1、Slide 14-1Copyright 2003 Pearson Education,Inc.IntroductionFactors that affect a countrys money supply or demand are among the most powerful determinants of its currencys exchange rate against foreign currencies.This chapter combines the foreign-exchange market with the money market to determine the
2、 exchange rate in the short run.It analyzes the long-term effects of monetary changes on output prices and expected future exchange rates.Slide 14-2Copyright 2003 Pearson Education,Inc.Money Defined:A Brief ReviewMoney as a Medium of ExchangeA generally accepted means of paymentMoney as a Unit of Ac
3、countA widely recognized measure of valueMoney as a Store of ValueA transfer of purchasing power from the present into the futureSlide 14-3Copyright 2003 Pearson Education,Inc.What Is Money?Assets widely used and accepted as a means of payment.Money is very liquid,but pays little or no return.All ot
4、her assets are less liquid but pay higher return.Money Supply(Ms)Ms=Currency+Checkable DepositsMoney Defined:A Brief ReviewSlide 14-4Copyright 2003 Pearson Education,Inc.How the Money Supply Is DeterminedAn economys money supply is controlled by its central bank.The central bank:Directly regulates t
5、he amount of currency in existence Indirectly controls the amount of checking deposits issued by private banks Money Defined:A Brief ReviewSlide 14-5Copyright 2003 Pearson Education,Inc.Three factors influence money demand:Expected returnRiskLiquidityExpected ReturnThe interest rate measures the opp
6、ortunity cost of holding money rather than interest-bearing bonds.A rise in the interest rate raises the cost of holding money and causes money demand to fall.The Demand for Money by IndividualsSlide 14-6Copyright 2003 Pearson Education,Inc.RiskHolding money is risky.An unexpected increase in the pr
7、ices of goods and services could reduce the value of money in terms of the commodities consumed.Changes in the risk of holding money need not cause individuals to reduce their demand for money.Any change in the riskiness of money causes an equal change in the riskiness of bonds.The Demand for Money
8、by IndividualsSlide 14-7Copyright 2003 Pearson Education,Inc.LiquidityThe main benefit of holding money comes from its liquidity.Households and firms hold money because it is the easiest way of financing their everyday purchases.A rise in the average value of transactions carried out by a household
9、or firm causes its demand for money to rise.The Demand for Money by IndividualsSlide 14-8Copyright 2003 Pearson Education,Inc.Aggregate Money DemandAggregate money demandThe total demand for money by all households and firms in the economy.It is determined by three main factors:Interest rate It redu
10、ces the demand for money.Price level It raises the demand for money.Real national income It raises the demand for money.Slide 14-9Copyright 2003 Pearson Education,Inc.The aggregate demand for money can be expressed by:Md=P x L(R,Y)(14-1)where:P is the price levelY is real national incomeL(R,Y)is the
11、 aggregate real money demandEquation(14-1)can also be written as:Md/P=L(R,Y)(14-2)Aggregate Money DemandSlide 14-10Copyright 2003 Pearson Education,Inc.Figure 14-1:Aggregate Real Money Demand and the Interest RateL(R,Y)Interest rate,RAggregate realmoney demandAggregate Money DemandSlide 14-11Copyrig
12、ht 2003 Pearson Education,Inc.Figure 14-2:Effect on the Aggregate Real Money Demand Schedule of a Rise in Real IncomeL(R,Y2)Increase inreal incomeL(R,Y1)Interest rate,RAggregate realmoney demandAggregate Money DemandSlide 14-12Copyright 2003 Pearson Education,Inc.Equilibrium in the Money MarketThe c
13、ondition for equilibrium in the money market is:Ms=Md (14-3)The money market equilibrium condition can be expressed in terms of aggregate real money demand as:Ms/P=L(R,Y)(14-4)The Equilibrium Interest Rate:The Interaction of Money Supply and DemandSlide 14-13Copyright 2003 Pearson Education,Inc.The
