International Economics 国际经济学 Lectured by Yuanfen Tu School of International Trade and Economics Email:jxnctyf@126.com

International Economics By Robert J. Carbaugh 13th Edition Chapter 3: Exchange-Rate Determination

Exchange-Rate Determination Main Contents This chapter seeks to explain the forces that underlie currency appreciation and deprecation under a system of market-determined (floating) exchange rates.

What Determines Exchange Rates? Factors that cause the supply and demand schedules of currencies to change Market fundamentals (economic variables) Productivity, inflation rates, real interest rates, consumer preferences, and government trade policy Market expectations News about future market fundamentals Traders’ opinions about future exchange rates 4

What Determines Exchange Rates? Factors affecting exchange rates Short term: transfers of assets Differences in real interest rates and to the shifting expectations of future exchange rates Interim: cyclical factors Fluctuations in economic activity Long term: flows of goods, services, and investment capital Inflation rates, investment profitability, consumer tastes, productivity, and government trade policy 5

The path of the Yen’s exchange rate FIGURE 3.1 The path of the Yen’s exchange rate This figure views the exchange value of a nation’s currency as being determined by long-term structural, interim cyclical, and short-term speculative forces. 6

When are these factors important? Exchange-Rate Determination There exists some equilibrium level or path to which a currency will eventually gravitate. It serves as a long-term magnet or anchor, ensuring that exchange rates will not fluctuate aimlessly without limit but rather will tend to gravitate over time toward the long-term equilibrium path.

Determining Long-Term Exchange Rates Exchange rate changes Reactions of traders in the foreign-exchange market to changes in Relative price levels Relative productivity levels Consumer preferences for domestic or foreign goods Trade barriers 8

Determinants of the dollar’s exchange rate in the long term TABLE 3.1 Determinants of the dollar’s exchange rate in the long term 9

Determining Long-Term Exchange Rates Relative Price levels Increase in the U.S. price level relative to price levels in other countries Increase in the demand for foreign currency Decrease in the supply of foreign currency Depreciation of the dollar 10

FIGURE 3.2 Market fundamentals that affect the dollar’s exchange rate in the long term (a) In the long term, the exchange rate between the dollar and the pound reflects relative price levels, relative productivity levels, preferences for domestic or foreign goods, and trade barriers. 11

Determining Long-Term Exchange Rates Relative Productivity Levels U.S. productivity growth is faster than that of other countries Increase in the supply of foreign currency Decrease in the demand for foreign currency Appreciation of the dollar 12

FIGURE 3.2 Market fundamentals that affect the dollar’s exchange rate in the long term (b) In the long term, the exchange rate between the dollar and the pound reflects relative price levels, relative productivity levels, preferences for domestic or foreign goods, and trade barriers. 13

Determining Long-Term Exchange Rates Preferences for Domestic or foreign Goods An increased preferences for foreign goods An increased demand for foreign currency Depreciation of the dollar Trade Barriers U.S. imposes trade barriers Appreciation of the dollar 14

FIGURE 3.3 Market fundamentals that affect the dollar’s exchange rate in the long term (c) In the long term, the exchange rate between the dollar and the pound reflects relative price levels, relative productivity levels, preferences for domestic or foreign goods, and trade barriers. 15

FIGURE 12.2 Market fundamentals that affect the dollar’s exchange rate in the long term (d) In the long term, the exchange rate between the dollar and the pound reflects relative price levels, relative productivity levels, preferences for domestic or foreign goods, and trade barriers. 16

Inflation Rates, Purchasing Power Parity, and Long-Term Exchange Rates Law of one price Identical goods should be sold everywhere at the same price When converted to a common currency Assuming that it is costless to ship the good between nations, there are no barriers to trade, and markets are competitive Prevailing market-exchange rate is the true equilibrium rate 17

Inflation Rates, Purchasing Power Parity, and Long-Term Exchange Rates The Big Mac Index An attempt to measure the true equilibrium value of a currency based on one product, a Big Mac Can be used to determine the extent to which the market exchange rate differs from the true equilibrium exchange rate 18

TABLE 12.2 Big Mac Index 19

Inflation Rates, Purchasing Power Parity, and Long-Term Exchange Rates 20

Inflation Rates, Purchasing Power Parity, and Long-Term Exchange Rates 巨无霸指数（Big Mac index）是一个非正式的经济指数，用以测量两种货币的汇率理论上是否合理。这种测量方法假定购买力平价理论成立。此指数是由《经济学人》（The Economist）之编辑Pam Woodall(毕业于曼彻斯特大学及伦敦政经学院，主修经济)于1986年9月推出。就是假设全世界的麦当劳巨无霸汉堡包的价格都是一样的，然后将各地的巨无霸当地价格，通过汇率换算成美元售价，就可以比较出各个国家的购买力水平差异。 21

