1、1International Economics 国际经济学2International EconomicsBy Robert J.Carbaugh9th EditionChapter 13:Exchange-Rate Determination3Exchange-Rate DeterminationMain ContentsnThis chapter seeks to explain the forces that underlie currency appreciation and deprecation under a system of market-determined(floati
2、ng)exchange rates.4Exchange-rate determination in a free marketIf we are to understand why some currencies depreciate and other appreciate,we must investigate the factors that cause the supply and demand schedules of currencies to change.These factors include market fundamentals(economic variables)a
3、nd market expectations.Exchange-Rate DeterminationExchange-Rate DeterminationFactors influencing exchange ratesnMarket fundamentals(市场基本要素）nBilateral trade balancesnReal incomenReal interest ratesnInflation ratesnConsumer preferences for domestic or foreign productsnProductivity changes affecting pr
4、oduction costsnProfitability and riskiness of investmentsFactors influencing exchange ratesnMarket fundamentals(contd)nProduct availabilitynMonetary policy and fiscal policynGovernment trade policynMarket expectations（市场预期）nNews about future market fundamentalsnSpeculative opinion about future excha
5、nge ratesExchange-Rate DeterminationWhen are these factors important?nShort run(days)nDominated by financial transfers responding to:nDifferences in real interest ratesnShifting expectations of future exchange ratesnMedium run(months)nPrimarily influenced by economic cyclesExchange-Rate Determinatio
6、nWhen are these factors important?nLong run(years)nDominated by movements of goods,services,investment,which are influenced by:nInflation ratesnInvestment profitabilitynConsumer tastesnReal incomenProductivitynTrade policynHow these factors interact to affect exchange rates depends on the relative i
7、mportance of trade and financial relations between the countriesExchange-Rate DeterminationWhen are these factors important?nExchanges rates are determined simultaneously by long-run structural,medium-run cyclical,and short-run speculative forces.nThere exists some equilibrium level or path to which
8、 a currency will eventually gravitate.Exchange-Rate DeterminationFactors influencing exchange ratesReal income differentialsnA country with faster economic growth than the rest of the world will have a depreciating currency(other things being equal)nImports rise faster than exports,so demand for for
9、eign currency rises faster than its supplyImpact of real income differentialsFactors influencing exchange ratesFactors influencing exchange ratesReal income differentialsnOne shouldnt conclude that a strong currency is an indicator of a strong economy.nReal income changes can also reflect other proc
10、esses,which might lead to rising exportsnFor example,the rise in real income is due to a supply-side factor-an improvement in the nations productivity.Factors influencing exchange ratesReal interest ratesnShort term real interest rate differences influence international capital movementsnEasy credit
11、,low short term rates lead to less demand for the currency and depreciationnTight credit,high rates lead to greater demand for the currency and appreciationImpact of interest rate differentialsFactors influencing exchange ratesFactors influencing exchange ratesReal interest ratesnMost experts in int
12、ernational finance agree that interest-rate differentials are a major determinant of exchange rates in the short run.nFor international investors,it is relative changes in the real interest（实际利率）that matter.Factors influencing exchange ratesReal interest ratesnNominal interest rate（名义利率）refers to th
13、e rate of return on assets that can be earned in a particular country,not adjusted for the rate of inflation.nReal interest rate（实际利率）is the nominal exchange rate adjusted for changes in relative price level.Real interest rate=nominal interest rate-inflation rateBackFactors influencing exchange rate
14、sReal interest ratesnCountries that experience relatively low real interest rates tend to find their currencies depreciating.Inflation Rates,Purchasing Power Parity,Long-Run Exchange RatesnLaw of one pricenAn identical good should cost the same in all nations,assuming costless shipping and no barrie
15、rsnTheory:Pursuit of profits and price equalizationnSingle price might not apply in practicenBig Mac indexnPrimitive and has many flaws but widely understood nServes as an approximation of currency strengthnPrice of a Big Mac(Table 12.3)BackFactors influencing exchange ratesRelative purchasing power
16、 paritynWhen applying the purchasing-power-parity concept,most analyst consider a nations overall inflation(deflation)rate measured by the producer price index or consumer price index.Purchasing Power ParitynPurchasing power parity theorynExchange rates are related to differences in the level of pri
17、ces between two countriesnChanges in relative national price levels determine changes in exchange rates over the long runnGiven in symbols as:nApplication of the concept(Table 12.4)BackImpact of inflation rate differentialsFactors influencing exchange ratesPurchasing Power ParitynLimitations of the
