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Econ 330 > Chapter 17: The Foreign Exchange Market > Flashcards

Chapter 17: The Foreign Exchange Market Flashcards

1
Q

exchange rate

A

the price of one currency in terms of another currency

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2
Q

what does the exchange rate affect?

A

inflation and output

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3
Q

foreign exchange market

A

where trading of currencies and bank deposits denominated in particular currencies takes place
- organized as a over-the-counter market

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4
Q

foreign exchange market

A

where trading of currencies and bank deposits denominated in particular currencies takes place
- organized as an over-the-counter market

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5
Q

What are the two kinds of exchange rate transactions

A

spot transactions and forward transactions

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6
Q

spot transactions

A

the immediate two day exchange of bank deposits

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7
Q

forward transactions

A

the exchange of bank deposits at some specific future date

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8
Q

spot exchange rate

A

the exchange rate for spot transactions

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9
Q

forward exchange rate

A

the exchange rate for forward transactions

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10
Q

appreciation

A

when a currency increases in value

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11
Q

depreciation

A

when a currency decreases in value

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12
Q

why are exchange rate important?

A

affect relative prices of domestic and foreign goods

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13
Q

relationship between the value of currency and import/export prices

A
  • if currency appreciates, the price of imports decreases and the price of exports increases
  • if currency depreciates, the price of imports increases and the price of exports decreases
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14
Q

deposits denominated in dollars

A

when a bank is buying dollars in the foreign exchange market

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15
Q

two parts of analyzing exchange rates

A
  1. how exchange rates are determined in the L.R
  2. use L.R determinants of exchange rates to help us understand how they are determined in the S.R
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16
Q

Theory of Purchasing Power Parity (PPP)

A

the exchange rate between two countries’ currencies in terms of goods and services
- ensures that the prices are consistent across two countries

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17
Q

real exchange rate

A

the rate at which domestic goods can be exchanged for foreign goods

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18
Q

relationship between price level and the value of currency

A
  • if a country’s price level rises, then the other country’s currency appreciates
  • if a country’s price level rises, then their country’s currency depreciates
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19
Q

Pros and cons of PPP

A

Pro: good prediction of long run exchange rates
Con: bad prediction of short run exchange rates, can be a big discrepancy between the actual exchange rate and the PPP exchange rate

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20
Q

Why the PPP cannot fully explain exchange rates

A
  1. does not take into account nontradable goods and services
  2. similar goods are not identical
  3. there are barriers to trade (tariffs and quotas)
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21
Q

nontradable goods and services

A

things that cannot be traded across borders (housing, land, haircuts, golf lessons)

22
Q

tariffs

A

taxes on imported goods

23
Q

quotas

A

restrictions on the quantity of goods and that can imported

24
Q

overvalued

A

when a country’s goods and services are expensive relative to other countries’

25
Q

undervalued

A

when a country’s goods and services are cheap relative to other countries’

26
Q

four major factors that affect the exchange rate

A
  1. relative price levels
  2. trade barriers
  3. preferences for domestic vs foreign goods
  4. productivity
27
Q

relationship between factors that affect the exchange rate and the value of currency

A
  • if factor increases demand of domestic goods, domestic currency will appreciate
  • if factor decreases demand of domestic goods, domestic currency will depreciate
28
Q

price levels and currency

A
  • a rise in price level causes currency to depreciate
  • a fall in price level causes currency to appreciate
29
Q

trade barriers and currency

A

increasing trade barriers causes a country’s currency to appreciate

30
Q

preferences and currency

A
  • increased demand for a country’s exports causes currency to appreciate
  • increased demand for imports causes the domestic currency to currency to depreciate
31
Q

productivity and currency

A

as a country becomes more productive, its currency appreciates

32
Q

what does a shift in demand curve mean

A
  • right shift => currency appreciation
  • left shift => currency depreciation
33
Q

causes of shifts in demand

A
  1. domestic interest rates (increase leads to right shift)
  2. foreign interest rates (increase leads to left shift)
  3. expected future exchange rate (increase leads to right shift)
34
Q

effects of changes in interest rates on the exchange rate

A
  • domestic real interest rates rise => domestic currency appreciates
  • domestic interest rates rise due to expected increase in inflation => domestic currency depreciates
35
Q

gold and value of currency

A
  • when value of currency falls, price of gold increases
  • both serve as a store of value
36
Q

why is the price of gold high?

A
  1. low opportunity cost (interest rates) of holding gold
  2. expected depreciation of dollar
    - QE => price of $ decreases
  3. unusual levels of uncertainty
    - COVID
  4. fears that central bank may inflate their way out of debt crisis
    - debt/P
37
Q

Factors that caused dollar to appreciate

A
  1. better US economic growth vs ROS
  2. foreign firms buying profitable US firms
  3. the Fed is expected to raise interest rates faster than ECB or BOJ
  4. rising interest rate differentials are providing opportunities for carry trade investors
38
Q

Advantages of $ appreciation for US

A
  1. lower interest rates
  2. rising asset prices
  3. falling import prices and US tourists abroad benefit from increased purchasing power of the dollar
  4. falling inflation
39
Q

Disadvantages of $ appreciation for US

A
  1. US firms overseas profits are worth less in dollar terms
  2. US exports are less price competitive vs foreign goods and services
  3. Falling exports will reduce AD and reduce economic growth
40
Q

Advantages of $ appreciation for ROW

A
  1. Euro Zone and Japan will see faster inflation and economic growth
41
Q

disadvantages of $ appreciation for ROW

A
  1. capital will outflow from emerging market economies
  2. bad for foreign governments and firms who have liabilities denominated in dollars and revenues denominated in local currency
42
Q

Why the $ exchange rate fell in 2002-2008

A
  1. subprime credit mess => subprime currency
  2. Fed lowering money market interest rate
  3. weaker US investment prospects
  4. trade deficits
  5. US budget deficit
  6. inflation concerns
43
Q

what causes trade deficits?

A
  1. insufficient savings
  2. budget deficits
44
Q

twin deficits

A

exports decrease as imports increase

45
Q

currency wars

A

when countries devalue their currency

46
Q

pros and cons of devaluing currency

A

pro: exports will be more attractive to foreign countries
cons: imports will cost more, politicization of exchange rates, downward spiral of competitive devaluation

47
Q

Why doesn’t Greece devalue to restore their economy?

A

they don’t solely control value of euro

48
Q

How can Greece restore competitiveness?

A
  1. domestic deflation (falling wages and prices) => shift right the AS curve
  2. increased productivity => shift right AS curve
49
Q

real exchange rate equation

A

real exchange rate = nominal exchange rate * PL_US/PL_ROW

50
Q

Equation for the profits on goods when the loan is in dollars

A

profits = PQ (revenue) - wL (labor costs) - iDexchange rate (interest on debt in dollars)

Econ 330 (17 decks)

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