Overview Chapters 12-17

Ch. 12: Int. Fin. Markets

• Currency Trading -> Exchange Rate

• Time lag twix ship and receive bigger than time needed for cable transfer. Solution: commercial bill of exchange

• Spot vs. Forward XR: risk transferred to speculators

• Also: Futures, Options, Swaps

Capital Flows

• To get higher return

• To get safer return: risk diversification

• SR: Money Market (maturity < 1 year)

• LR: Capital Market (maturity > 1 year)

Eurocurrency

• E.g., Eurodollar = $-denominated account outside the US

Ch. 13: XR (basic model)

• It’s a supply and demand thing.

• Demand for currency shifts with income and changing relative prices.

• Ditto for supply of currency

Ch. 14: XR (add M and i)

• Previous model good for long-term predictions. But other determinants matter in the shorter term: M and i.

• What is M?

• How does Supply of M work? (Reserve requirement -> multiplier)

• Discount rate, Open mkt ops

Demand for M

• MD=f(i,P,Y)

• MD=MS determines i

• Interest arbitrage: capital movement

• Affects XR, which affects Exp-Imp

Ch. 15: XRPPP

• What are the determinants of the exchange rate over long periods of time?

• What effect does monetary policy have on the country’s price level and therefore its exchange rate?

• Is there a benchmark for the current exchange rate?

Ch. 15: XRPPP

• arbitrage -> law of 1 price -> PPP

• relative PPP:

• RXR:

€

%ΔXR ≈ %ΔPU .S. −%ΔPU .K .

U.S.

U.K.

P

P*£)/($£)/($ RRXR =

Ch. 16: Y and XR (SR)

• AD and AS (slopes)

• Intersection determines Y and P

• Foreign income affects Exp

• Domestic income affects Imp

• XR affects both Imp and Exp

• XR affects composition of output(tradable vs. non-tradables)

Ch.17: Macro Policy

• Internal Balance– GDP (full employment)– P (keep inflation in check)

• External Balance– X-M (current account balance)

Fiscal Policy (expansionary)

(G and/or T) 1. direct effect: AD and P2. indirect effect: budget deficit Gov. must

borrow i attracts foreign capital (until i back at original level) XR (X-M) AD and P

3. net effect: ambiguous! Fiscal policy now used less as a means of stabilizing the economy than 30 years ago b/c of flexible exchange rates and increased international mobility of capital.

Monetary Policy (expansionary)

MS i1. direct effect: (C and I) (AD and P)2. indirect effect: outflow of capital XR (X-M)

(AD and P)3. net effect: clear!

monetary policy is more effective than fiscal policy as a stabilization tool b/c of flexible exchange rates.