ECON 101 Lecture Notes - Lecture 6: Renminbi, Shortage, Monetary Base
1 May 2018
School
Department
Course
Professor
Economics 101
Lori Leachman
Part 6 • Lecture
• e = domestic price of foreign money
o Increasing e - $ depreciations, FC appreciation
o Decreasing e - $ appreciation, FC depreciation
o Appreciate/depreciate - market (float); revalue/devalue - government (fixed)
o When currencies appreciate, it becomes more expensive for other countries to buy their goods
• When Balance of payments does not equal zero 0
o The exchange rate changes - only in floating currency
o If exchange rate is fixed (cannot adjust), Central Bank intervenes in market to buy/sell currency
to accommodate surplus/shortage - using reserves
• - Case: China
o China has positive BP, trade surplus (they export more), leading to excess demand for home
currency
▪ Float: Excess demand leads to increasing e, and China’s currency (FC) appreciates
▪ Fixed: Sells Chinese currency and buys American currency and uses it to invest and buy
assets/bonds (biggest U.S. debt holder)
• Central bank balance sheet - gov. intervention
o Assets: Gold/silver, bonds, foreign currency
o Liabilities: deposits of banks, treasury account, currency in circulation
• **Fixed currencies can lead to overvaluation and undervaluation
o Overvaluation: BP deficit - price floor
▪ *More quantity supplied than quantity demanded - central bank has to buy up excess
supply and sell FC
▪ *Depletes FC reserves, lowers monetary base, lowers MS, interest rate rises, less
investment & spending, causes unemployment to rise, GDP falls (slower growth)
▪ Long run options
• Devalue earlier (while still have reserves)
• Move to float; let currency depreciate
o Undervaluation: BP surplus - price ceiling
▪ *More quantity demanded than quantity supplied - central bank has to sell currency to
meet excess demand and buy FC
▪ *Increases FC reserves, increases monetary base, increases MS, interest rate falls, more
investment & spending, rising inflation, employment, GDP rise (expansion/overheating)
▪ Long run - nothing really happens - push back from rest of world (tariffs... etc)
• Small countries can fix currency to become financial centers (banking... etc)
find more resources at oneclass.com
find more resources at oneclass.com
Document Summary
Part 6 lecture e = domestic price of foreign money. If exchange rate is fixed (cannot adjust), central bank intervenes in market to buy/sell currency to accommodate surplus/shortage - using reserves. **fixed currencies can lead to overvaluation and undervaluation: overvaluation: bp deficit - price floor. *more quantity supplied than quantity demanded - central bank has to buy up excess supply and sell fc. *more quantity demanded than quantity supplied - central bank has to sell currency to meet excess demand and buy fc.