Inflation Rates, Purchasing Power Parity, and Long-Term Exchange Rates 选择巨无霸的原因是，巨无霸在多个国家均有供应，而它在各地的制作规格相同，由当地麦当劳的经销商负责为材料议价。这些因素使该指数能有意义地比较各国货币。 22

Inflation Rates, Purchasing Power Parity, and Long-Term Exchange Rates 巨无霸指数是由<经济学人>于1986年9月推出，此后该报每年出版一次新的指数。该指数在英语国家里衍生了Burgernomics（汉堡包经济）一词。 在2004年1月，《经济学人》推出了Tall Latte index（中杯鲜奶咖啡指数）；计算原理一样，但巨无霸被一杯星巴克咖啡取代，标志著该连锁店的全球扩展。在1997年，该报也出版了一份“可口可乐地图”，用每个国家的人均可乐饮用量，比较国与国间的财富；该图显示可乐饮用量越多，国家就越富有。 23

Inflation Rates, Purchasing Power Parity, and Long-Term Exchange Rates Purchasing-power-parity theory Exchange rates adjust to make goods and services cost the same everywhere An application of the law of one price 24

The law of one price applied to a single product, steel TABLE 3.3 The law of one price applied to a single product, steel 25

Inflation Rates, Purchasing Power Parity, and Long-Term Exchange Rates Purchasing-power-parity theory If the rate of inflation is much higher in one country Its money has lost purchasing power over domestic goods Currency depreciation to restore parity with prices of goods abroad 26

Inflation Rates, Purchasing Power Parity, and Long-Term Exchange Rates Purchasing-power-parity theory Trade flows are mechanism that makes a currency depreciate or appreciate Changes in relative national price levels determine changes in exchange rates over long term Foreign-exchange value of currency tends to appreciate or depreciate at rate equal to difference between foreign and domestic inflation 27

Inflation Rates, Purchasing Power Parity, and Long-Term Exchange Rates Purchasing-Power-Parity theory (cont.) A currency is expected to depreciate By an amount equal to the excess of domestic inflation over foreign inflation A currency is expected to appreciate By an amount equal to the excess of foreign inflation over domestic inflation 28

Inflation Rates, Purchasing Power Parity, and Long-Term Exchange Rates Purchasing-power-parity theory Used to predict long-term exchange rates P - price indexes of the U.S. and Switzerland 0 - the base period 1 - period 1 S0 - equilibrium exchange rate in the base period S1 - estimated target at which the actual rate should be in the future 29

Inflation Rates, Purchasing Power Parity, and Long-Term Exchange Rates Purchasing-power-parity theory Overlooks: exchange-rate movements may be influenced by investment flows Problems Choosing the appropriate price index to be used in price calculations Determining equilibrium period to use as a base Government policy may interfere with the operation of the theory Trade restrictions 30

Inflation Rates, Purchasing Power Parity, and Long-Term Exchange Rates 购买力平价理论是关于汇率决定的一种理论。最初由英国经济学家桑顿在1802年提出，其后成为李嘉图的古典经济理论的一个组成部分，最后由瑞典经济学家K.G.卡瑟尔(1866～1945）加以发展和充实 ，并在其1922年出版的《 1914 年以后的货币与外汇》一书中作了详细论述。

Purchasing power parity: United States - United Kingdom, 1973–2011 FIGURE 3.3 Purchasing power parity: United States - United Kingdom, 1973–2011 This figure suggests that the predictive power of the purchasing-power-parity theory is most evident in the long term. In the short term, the theory has negligible predictive power. 32

Inflation differentials and the exchange rate Purchasing-power-parity theory Changes in relative national price levels Determine changes in exchange rates, long term A currency is expected to depreciate By an amount equal to the excess of domestic inflation over foreign inflation A currency is expected to appreciate By an amount equal to the excess of foreign inflation over domestic inflation 33

Inflation differentials and the dollar’s exchange value FIGURE 3.4 Inflation differentials and the dollar’s exchange value 34

Determining Short-Term Exchange Rates: The Asset-Market Approach Foreign-exchange market activity Dominated by investors in assets Treasury securities, corporate bonds, bank accounts, stocks, and real property Asset-market approach Investors deciding between domestic and foreign investments Relative levels of interest rates Expected changes in the exchange rate itself over the term of the investment 35