18、theorynOverlooks the fact that exchange-rate movements may be influenced by investment flowsnChoosing the appropriate price index nDetermining the equilibrium period basenGovernment policy interferencenPredictive power most evident in the long runnPurchasing power parity:U.S.-United Kingdom(Figure 1
19、2.3)ContinuedBackFactors influencing exchange ratesRelative purchasing power paritynEvidence concerning the validity of the purchasing-power-parity theory is mixed.nThe purchasing-power-parity theory also doesnt appear to hold as well when tests are conducted over relatively short time period.nOver
20、a sufficiently long period it is possible that economic forces work to maintain purchasing-power-parity levels.Factors influencing exchange ratesOther market fundamentals nBilateral trade relationshipsnConsumer TastesnInvestment ProfitabilitynProduct AvailabilitynProductivity ChangesnTrade PolicyMar
21、ket Fundaments and Dollars Exchange ValueExchange-Rate DeterminationFactorchangeEffect on Dollars Exchange ValueForeign demand for U.S.exportsDecreaseDepreciationIncreaseAppreciationForeign demand for U.S.assetsDecreaseDepreciationIncreaseAppreciationU.S.demand for foreign exportsDecreaseAppreciatio
22、nIncreaseDepreciationU.S.demand for foreign assetsDecreaseAppreciationIncreaseDepreciationMarket Fundaments and Dollars Exchange ValueExchange-Rate DeterminationFactorchangeEffect on Dollars Exchange ValueU.S.price levelDecreaseAppreciationIncreaseDepreciationU.S.interest ratesDecreaseDepreciationIn
23、creaseAppreciationU.S.real incomeDecreaseAppreciationIncreaseDepreciationU.S.ProductivityDecreaseDepreciationIncreaseAppreciationU.S.trade restrictionsDecreaseDepreciationIncreaseAppreciationFactors influencing exchange ratesMarket expectationsnFluctuations in exchange rates are sometimes too large
24、and too sudden to be explained by market fundamental,they are subject to market expectations,that is to say rates can move in anticipation of future changes.Factors influencing exchange ratesMarket expectationsnLike stocks,foreign exchange rate react quickly to news or even rumors that point to futu
25、re changes affecting rates.Market expectations and Exchange-Rate FluctuationsUnanticipated rise in the growth of the U.S money supply occurs Factors influencing exchange ratesMarket expectationsnFuture expectations can be self-fulfilling.n The exchange rate is also effected by speculative bubbles（投机
26、泡沫）,which can start without any real information but can become self sustaining for a while.Factors influencing exchange ratesMarket expectationsFactorChangeEffect on Dollars Exchange ValueExpected U.S.price levelIncreaseDepreciationDecreaseAppreciationExpected U.S.interest rateIncreaseAppreciationD
27、ecreaseDepreciationExpected U.S.trade barriersIncreaseAppreciationDecreaseDepreciationExpected U.S.import demandIncreaseDepreciationDecreaseAppreciationExpected U.S.productivityIncreaseAppreciationDecreaseDepreciationFactors influencing exchange ratesInteraction of exchange rate determinantsnWhether
28、 the home currency will rise or fall against the foreign currency depends on the nature of the international transactions between the two countriesnInvestment interest ratenInternational trade real income and inflationFactors influencing exchange ratesThe federal reserve and the Monetary approach to
29、 exchange-rate determinationnMonetary approach（货币分析法）was put forward by J.Frenkel（弗兰克尔）、M.Mussa（穆萨）et al in 1970s.nMonetary approach sees exchange rates as determined by the free-market responses to changes in the total demands and supplies of national currencies.Factors influencing exchange ratesTh
30、e federal reserve and the Monetary approach to exchange-rate determinationnThey emphasizes the fact that the foreign-exchange markets is a monetary phenomenon,where monies are traded for monies.nExchange-rate is the relative price between the currencies in two countries,not the relative price betwee
31、n the commodities.(汇率是两国货币的相对价格，而不是两国商品的相对价格)Factors influencing exchange ratesThe federal reserve and the Monetary approach to exchange-rate determinationnAssumptions:nAggregate supply curve is vertical(垂直的总供给曲线),which means wage is flexible,price is also flexible and the variations of price wont e
32、ffect the output.nThe demand for money is steady（稳定的货币需求）nThe theory of PPP is tenable（购买力平价的成立）Factors influencing exchange ratesThe federal reserve and the Monetary approach to exchange-rate determinationnThe aggregate demand for money in a nation depends on the level of nReal income nPrices nInte
33、rest rates nMd=P L(i，Y)Md/P=L(i，Y)nMoney supplies can be controlled by central banks.Factors influencing exchange ratesThe federal reserve and the Monetary approach to exchange-rate determinationnWhen in equilibrium:Ms=Md Ms/P=L(i，Y)nIn PPP theorynSo:*EPPP=(i,Y)ssdMMML*/(,)E=/(,)sdssdsM MM L i YM MM
