able to download a presentation, the publisher may have deleted the file from their server. During download, if you can't get a presentation, the file might be deleted by the publisher.

E N D

Presentation Transcript

  1. 10. Foreign Exchange • The basics • Long run / PPP • Short run / Demand & Supply • Gov’t intervention

  2. Exchange rates (XR) • Price of one countries currency in terms of another • Impacts • Relative prices of imports/exports • Attractiveness of domestic vs. foreign assets

  3. Two ways to quote XR • Foreign currency per 1 US $ • Used to quote • Yen (Japan) • Yuan (China) • Won (S. Korea) • Peso (Mexico) • Rupees (India) • Canadian $

  4. US $ per 1 unit of foreign currency • Euro • British Pound

  5. XR market • Worldwide market • $1 trillion in transactions daily • 90% involve US $ • Size of economy • Store of value • World price of oil in US $

  6. Nominal XR • Rate of one country’s currency exchanges for another

  7. US $ Depreciation • US $ buys less of foreign currency • 2000-2008 • Canada, Euro, UK, China . . . • Most major trading partners • US $ has fallen • US $ is weaker

  8. US $ appreciation • US $ buys more of foreign currency • 2000-2008 • Mexico • US $ has risen • US $ is stronger

  9. Example: Yen/$ • If $ appreciates, the Yen must depreciate • XR are a “seesaw” • XR changes have winners and losers

  10. Real XR • Relative cost of certain goods in two countries • Changes in the nominal XR

  11. Example: U.S. $ vs. Can $ • SUNY tuition, nonresident • Fall 2000: $4150/sem • Fall 2007: $5305/sem • The finest system of public higher ed in the nation: priceless • XR • Fall 2000: $1.50 C$ per 1 US $ • Fall 2007: $1.10 C$ per 1 US $

  12. How much is tuition to a Canadian student? • Convert US $ tuition to Can $ • 2000: 4150(1.50) = C$ 6225 • 2007: 5305(1.10) = C$ 5835.50 • Can $ appreciation means an actual fall in tuition for Canadian students

  13. U.S. $ depreciation • Imported goods more expensive • Less purchasing power abroad • Exports less expensive abroad • Foreign visitors have more purchasing power

  14. Univ of W. Ontario, nonresident • Fall 2000: C$ 5190/sem • Fall 2007: C$ 7300/sem • Tuition costs for a U.S. student • 2000: 5190/1.5 = $3460 • 2007: 7300/1.1 = $6636

  15. XR in the long run • Primarily depends on relative inflation • Law of One Price • Identical goods should be about the same price everywhere in the world

  16. Pack of gum • If $1 = 115 yen • Then gum should cost $1 in U.S. and 115 Y in Japan

  17. Now suppose prices double in US, so gum is $2. • At the XR of 115Y/$, gum is cheaper in Japan • Gum is 115Y or $1 in Japan • Run on gum in Japan

  18. To equalize things, • XR moves: $ must depreciate • 57.5Y/$ then gum is same price

  19. Purchasing power parity (PPP) • XR adjust to relative price changes in two countries, so law of one price holds • If US inflation is higher than other countries • $ depreciate • If lower, then $ appreciates

  20. Does PPP hold? • In the long run, yes • In the short run, no way • Big Mac Index (240-41) • Not all goods identical or traded across countries

  21. Other LR factors • Trade barriers—tariffs/quotas • Boost domestic demand • $ appreciates • Productivity -- GDP/labor hour • Higher relative productivity in US • $ appreciates

  22. XR in the Short Run • Supply and Demand, US $ • Explains short term volatility

  23. Who supplies $ to XR market? • People buying foreign goods • People investing in foreign assets • As $ appreciates (Price of $ rises) • People buy more foreign goods because they are cheaper • Supply slopes up

  24. E/$ Q of $ S

  25. Who demands $ in XR market? • People wanting to buy U.S. goods or dollar assets • As $ depreciates (Price of $ falls) • People buy more US goods because they are cheaper • Demand slopes down

  26. E/$ Q of $ S D

  27. What causes the $ to depreciate? • An increase in the supply of $ • A decrease in the demand for $

  28. What increases $ supply? • Increase in preference for foreign goods • An increase in US GDP and income • Buy more imports • An increase in real interest rate on foreign bonds relative to US OR decrease in relative foreign investment risk • Investors supply more $ to buy them • Expectation of $ depreciation • People supply $ now

  29. What decreases $ demand? • Decrease in preference for US goods in foreign countries • A decrease in foreign GDP/income • A decrease in real interest rate OR increase in relative risk of U.S. bonds and investments • An expected depreciation of the $

  30. E/$ S’’ Q of $ Increase in $ supply S D

  31. E/$ D’’ Q of $ Decrease in $ demand S D

  32. So what is causing $ depreciation? • Trade deficit • US imports > US exports As $ depreciates, this will narrow the trade deficit • Federal deficit • World market believes the US borrows too much?

  33. Consequences? • The good: • Rising US exports • Tourism in US • Less pressure for trade barriers

  34. The bad: • Possible inflation (higher import prices) • US tourists abroad • US debt less attractive • Pressure to move oil pricing to Euros

  35. Government Intervention • Can the government affect XR markets? • Yes, but interventions are rare • Only effective if nations cooperate, scale is large • At best interventions are short run solutions

More Related