TABLE 3.4 Determinants of the dollar’s exchange rate against the pound in the short term 36

Determining Short-Term Exchange Rates: The Asset-Market Approach Level of the nominal (money) interest rate A first approximation of the rate of return on assets that can be earned in a particular country Differences in the level of nominal interest rates between economies Likely to affect international investment flows Investors seek the highest rate of return 37

Determining Short-Term Exchange Rates: The Asset-Market Approach If interest rates in U.S. > interest rates abroad Increase in the demand for dollars Dollar appreciation If interest rates in U.S. < interest rates abroad Decrease in the demand for dollars Dollar depreciation Real interest rate Nominal interest rate minus the inflation rate 38

Factors affecting the dollar’s exchange rate in the short term (a) FIGURE 3.5 Factors affecting the dollar’s exchange rate in the short term (a) In the short term, the exchange rate between the dollar and the pound reflects relative interest rates and expected changes in the exchange rate. 39

Short-term nominal and real interest rates, 2007 TABLE 3.5 Short-term nominal and real interest rates, 2007 40

Interest rate differentials and exchange rates FIGURE 3.6 Interest rate differentials and exchange rates An increase in the U.S. real interest rate increases the expected return on dollar assets, such as Treasury bills and certificates of deposit. This increase encourages flows of foreign investment into the United States, thus causing the dollar’s exchange value to appreciate. Conversely, a decrease in the U.S. real interest rate reduces the expected profitability on dollar assets, which promotes a depreciation of the dollar’s exchange value. 41

Determining Short-Term Exchange Rates: The Asset-Market Approach Expected change in the exchange rate Future expectations of an appreciation of the dollar can be self-fulfilling for today’s value of the dollar 42

Factors affecting the dollar’s exchange rate in the short term (b) FIGURE 3.5 Factors affecting the dollar’s exchange rate in the short term (b) In the short term, the exchange rate between the dollar and the pound reflects relative interest rates and expected changes in the exchange rate. 43

Determining Short-Term Exchange Rates: The Asset-Market Approach Other factors affecting investment flows among economies Size of the stock of assets denominated in a particular currency in investor portfolios Significant safe-haven effect behind some investment flows 44

The Ups and Downs of the Dollar The 1980s, appreciation and then depreciation 1979, dollar appreciation Sharp tightening of monetary policy Reagan administration - sizable tax cuts along with increased government spending Peak in1985 45

The Ups and Downs of the Dollar The 1980s, appreciation and then depreciation Second half of the 1980s, dollar depreciation Speculators – expected dollar depreciation Sizable currency interventions aimed at weakening an overvalued dollar Expansionary monetary policy Fiscal policy - to reduce the size of budget deficits 46

The Ups and Downs of the Dollar The 1990s Weakening economy, recession in 1991 Expansionary monetary policy Fiscal policy - increased government spending and dampened tax receipts Economic activity abroad was moving relatively briskly Dollar depreciation 47

The Ups and Downs of the Dollar The 1990s Mid-1990s, the U.S. economy was growing rapidly Sharp increase in the pace of investment spending by business Market acceleration in productivity growth Strong consumer demand Deregulation; Trade liberalization; Computer era Declining rate of inflation Dollar appreciation 48

The Ups and Downs of the Dollar First decade of the 2000s 2002-2004, depreciation of the dollar Weakening of the demand for dollar-denominated assets Recession in the U.S. in 2001 Declining stock market Uncertainty about corporate accounting practices Steady decline in interest rates Uncertainty due to the ongoing war on terrorism and the war with Iraq 49

The Ups and Downs of the Dollar First decade of the 2000s By 2005, dollar appreciation Current and prospective strong performance of the U.S. economy Restrictive monetary policy – higher interest rates 2006–2007, weakening dollar Slackening of private investment flows By 2008, stronger dollar U.S. - safe haven; economic crisis of 2007–2008 2009, weakening dollar 50

Exchange-rate overshooting Factors influencing exchange rates The Overshooting Model or Exchange rate overshooting（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）

Exchange-Rate Overshooting When exchange-rate short-term response (depreciation or appreciation) To a change in market fundamentals Is greater than its long-term response Helps explain why exchange rates depreciate or appreciate so sharply from day to day 52