34、L i YFactors influencing exchange ratesThe federal reserve and the Monetary approach to exchange-rate determinationnThe quantity of money supplied is predicted not to influence the amount of output,(real)interest rates,and the aggregate demand of real monetary assets L(i,Y).nHowever,the quantity of
35、money supplied is predicted to make the level of average prices adjust proportionally.nThe equilibrium condition Ms/P=L(i,Y)shows that P is predicted to adjust proportionally when Ms adjusts,because L(i,Y)does not change.Factors influencing exchange ratesThe federal reserve and the Monetary approach
36、 to exchange-rate determinationPrice is completely flexible.We call it flexible price monetary approach.（弹性价格货币分析法）（弹性价格货币分析法）Factors influencing exchange ratesThe federal reserve and the Monetary approach to exchange-rate determinationChangeImpactIncrease in money supplyDepreciationDecrease in mone
37、y supplyAppreciationIncrease in money demandAppreciationDecrease in money demandDepreciationIt emphasizes that movements in currency values play a primary role in restoring equilibrium between money demand and money supply.Factors influencing exchange ratesThe federal reserve and the Monetary approa
38、ch to exchange-rate determinationnShortcomingsnIt offers only a partial view of the forces influencing exchange rates,ignoring nonmonetary assets nIt is controversial that price is completely flexiblenIt is based on PPP,so if the PPP is untenable,its creditability will be doubtfulFactors influencing
39、 exchange ratesThe federal reserve and the Monetary approach to exchange-rate determinationnIt is helpful to predict the changes of exchange-rate in the long term.nIt highlights the importance of monetary policy in influencing exchange rates,and correctly warns that excessive monetary expansion lead
40、s to currency depreciation.Factors influencing exchange ratesExchange-rate overshootingnThe Overshooting Model or Exchange rate overshooting（汇率超调）（汇率超调）,first established by economist Rudi Dornbusch（多恩布什）in 1976,is referred to sticky price monetary approach（粘性价格货币分析法）Factors influencing exchange rat
41、esExchange-rate overshootingnOvershooting is an instance of an exchange rates short-run response to a change in market fundamentals is greater than its long-run response.nIt is an important phenomenon because it helps explain why exchange rates depreciate or appreciate so sharply from day to day.Sho
42、rt,long run equilibrium:overshootingExchange rate marketsFactors influencing exchange ratesExchange-rate overshootingnOvershooting can be explained bynThe tendency of elasticity to be smaller in the short run than in the long run.nExchange rates tend to be more flexible than many other prices.Factor
43、s influencing exchange ratesExchange-rate overshootingFactors influencing exchange ratesExchange-rate overshootingnThe Overshooting Model or Exchange rate overshooting（汇率超调）first involved the dynamic adjustments of exchange rate,after that an important branch of exchange rate theory Exchange Rate dy
44、namics（汇率动态学）was established.Factors influencing exchange ratesFinancial assets as determinants of exchange ratesnCapital flows have become more important than trade in determining exchange rates.nOnly 1 to 2 percent of all foreign-exchange transactions are related to the financing of exports and im
45、ports.nDecisions to hold foreign or domestic financial assets play a much greater role in the determination of exchange rates than the demand for imports and exports does.Factors influencing exchange ratesFinancial assets as determinants of exchange ratesnThe asset-market approach（资产市场分析法）,or asset
46、portfolio balance approach（资产组合平衡法）is a method of determining short-run exchange rates where investors consider two key factors when deciding between domestic and foreign investment-relative levels of interest rates and expected changes in the exchange rate itself over the term of the investment.Fac
47、tors influencing exchange ratesAsset-market ApproachnW=M+B+rFnThe asset-markets approach assumes that domestic and foreign bonds are not perfect substitutes.nInvestors balance their portfolios among domestic money,domestic bonds,and foreign-currency bonds.nThey modify their portfolios as conditions
48、change.Factors influencing exchange ratesAsset-market ApproachnIn the process of equilibrating the demand for,and supply of financial assets in each country that determinants the exchange rate.nFactors influenced the investors portfolionThe holders wealth and tastesnThe level of domestic and foreign
49、 interest ratesnExpectations of future inflationFactors influencing exchange ratesAsset-Market ApproachnThere is no unified theory of exchange-rate determination based on the asset-markets approach that has proved reliable in forecasting.nRationale:nJapanese yen in 1999nEuro in 1999Exchange rate mar
50、ketsForecasting exchange ratesnEven a clear understanding of how factors influence exchange rates doesnt guarantee that we can forecast how exchange rate will change.nDeterminants often point in the opposite directionnPredicting how the determinants will change is difficultExchange rate marketsForec
