Macro Chapter 9

changes in the supply of U.S. dollars

- U.S. demand for imports - U.S. interest rate relative to the foreign interest rate - the expected future exchange rate

the exchange rate policies

- flexible exchange rate - fixed exchange rate - crawling peg

the outcomes of arbitrage in the foreign exchange market

- the law of one price - no round-trip profit - interest rate parity - purchasing power

changes in the demand for U.S. dollars

- world demand for U.S. exports - U.S. interest rate relative to the foreign interest rate - the expected future exchange rate

the exchange rate influences the quantity of U.S. dollars for two reasons:

1. exports effet 2. expected profit effect

the exchange rate influences the quantity of dollars supplied for two reasons:

1. imports effect 2. expected profit effect

what factors determines the quantity supplied of U.S. dollars in the foreign exchange market?

1. the exchange rate 2. U.S. demand for imports 3. interest rates in the United States and other countries 4. the expected future exchange rate

what factors determine demand of U.S. currency?

1. the exchange rate 2. world demand for U.S. exports 3. interest rate in the United States and other countries 4. the expected future exchange rate

current account balance

CAB = NX + net interest income + net transfers

government sector balance

GAB = net taxes - government expenditure

net exports

NE = exports of goods and services - imports of goods and services

debtor nation

a country that during its entire history has borrowed more from the rest of the world than it has lent to it. it has a stock of outstanding debt to the rest of the world that exceeds the stock of its own claims on the rest of the world

a creditor nation

a country that during its entire history has invested more in the rest of the world than other countries

net borrower

a country that is borrowing more from the rest of the world than it is lending to the rest of the world

net lender

a country that is lending more to the rest of the world than it is borrowing from the rest of the world

depreciation of the U.S. dollar

a fall in the exchange rate, we get less money for our dollar

the expected future exchange rate

a fall in the expected future exchange rate decreases the profit that can be made by holding U.S. dollars and decreases the quantity of U.S. dollars that people and business hold. to reduce their holdings of U.S. dollars assets, people and businesses must sell U.S. dollars, when they do so, the supply of the U.S. dollars in foreign exchange market increases

appreciation of the U.S. dollar

a rise in the exchange rate, we get more money for our dollar

the expected future exchange rate

a rise in the expected future exchange rate increases the profit that people expect to make by holding U.S. dollars and the demand for the U.S. dollar increases today. an increase in the demand for U.S. exports, a rise in the U.S. interest rate differential, or a rise in the expected future exchange rate increases the demand for U.S. dollars today and shifts the demand curve rightward

exchange rate votality

an exchange rate might rise one day and fall the next as news about the influence on the exchange rate changes the expected future exchange rate

crawling peg

an exchange rate that follows a path determined by a decision of the government or the central bank and is achieved in a similar way to a fixed exchange rate by central bank intervention in the foreign exchange market. works as a fixed exchange rate except that the target value changes. could change in fixed intervals (daily, weekly, monthly) - our fed has never acted in a crawling peg

fixed exchange rate

an exchange rate that is determined by a decision of the government of the central bank and is achieved by central bank intervention in the foreign exchange market to block the unregulated forces of demand and supply. intervention to buy U.S. dollars stops when U.S. official foreign currency reserves runs out

a flexible exchange rate

an exchange rate that is determined by demand and supply in the foreign exchange market with no direct intervention by the central band. if the Fed raises the U.S. interest rate and other countries keep their interest rates unchanged, the demand for U.S. dollars increases and the supply of U.S. dollars increases and the exchange rate rises. if the Fed lowers the U.S. interest rate, the demand for U.S. dollars decreases, the supply increases, and the exchange rate falls

U.S. demand for imports

an increase in the U.S. demand for imports increases the supply of U.S. dollars in the foreign exchange market

world demand for exports

an increase in the world demand for U.S. exports, increases the demand for U.S. dollars

no round trip profit

arbitrage removes profit from all transactions of this type

interest rate parity

borrowers and lenders must choose the currency in which to denominate their assets and debts. equal rates of return across currencies, means that for risk-free transactions, there is no gain from choosing one currency over the other

foreign exchange market

called Forex, where the currency from one country is exchanged for the currency of the other country

purchasing power partiy

equal value of money, when the value of money is not equal in two countries, an item in one location may cost less than in another location. if most goods and services cost more in one country than another, the currency of the first country said to be overvalued, a depreciation of the currency would restore PPP the currency of the country with the lower prices is said to be undervalued, an appreciation of that currency would restore PPP when goods and services cost the same in two countries there currencies are said to be at their PPP

supply in the foreign exchange market

people and businesses sell U.S. dollars and buy other currencies so they can buy foreign-produced goods and services - U.S. imports, or they can buy foreign assets such as stocks, bonds, businesses and real estate

balance of payment accounts

records a countries international trading, borrowing, and lending in: - current account - capital and financial account - official settlements accounts

capital and financial account

records foreign investment in the United States minus the U.S. investment abroad

current account

records receipts from exports of goods and services sold abroad, payments for imports of goods and services from abroad, net interest income paid abroad, and net transfers abroad

the official settlements account

records the change in U.S. official reserves

the law of one price

states that if an item is traded in more than one place, the price will be the same in all locations

