Professional Documents
Culture Documents
Arbitrage has been eliminated due to telecommunications
Forex equilibrium
o When selling dollars for euros, the euro appreciates until the exchange
rate equals the rate of return
o Expected depreciation:
o Interest Parity Condition:
All currencies are equally
desirable
Change in interest rate: If
people switch to , sell $ and
buy , $ value depreciates,
and
Change in
: If
, causes
, switch to $, buy $
and sell ,
Chapter 15
Money is a medium of exchange (eliminates informational needs, and the
problem of wants) and a unit of account goods are determined in terms of
their monetary value) and a store of value
Government facilitates monetary system by taxing in currency
Liquid assets have small interest, illiquid have high interest
Money Markets and Interest Rates
Money demand is determined by interest rates, liquidity, and risk
o Inversely related to the interest rate
Money supply is determined by the Central Bank
Inflated interest rates
o At ,
Chapter 16
Exchange rates in the long run
Law of one price states prices are equal
Purchasing power parity
o
Expected appreciation and interest rates
o
o When inflation occurs, the exchange rate must change to meet changing
purchasing power
Monetary approach
PPP Theory of exchange rates in the
long run
Shortcomings of PPP
- no data support
-law of one price does
not hold
-trade barriers
-imperfect competition
-different measures
o
Fischer Effect
o Interest rates should move together with inflation
o
o In the long run, real interest rates must be equal
Long Run Interest Rate Model
Real exchange rate approach
o
o If absolute PPP holds then
o If relative PPP holds then
Relative demand and supply for goods
Relative demand for US goods increases, relative
and
Relative output supply of US goods increases, relative
and
o
o
Balassa Samuelson Effect
o Relative price rise as a country becomes richer and nominal inflation will
increase
o Prices in tradeables and non-tradeables , demand for non-tradeables ,
and appreciation occurs
o Productivity gains occur in the tradeable sector
Import quotas/tariffs
o
Chapter 17
Output, interest rates, and exchange rates
Determinates of aggregate demand
Output (actual spending) and aggregate demand (planned spending
IS, AS, LM, AA curves
AD/IS shifts right
o
o
o
AA/LM shifts right
o
o