ECN 301 Chapter Notes - Chapter 10: Foreign Exchange Market, Bretton Woods System, Purchasing Power Parity

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4 Jan 2018

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Ecn301 chapter 10 notes: exchange rates, nominal exchange rates, the rate at which two currencies can be traded is the nominal exchange rate between the two currencies. I(cid:374) the p(cid:396)e(cid:272)edi(cid:374)g e(cid:395)uatio(cid:374), the te(cid:396)(cid:373) p/p, the pe(cid:396)(cid:272)e(cid:374)tage (cid:272)hange in the domestic price level, is the same as the domestic rate of inflation. , a(cid:374)d the te(cid:396)(cid:373) pfo(cid:396)/pfo(cid:396), the pe(cid:396)(cid:272)e(cid:374)tage (cid:272)ha(cid:374)ge i(cid:374) the fo(cid:396)eig(cid:374) p(cid:396)i(cid:272)e le(cid:448)el, is the sa(cid:373)e as the fo(cid:396)eig(cid:374) (cid:396)ate of i(cid:374)flatio(cid:374) fo(cid:396): making these substitutions and rearranging the equation, we rewrite this equation as. It is worth noting that a special case of eq. (10. 3) occurs when the real exchange rate is constant: this would be so if ppp holds, in which case e = 1 and of course. Suppose that the real exchange rate is high such that a unit of the domestic good can buy relatively many units of the foreign good.

Related Questions

Assume that the U.S. dollar and the Japanese yen are the only two currencies in the world.

a. A bilateral nominal exchange rate S is the spot (now) exchange value of one currency in terms of the other and S can be written as dollars per 1 yen or yen per 1 dollar. If S = yen/1 dollar = 76.92 then the inverse 1/S gives dollars per 1 yen where 1/S = 1/(yen/1 dollar) = 1/76.92 = .013. If the 1/S increases to .014, has the dollar appreciated (1 dollar is worth more yen) or depreciated (1 dollar is worth less yen)? Explain.

b. Changes in demand and supply in the foreign exchange (FX) market determine the value of floating exchange rates S. If S is expressed as S = yen/1 dollar, then we have the FX market in terms of the demand and supply of dollars. (If S = dollars/1 yen, then we get the FX market in terms of the demand and supply of yen. Note also that no matter which currency the FX market is expressed, it is still an FX market where dollars are exchanged for yen. This means that an upward-sloping supply of dollars curve is exactly the same as a demand for yen curve and a downward-sloping demand for dollars curve is exactly the same as a supply of yen curve). Using S = yen/1 dollar and the FX market in terms of the demand and supply of dollars, an increase in S (dollar appreciation) leads to an increase in the number of dollars supplied (increase in the quantity of yen demanded). For dollar demand (or the supply of yen), an increase in S (dollar appreciation) leads to a decrease in the number of dollars demanded (or an increase in the number of yen supplied). The dollar demand curve shifts to the right if more yen are offered for dollars at any exchange rate S. An increase in dollar demand is caused mostly by private sector transactions in the current and capital accounts. Either an increase in demand for U.S. goods (merchandise trade in the current account) or an increase in demand for U.S. stocks and bonds (capital account inflows) will shift the dollar demand curve to the right. If private transactions in the current and capital accounts also cause shifts in the dollar supply curve, what are the corresponding factors that would lead to an increase in dollars supplied (yen demanded) at any exchange rate S?

brownhorse801

1.Purchasing power parity implies that

a. the real exchange rate is equal to 1.

b. the law of one price does not hold.

c. inflation rates are equal across countries.

d. the real exchange rate is equal to 0.

e. if the domestic country has low prices, then the domestic currency will depreciate until foreign citizens can buy the same amount of goods as domestic citizens.

2.Which of the following is a prediction from the PPP model of exchange rates?

A. An increase in the US money supply leads to an appreciation of the dollar in the long run.

B. An increase in US production leads to a depreciation of the dollar.

C. An increase in US production will lead to a proportional increase in the inflation rate.

D, An increase in the US money supply leads to a depreciation of the dollar in the long run.

E.An increase in the US interest rates leads to a fall in prices.

3.Relative purchasing power parity predicts that

A.the difference between the inflation rates in the two countries should equal the ratio of the interest rates in the two countries.

B. the difference between the inflation rates in two countries should equal the per cent change in the exchange rate.

C.inflation rates should be equal across countries.

D.the real exchange rate should equal one.

E.relative price levels in the two countries should be equal when expressed in the same currency.