Short-term/long-term equilibrium exchange rates: overshooting FIGURE 3.7 Short-term/long-term equilibrium exchange rates: overshooting Given the short-term supply of pounds (S0), if the demand for pounds increases from D0 to D1, then the dollar depreciates from $2 per pound to a short-term equilibrium of $2.20 per pound. In the long term, the supply of pounds is more elastic (S1), and the equilibrium exchange rate is lower, at $2.10 per pound. Because of the difference in these elasticities, the short-term depreciation of the dollar overshoots its long-term depreciation. 53

Exchange-Rate Overshooting Can be explained by Tendency of elasticities to be smaller in the short term than in the long term Exchange rates tend to be more flexible than many other prices 54

Exchange-rate overshooting Factors influencing exchange rates 所谓超调通常是指一个变量对给定扰动做出的短期反应超过了其长期稳定均衡值，因而被一个相反的调节所跟随。汇率超调的前提条件是商品价格具有粘性。 所谓粘性价格是指短期内商品价格粘住不动，但随着时间的推移，价格水平会逐渐发生变化直至达到其新的长期均衡值。

Exchange-rate overshooting

Exchange-rate overshooting

Exchange-rate overshooting

Exchange-rate overshooting

Exchange-rate overshooting

Exchange-rate overshooting

Exchange-rate overshooting

Exchange-rate overshooting Factors influencing exchange rates 63

Forecasting Foreign-Exchange Rates Forecasting exchange rates Is very tricky, especially in the short term Necessary for exporters, importers, investors, bankers, and foreign-exchange dealers Consulting firms 64

Exchange-rate forecasters TABLE 3.6 Exchange-rate forecasters 65

Forecasting Foreign-Exchange Rates Judgmental forecasts Subjective or common sense models. Require Wide array of political and economic data Interpretation of these data in terms of the timing, direction, and magnitude of exchange-rate changes Projections based on a thorough examination of individual nations Economic indicators; Political factors Technical factors; Psychological factors 66

Forecasting Foreign-Exchange Rates Technical forecasts Technical analysis Use of historical exchange-rate data to estimate future values Ignoring economic and political determinants of exchange-rate movements “History repeats itself” 67

Technical analysis of the Yen’s exchange value FIGURE 3.8 Technical analysis of the Yen’s exchange value When forecasting exchange rates, technical analysts watch for new highs and lows, broken trend lines, and patterns that are thought to predict price targets and movement. 68

Forecasting Foreign-Exchange Rates Fundamental analysis The opposite of technical analysis Considerations of economic variables that are likely to affect the supply and demand of a currency Computer-based econometric models For individual nations Attempt to incorporate the fundamental variables that underlie exchange-rate movements Interest rates, balance of trade, productivity, inflation rates 69

Forecasting Foreign-Exchange Rates Limitations of econometric models used to forecast exchange rates Rely on predictions of key economic variables Factors affecting exchange rates that cannot easily be quantified Precise timing of a factor’s effect on a currency’s exchange rate may be unclear 70

International comparisons of GDP: purchasing power parity Gross domestic product (GDP) Add up the market values of the goods and services its economy produces Use market exchange rate Misleading: not all goods and services are traded in a world market 71

International comparisons of GDP: purchasing power parity Exchange rates Overstate the size of economies with relatively high price levels Understate the size of economies with relatively low price levels Subject to sizable fluctuations 72

International comparisons of GDP: purchasing power parity Takes into account the relative cost of living and the inflation rates of different countries GDPs of countries converted into a common currency using purchasing power parities Are valued at a uniform price level Reflect only differences in the volumes of goods and services produced in countries 73

TABLE 3.7 Comparing GDPs internationally, 2008: top 8 countries (billions of dollars) 74

Commercial Mexicana gets burned by speculation October 2008, Comercial Mexicana was prospering Mexico’s third largest retailer and a competitor of discount giant Wal-Mart Few days later, it went bankrupt, Foreign currency losses 75

Comercial Mexicana gets burned by speculation Made bad bets using currency contracts - linked to the dollar/peso exchange rate Expectations of a stronger peso World credit crisis of 2008 – depreciation of the peso 76

汇率决定理论

国际借贷说

国际收支说

国际收支说

国际收支说

利率平价理论

利率平价理论

利率平价理论

利率平价理论

利率平价理论

利率平价理论

货币分析法 弹性价格货币分析法 粘性价格货币分析法（汇率超调）

弹性价格货币分析法

弹性价格货币分析法

弹性价格货币分析法

弹性价格货币分析法

弹性价格货币分析法

货币分析法

资产组合分析法

资产组合分析法

资产组合分析法

资产组合分析法

资产组合分析法