U.S. interest rate differential

the U.S. interest rate minus the foreign interest rate if the U.S. interest rate rises and the foreign interest rate remains constant, the U.S. interest rate differential increases. the larger is the U.S. interest rate differential, the greater is the demand for U.S. assets and the greater is the demand for U.S. dollars in the foreign exchange market

who determines the exchange rate?

the foreign exchange market

U.S. official reserves

the government's holding of foreign currency increase - if the official settlements account balance is negative the sum of the balance of the three accounts always equals 0

expected profit effect

the higher the exchange rate today, the larger is the expected profit from selling U.S. dollars today and holding foreign currencies so the greater is the quantity of U.S. dollars supplied in the foreign exchange market

the law of supply of foreign exchange

the higher the exchange rate, the greater is the quantity of U.S. dollars supplied in the foreign exchange market

the law of demand for foreign exchange

the higher the exchange rate, the smaller is the quantity of U.S. dollars demanded in the foreign exchange market

U.S. interest rate relative to the foreign interest rate

the higher the interest rate that people can make on U.S. assets compared with foreign assets, the more U.S. assets the buy today

U.S. interest rate relative to the foreign interest rate

the larger the U.S. interest rate differential, the smaller is the supply of U.S. dollars in the foreign exchange market. a rise in the U.S. interest rate, decreases the supply of U.S. dollars in the foreign exchange market

expected profit effect

the larger the expected profit holding from U.S. dollars, the greater is the quantity of U.S. dollars demanded in the foreign exchange market for a given expected future exchange rate, the lower the exchange rate today, the larger is the profit from buying U.S. dollars today and holding them, so the greater is the quantity of U.S. dollars demanded in the foreign exchange market

exports effect

the larger the value of U.S. exports, the larger is the quantity of U.S. dollars demanded by the buyers of U.S. exports in the foeign exchange market. the lower the exchange rate, the lower are the prices of U.S. produced good and services to foreigners and the greater is the volume of U.S. exports

imports effect

the larger the value of U.S. imports, the larger is the quantity of U.S. dollars supplied in the foreign exchange market. the higher the exchange rate, the lower are the prices of foreign-produced goods and services to Americans and the greater is the volume of U.S. imports. if the exchange rate rises, the quantity of U.S. dollars supplied in the foreign exchange market increases

foreign currency

the money of other countries regardless of whether the money is in the form of notes, coins or bank deposits

arbitrage

the practice of seeking to profit by buying in one market and selling for a higher price in another related market

exchange rate

the price at which one currency exchanges for another currency in the foreign exchange market - can flucutate

demand in Forex

the quantity of U.S. dollars demanded in the foreign exchange market is the amount that traders plan to buy during a given time period at a given exchange rate

the real exchange rate

the relative price of U.S. produced goods or services to foreign-produced goods and services. RER = ( E x P ) / P* E = exchange rate (yen per dollar) P = the U.S. price level P* = the japanese price level

the current account balance

the sum of exports minus imports, net interest income, and net transfers

speculation

trading on the expectation of making a profit (contradicts with arbitrary, which is trading on the certainty of making a profit)

the expected future exchange rate

use scientific models and data to make their predictions, but there is a great level of uncertainty. the dependence of today's exchange rate of forecasting of tomorrow's exchange rate can give rise to exchange rate volitality in the short run

round trip profit

using currency A to buy currency B, and then using B to buy A

foreign exchange brokers

what the foreign exchange market is made up of, thousands of people - importers and exporters, banks, international investors and speculators, international travelers, and specilaist traders

changes in the exchange rate

when the demand for dollars or the supply for dollars changes - if the demand for dollars increases and the supply does not change, the exchange rate rises - if the demand for dollars decreases and the supply does not change, the exchange rate decreases - if the supply of dollars decreases and the demand does not change, the exchange rate rises. - if the supply of dollars increases and the demand does not change, the exchange rate falls