14、Equilibrium Interest Rate:The Interaction of Money Supply and DemandFigure 14-3:Determination of the Equilibrium Interest RateAggregate realmoney demand,L(R,Y)Interest rate,RReal moneyholdingsReal money supplyMS P(=Q1)R2Q22R11R3Q33Slide 14-14Copyright 2003 Pearson Education,Inc.Interest Rates and th
15、e Money SupplyAn increase(fall)in the money supply lowers(raises)the interest rate,given the price level and output.The effect of increasing the money supply at a given price level is illustrated in Figure 14-4.The Equilibrium Interest Rate:The Interaction of Money Supply and DemandSlide 14-15Copyri
16、ght 2003 Pearson Education,Inc.M2 PR22M1 PReal money supplyReal moneysupply increaseThe Equilibrium Interest Rate:The Interaction of Money Supply and DemandFigure 14-4:Effect of an Increase in the Money Supply on the Interest RateL(R,Y1)R11Interest rate,RReal moneyholdingsSlide 14-16Copyright 2003 P
17、earson Education,Inc.Output and the Interest RateAn increase(fall)in real output raises(lowers)the interest rate,given the price level and the money supply.Figure 14-5 shows the effect on the interest rate of a rise in the level of output,given the money supply and the price level.The Equilibrium In
18、terest Rate:The Interaction of Money Supply and DemandSlide 14-17Copyright 2003 Pearson Education,Inc.Q21The Equilibrium Interest Rate:The Interaction of Money Supply and DemandFigure 14-5:Effect on the Interest Rate of a Rise in Real IncomeL(R,Y1)L(R,Y2)Increase inreal incomeReal money supplyMS P(=
19、Q1)R22R11Interest rate,RReal moneyholdingsSlide 14-18Copyright 2003 Pearson Education,Inc.The Money Supply and the Exchange Rate in the Short RunShort run analysisThe price level and the real output are given.Long run analysisThe price level is perfectly flexible and always adjusted immediately to p
20、reserve full employment.Slide 14-19Copyright 2003 Pearson Education,Inc.Linking Money,the Interest Rate,and the Exchange RateThe U.S.money market determines the dollar interest rate,which in turn affects the exchange rate that maintains the interest parity.Figure 14-6 links the U.S.money market(bott
21、om)and the foreign exchange market(top).The Money Supply and the Exchange Rate in the Short RunSlide 14-20Copyright 2003 Pearson Education,Inc.The Equilibrium Interest Rate:The Interaction of Money Supply and DemandFigure 14-6:Simultaneous Equilibrium in the U.S.Money Market and the Foreign-Exchange
22、 MarketReturn on dollar depositsExpectedreturn oneuro depositsL(R$,YUS)U.S.real money holdingsRates of return(in dollar terms)Dollar/euro exchange Rate,E$/0(increasing)ForeignexchangemarketMoneymarketE1$/1R1$1U.S.realmoneysupplyMSUS PUSSlide 14-21Copyright 2003 Pearson Education,Inc.The Equilibrium
23、Interest Rate:The Interaction of Money Supply and DemandFigure 14-7:Money-Market/Exchange Rate LinkagesEuropean money marketUnited Statesmoney marketEuropeEuropean System of Central BanksUnited StatesFederal Reserve System(United Statesmoney supply)MSUSMSE(European money supply)R$(Dollar interest ra
24、te)R(Euro interest rate)ForeignexchangemarketE$/(Dollar/Euro exchange rate)Slide 14-22Copyright 2003 Pearson Education,Inc.U.S.Money Supply and the Dollar/Euro Exchange RateWhat happens when the Federal Reserve changes the U.S.money supply?An increase(decrease)in a countrys money supply causes its c
25、urrency to depreciate(appreciate)in the foreign exchange market.The Equilibrium Interest Rate:The Interaction of Money Supply and DemandSlide 14-23Copyright 2003 Pearson Education,Inc.Increase in U.S.real money supplyExpectedreturn oneuro depositsThe Equilibrium Interest Rate:The Interaction of Mone
