Download Appreciation

The Open Economy:
FOREX Models,
Graphs, and Practice
Copyright © 2004 South-Western
Mods
42-44
Understanding Exchange Rates
Foreign Exchange
Market
•Exchange Rates
•Appreciate
US $
JP ¥
€
$1.00
1
98.3
0.77
¥1
0.0101
1
.0078
€1.00
1.3
127.9
1
•Depreciate
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Quick Review Guide of Exchange
Rate Features
Appreciation:
• When a currency appreciates, it gains in value in
relation to another currency. It would take less of that
currency to “buy” the other currency.
• We say that the appreciated currency has
strengthened.
• Because of that appreciation, the goods of that
country would cost more for other countries to buy,
so exports of the appreciated currency’s country
would decline.
• Appreciation of your currency is good if you are
traveling, but bad if you are an exporter of goods.
Copyright © 2004 South-Western
Quick Review Guide of Exchange
Rate Features
Depreciation:
• When a currency depreciates, it loses in value in
relation to another currency. It would take more of
that currency to “buy” the other currency.
• We say that the depreciated currency has weakened.
• Because of that depreciation, the goods of that
country would cost less for other countries to buy, so
exports of the depreciated currency’s country would
increase.
• Depreciation of your currency is bad if you are
traveling, but good if you are an exporter of goods.
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The Equilibrium Exchange Rate
Graph
•FOREX
follows laws of
supply &
demand
•Equilibrium
Exchange Rate
Copyright © 2004 South-Western
The steps for FOREX analysis
1. Draw 2 FOREX graphs (S & D graphs)
2. For X axes:
•
•
One for Q of 1 country’s currency—QD
One for Q of other country’s currency--Q€
3. For Y axes, always put the country’s currency
that you’ve drawn the graph for as the
denominator. In other words, “what goes
below (in the X axis), goes below” (in the Y
axis denominator).
Copyright © 2004 South-Western
The steps for FOREX analysis
3. Draw in S & D curves on each FOREX graph
4. Look at the problem or scenario
•
•
•
Think: “Who is wanting to buy what?”
On the graph for the country that will be doing the
buying, shift supply to show increase in supply of
their currency.
On the graph for the country where things will be
bought, shift demand to show increase in demand
for their currency
5. Read the new Ep for appreciation or depreciation
Copyright © 2004 South-Western
Wksht Practice
• FOREX Wksht
• Capital Flows Wksht
• Monetary and Fiscal Policy and Exchange
Rates Wksht
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Inflation and Real Exchange Rates
•Nominal Exchange Rates
•Real Exchange Rates
Copyright © 2004 South-Western
Exchange Rate Policy
• Governments have more
power to influence nominal
exchange rates than other
prices
• Exchange rates are
important to countries where
exports and imports are a
large fraction of GDP
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Exchange Rate Regimes
•Exchange Rate Regime
•Fixed Exchange Rate
•Floating Exchange Rate
•"Managed" & "Target Zone"
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How Can an Exchange Rate Be
Held Fixed?
•Exchange Market
Intervention
•Foreign Exchange
Reserves
•Foreign Exchange
Controls
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The Exchange Rate Regime
Dilemma
•The Case for Fixed Exchange Rates
• Facilitates trade by creating certainty about the
exchange rate
• Acts as a check on inflationary policies
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The Exchange Rate Regime
Dilemma
•The Case against Fixed Exchange Rates
• Requires large foreign currency reserves
• May divert monetary policy
• Distorts incentives
• Opportunity for corruption
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Purchasing Power Parity
•The notion that a dollar should buy the
same amount in all countries.
•In the long run, the exchange rate
between two countries should move
towards the rate that equalizes the prices
of an identical basket of goods and
services in each country.
•The Economist mag’s Big Mac Index:
•Our "basket" is a McDonald's Big
Mac, which is produced in about 120
countries.
Copyright © 2004 South-Western
Big Mac Index—January 2014
Copyright © 2004 South-Western