4.Which of the following is NOT a valid explanation for the failure of purchasing power parity?

a. Differences in monetary policies across countries

b. Lack of competition

c. Transportation costs

d. Trade barriers

5.If P represents (the level of) domestic prices, P* represents (the level of) foreign prices and E represents the exchange rate as units of domestic currency per units of foreign currency, then the real exchange rate equals

a. EP/P*	b. P*/EP
C. E/PP*	d. EP*/P
e. P/P*

6.The difference between nominal and real interest rates is that

A.Nominal interest rates are measured in terms of a country's output, while real interest rates are measured in monetary terms

B.Nominal interest rates are measured in monetary terms, while real interest rates are measured in terms of a country's output

C.Nominal interest rates can fluctuate, while real interest rates always remain fixed

D.Real interest rates can fluctuate, while nominal interest rates always remain fixed

E.Real interest rates are the same in every country, while nominal interest rates are different for every country

7.Which of the following is predicted to cause the value (or price or cost) of U.S. goods to appreciate relative to the value (or price or cost) of foreign goods in the long run?

a. An increase in the growth rate of U.S. GNP. b. A decrease in the growth rate of U.S. GNP.

c. A decline in the growth rate of the U.S. money supply.

d. An increase in the price of petroleum that reduces world demand for American cars. e. An appreciation of the dollar.

jadewallaby469

1. In which market will a company arrange to receive currency for a transaction at a future date?

Select one:

a. the forward market

b. the currency futures market

c. the arbitrage market

d. the forward spot market

2. The U.S. dollar is overvalued and the peso is undervalued in the foreign exchange market

Select one:

a. if a visitor to Mexico from the United States can buy more goods in the United States
than he can buy in Mexico when he converts dollars to pesos.

b. if a visitor to Mexico from the United States can buy the same amount of goods in
Mexico as he can buy in the United States when he converts dollars to pesos.

c. if a visitor to Mexico from the United States can buy more goods in Mexico than he can
buy in the United States when he converts pesos to dollars.

d. if a visitor to Mexico from the United States can buy more goods in Mexico than he can
buy in the United States when he converts dollars to pesos.

3. Given the following data (t is current time; t+1 is time after one period)

E_t = Â¥ 110 = $1

E_t+1 = Â¥ 95 = $1

Current Interest rate in the US = i_US= 8%

If the interest parity condition is expected to hold, interest rates in Japan (i_Japan) should equal approximately:

Select one:

a. 3.38%

b. 8%

c. -5.64%

d. None of the above.

4. Suppose the Japanese interest rate is I% while the interest rate in Britain is 3%. Interest rate parity predicts that relative to the Japanese Yen,

Select one:

a. the British pound will depreciate by 4%.

b. the British pound will appreciate by 2%.

c. the British pound will depreciate by 2%.

d. the British pound will appreciate by 4%.

5. Suppose the U.S. grows more slowly than Canada. The best medium term prediction is that the

Select one:

a. U.S. interest rates will rise.

b. U.S. dollar will appreciate against the Canadian dollar.

c. U.S. dollar will depreciate against the Canadian dollar.

6. Purchasing Power Parity (PPP) implies that

Select one:

a. In the long run, a forward exchange rate can purchase an interest rate swap for the same
price as the spot rate.

b. In the medium run, a forward exchange rate can purchase an interest rate swap for the
same price as the spot rate.

c. The short run, a given amount of money can buy the same amount of goods, whether
they are purchased at home or abroad.

d. the long run, a given amount of money can buy the same amount of goods, whether
they are purchased at home or abroad.

7. The current account balance will fall if

Select one:

a. the real exchange rate depreciates and disposable income goes up

b. the real exchange rate appreciates or disposable income goes up

c. the real exchange rate depreciates or disposable income goes down

d. the real exchange rate appreciates and disposable income goes down

8. A person who paid $10 for an umbrella in the U.S. sees the exact same umbrella in a store in London, England for 6 British pounds. If the person could expect the real exchange rate to be 1 U.S. umbrella per 1 English umbrella, then the person could infer that the nominal exchange rate is

Select one:

a. 0.6 U.S. dollars per 1 English pound.

b. 1.67 U.S. dollars per 1 English pound.

c. 0.6 English pounds per I U.S. dollar.

d. 1.67 English pounds per 1 U.S. dollar.

9. A U.S. wine merchant travelling in France has found a French wine of the same quality as a U.S. wine they regularly sell. She assumes that the real exchange rate should be 1 case of U.S. wine equals one case of French wine. The French wine merchant will sell her a case of the French wine for 350 euros. She knows that a case of the equivalent U.S. wine sells for $400. The euro is selling in France for $1.20. Assuming transportation costs are zero, the U.S. wine merchant should

Select one:

a. buy the French wine and sell it in the U.S. and make a profit.

b. buy the U.S. wine and sell it in France and make a profit.

c. It doesn't matter either way; there is no profit in the deal.

d. None of the above.

10. In a fixed exchange rate system, how do countries address the problem of currency market pressures that threaten to lower or raise the value of their currency?

Select one:

a. If demand falls, then countries must increase demand by buying up the excess supply
with domestic currency.

b. If demand rises, countries must fill the excess demand for foreign currency by selling
their reserves.

c. If demand rises, then countries can adjust the value of the exchange rate to the desired
level.

d. A and B only.

ECN 301 Chapter Notes - Chapter 10: Foreign Exchange Market, Bretton Woods System, Purchasing Power Parity

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