26、y Supply and DemandFigure 14-8:Effect on the Dollar/Euro Exchange Rate and Dollar Interest Rate of an Increase in the U.S.Money SupplyE2$/2U.S.real money holdingsRates of return(in dollar terms)Dollar/euro exchange Rate,E$/0Return on dollar depositsL(R$,YUS)E1$/1R1$1M1US PUSR2$2M2US PUSSlide 14-24Co
27、pyright 2003 Pearson Education,Inc.Europes Money Supply and the Dollar/Euro Exchange RateAn increase in Europes money supply causes a depreciation of the euro(i.e.,appreciation of the dollar).A reduction in Europes money supply causes an appreciation of the euro(i.e.,a depreciation of the dollar).Th
28、e change in the European money supply does not disturb the U.S.money market equilibrium.The Equilibrium Interest Rate:The Interaction of Money Supply and DemandSlide 14-25Copyright 2003 Pearson Education,Inc.Figure 14-9:Effect of an Increase in the European Money Supply on the Dollar/Euro Exchange R
29、ateIncrease in Europeanmoney supplyU.S.real money holdingsRates of return(in dollar terms)Dollar/euro exchange Rate,E$/0Expectedeuro returnL(R$,YUS)U.S.realmoneysupplyMSUS PUSR1$1E1$/1Dollar returnThe Equilibrium Interest Rate:The Interaction of Money Supply and DemandE2$/2Slide 14-26Copyright 2003
30、Pearson Education,Inc.主要央行目标利率Slide 14-27Copyright 2003 Pearson Education,Inc.人民币对主要货币汇率Slide 14-28Copyright 2003 Pearson Education,Inc.Money,the Price Level,and the Exchange Rate in the Long RunLong-run equilibriumPrices are perfectly flexible and always adjusted immediately to preserve full employ
31、ment.Money and Money PricesThe money market equilibrium(Equation 14-4)can be rearranged to give the long-run equilibrium price level:P=Ms/L(R,Y)(14-5)An increase in a countrys money supply causes a proportional increase in its price level.Slide 14-29Copyright 2003 Pearson Education,Inc.The Long-Run
32、Effects of Money Supply ChangesA change in the supply of money has no effect on the long-run values of the interest rate or real output.A permanent increase in the money supply causes a proportional increase in the price levels long-run value.This prediction is based on the money market equilibrium
33、condition:Ms/P=L or P=Ms/L.This condition implies that P/P=Ms/Ms-L/L.The inflation rate equals the monetary growth rate less the growth rate for money demand.Money,the Price Level,and the Exchange Rate in the Long RunSlide 14-30Copyright 2003 Pearson Education,Inc.Empirical Evidence on Money Supplie
34、s and Price LevelsIn a cross-section of countries,long-term changes in money supplies and price levels show a clear positive correlation.Money,the Price Level,and the Exchange Rate in the Long RunSlide 14-31Copyright 2003 Pearson Education,Inc.Figure 14-10:Monetary Growth and Price-Level Change in t
35、he Seven Main Industrial Countries,1973-1997Money,the Price Level,and the Exchange Rate in the Long RunSlide 14-32Copyright 2003 Pearson Education,Inc.Money and the Exchange Rate in the Long RunA permanent increase(decrease)in a countrys money supply causes a proportional long-run depreciation(appre
36、ciation)of its currency against foreign currencies.Money,the Price Level,and the Exchange Rate in the Long RunSlide 14-33Copyright 2003 Pearson Education,Inc.Inflation and Exchange Rate DynamicsInflationA situation where an economys price level rises.DeflationA situation where an economys price leve
37、l falls.Short-Run Price Rigidity versus Long-Run Price FlexibilityThe short-run“stickiness”of price levels is illustrated in Figure 14-11.Slide 14-34Copyright 2003 Pearson Education,Inc.Figure 14-11:Month-to-Month Variability of the Dollar/DM Exchange Rate and of the U.S./German Price-Level Ratio,19
38、74-2001Inflation and Exchange Rate DynamicsSlide 14-35Copyright 2003 Pearson Education,Inc.A change in the money supply creates demand and cost pressures that lead to future increases in the price level from three main sources:Excess demand for output and labor Inflationary expectations Raw material
