Lectures 18-20 Flashcards
(40 cards)
Exchange Rate (S)
Amount of domestic currency needed for one unit of foreign currency
Bilateral Exchange Rate
Rate between two countries
Effective/Trade-weighted exchange rate
Weighted average against multiple currencies, using trade shares as weights
Spot Rate
Immediate exchange of goods
Forward/Futures rate
Exchange currencies at future date with pre-agreed rate
Who demands foreign currency
- Importers
- Outgoing Foreign Investors
- Speculators
Who supply’s foreign currency
- Exporters
- Incoming Foreign Investors
- Speculators
Floating Exchange Rates
Set by supply and demand
What happens to floating exchange rates when domestic income increases?
Increase in imports –> increased demand for foreign currency –> fall in domestic currency value
Fixed Exchange Rates
Remains stable even with S&D shifts. Government intervenes by buying/selling currencies
Non-convertible currency
All exchange goes through central bank
Convertible but managed
Central bank actively intervenes to maintain fixed rate
Managed Float
Central Bank sometimes intervenes to stabilise S
Pure Float
No intervention, constant foreign reserves
Pure Fixed
Central Bank constantly adjusts reserves
Impossible Trinity
Can only have two of the following:
- Fixed Exchange Rate
- Free Capital Movement
- Independent Monetary Policy
Sterilisation
Neutralising foreign exchange intervention on domestic money supply
Taylor Rule
Banks set interest rates based on deviations of inflation and output from LR equilibrium
r-r*=
a(⎍-⎍)+b(Y-Y)
r-r=a(⎍-⎍)+b(Y-Y*). What does each letter stand for
r=real interest rate
⎍=inflation rate
*=LR levels
Y=real output
a, b= relative importance policymakers assign
i-i*=
(1+a)(⎍-⎍)+b(Y-Y)
Quantity Theory of Money equation
MV=PY
What does each letter stand for in Quantity Theory of Money equation
M - nominal money supply
V - velocity of money (number of times a unit of money changes hands)
Y - real output
P - Prices
Fisher Hypothesis
Real Interest Rate = Nominal Interest Rate - Expected Inflation Rate (r=i-π*)