39、s pricesInflation and Exchange Rate DynamicsSlide 14-36Copyright 2003 Pearson Education,Inc.Permanent Money Supply Changes and the Exchange RateHow does the dollar/euro exchange rate adjust to a permanent increase in the U.S.money supply?Figure 14-12 shows both the short-run and long-run effects of
40、the increase in the U.S.money supply.Inflation and Exchange Rate DynamicsSlide 14-37Copyright 2003 Pearson Education,Inc.Uncovered interest parityWhen Risk is induced in the CIP(covered interest parity)model,the model will be changed to UIP(uncovered interest parity),namely:R$=R+(Ee$/-E$/)/E$/+PMWhe
41、re PM=risk premium,is the function of macro economics stability,financial system stability,economy growth and so on Slide 14-38Copyright 2003 Pearson Education,Inc.Figure 14-12:Effects of an Increase in the U.S.Money Supply Dollar returnDollar returnM1US P1USM2US P1USU.S.real money supplyM2US P2USM2
42、US P1USDollar/euro exchangeRate,E$/Rates of return(in dollar terms)U.S.real money holdings0(a)Short-run effects0(b)Adjustment to long-run equilibriumDollar/euro exchangeRate,E$/U.S.real money holdingsE2$/2E3$/4R1$4R2$2R1$1Inflation and Exchange Rate Dynamics32E2$/Expectedeuro returnExpectedeuro retu
43、rnL(R$,YUS)R2$2L(R$,YUS)E1$/1Slide 14-39Copyright 2003 Pearson Education,Inc.The process of adjustment(1)Figure 14-12(a):short-run effect Money Market:MUS (M1US M2US)(M1US/P1US M2US/P1US)(R1US R2US)Foreign Exchange market:Dollar return decrease(shift left)A rise in the expected future dollar/euro ex
44、change rate raises the expected dollar return on euro deposits(shift right)point 2(dollar depreciation)greater than point 3Slide 14-40Copyright 2003 Pearson Education,Inc.Figure 14-12(b):adjustment to long-run equilibrium Money Market:PUS (P1US P2US)(M2US/P1US M2US/P2US=M1US/P1US)(R2US R1US)Foreign
45、Exchange market:Dollar return increase(shift right)(2 4)point 4(1 2 4)(exchange rate are proportional to the increase of money supply)Slide 14-41Copyright 2003 Pearson Education,Inc.Figure 14-13:Time Paths of U.S.Economic Variables After a Permanent Increase in the U.S.Money SupplyInflation and Exch
46、ange Rate DynamicsP2USE3$/E1$/t0(a)U.S.money supply,MUSTime(c)U.S.price level,PUSTime(b)Dollar interest rate,R$TimeM1USt0t0R1$M2USP1USt0R2$E2$/(d)Dollar/euro exchange rate,E$/TimeSlide 14-42Copyright 2003 Pearson Education,Inc.Exchange Rate OvershootingThe exchange rate is said to overshoot when its
47、 immediate response to a disturbance is greater than its long-run response.It helps explain why exchange rates move so sharply form day to day.It is a direct result of sluggish short-run price level adjustment and the interest parity condition.Inflation and Exchange Rate DynamicsSlide 14-43Copyright
48、 2003 Pearson Education,Inc.SummaryMoney is held because of its liquidity.Aggregate real money demand depends negatively on the opportunity cost of holding money and positively on the volume of transactions in the economy.The money market is in equilibrium when the real money supply equals aggregate
49、 real money demand.By lowering the domestic interest rate,an increase in the money supply causes the domestic currency to depreciate in the foreign exchange market.Slide 14-44Copyright 2003 Pearson Education,Inc.Permanent changes in the money supply push the long-run equilibrium price level proporti
50、onally in the same direction.These changes do not influence the long-run values of output,the interest rate,or any relative prices.An increase in the money supply can cause the exchange rate to overshoot its long-run level in the short run.SummarySlide 14-45Copyright 2003 Pearson Education,Inc.Refer
