Transcript (S↑) Depreciates

Foreign Exchange
(aka. FOREX)
Exchange Rate = Relative Price of Currencies
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ACDC Leadership 2015
I want a pallet of Mexican Avocados.
Why?........... Don’t ask questions...
What do I have to do to get one?
FOREX Supply and Demand
Simplified
Imagine a huge bucket with all the different
currencies from every country
This is the Foreign Exchange Market!
Just like at a product market, you can’t take
things without paying.
If you demand one currency, you must supply
your currency.
Ex: If Canadians what Russian Rubles.
The demand for Rubles in the FOREX
market will increase and the supply of
Canadian Dollars will increase.
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Exchange Rates
In the FOREX market we only look at two
countries/currencies at a time
Ex: US Dollars and Euros
We examine the price of one currency in
terms of the other currency. Ex: $3 = €2
The Exchange Rate depends on which
currency you are converting.
The price of one US Dollar in terms of Euros is
1 Dollar = €2/$3 = €.66
The price of one Euro in terms of Dollars is
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1 Euro = $3/€2= $1.5
What happens if you need more dollars to buy
one euro (the price for a euro increases)?
Ex: From $3=€2 to $6=€2
•The U.S. Dollar DEPRECIATES relative
to the Euro.
Depreciation- The loss of value of a
country's currency with respect to a foreign
currency
•More units of dollars are needed to buy a
single unit of the other currency.
•The dollar is said to be “Weaker”
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What happens if you need less dollar to buy
one euro (the price for a euro decreases)?
Ex: From $3= €2 to $1= €2
•The U.S. Dollar APPRECIATES relative to
the euro.
Appreciation- The increase of value of a
country's currency with respect to a foreign
currency
•Less units of dollars are needed to buy a
single unit of the other currency.
•The dollar is said to be “Stronger”
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What happens if Europeans prefer
vacationing in the United States?
€
$
Dollars
$
€
S
er1
S
S1
ere
D1
ere
er1
D
Quantity of Dollars
The Dollar APPRECIATES
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Euros
D
Quantity of Euros
The Euro DEPRECIATES
Flexible Exchange Rates
• Determinants of exchange rates
• Factors that shift demand/supply
–Changes in tastes
–Relative income changes
–Relative price-level changes
• Purchasing-power-parity theory
–Relative interest rates
–Relative expected returns on assets
–Speculation
38-8
Change in Tastes
Vs.
Change in Relative Income
Change in Relative Price Level
Change in Relative Interest Rates
Change in
Relative
Expected
Returns on
Investment
Currency Speculation
Selffulfilling
prophecy
What will happen to the international value of the
Mexican peso if there is high inflation in Mexico?
Pesos
The peso DEPRECIATES
The demand for pesos
will decrease since
Mexico's trading
partners will not want
to purchase higher
priced Mexican
products.
The supply will
increase as Mexicans
look to buy lower
priced imports.
Practice
For each of the following examples, identify what will
happen to the value of US Dollars and Japanese Yen.
1. American tourists increase visits to Japan.
2. The US government significantly decreases
personal income tax.
3. Inflation in the Japan rises significantly faster
than in the US.
4. Japan has a large budget deficit that increases
Japanese interest rates.
5. Japan places high tariffs on all US imports.
6. The US suffers a larger recession.
7. The US Federal Reserve sells bonds at high
interest rates.
How do these scenarios affect exports and imports?
Practice
Shifter
Value of
Dollar ($)
Value of
Yen (¥ )
1
2
3
4
5
6
7
16
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Practice
Shifter
Value of
Dollar ($)
Value of
Yen (¥ )
1
Tastes
(S↑) Depreciates (D↑) Appreciates
2
Income
(S↑) Depreciates (D↑) Appreciates
3
Price Level
(D↑) Appreciates (S↑) Depreciates
4
Interest Rate (S↑) Depreciates (D↑) Appreciates
5
Regulation
(D↓) Depreciates (S↓) Appreciates
6
Income
(S↓)Appreciates (D↓) Depreciates
Interest Rate (D↑) Appreciates (S↑) Depreciates
Scenarios 1, 2, and 4 will increase US exports because
US products are now relatively “cheaper” 17
7
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2008 Audit Exam
2008 Audit Exam
High interest rates attract foreign currency
2010 FRQ #3
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2010 FRQ #3
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Flexible Exchange Rates
• Pro - Eliminates balance of payments deficit or
surplus
– Large imports from Mexico increase demand for
the peso, causing it to appreciate, making
Mexican goods more expensive and less likely
to be imported.
38-22
Flexible Exchange Rates
• Disadvantages of flexible exchange rates?
– Volatility
– Uncertainty and diminished trade
– Terms-of-trade changes
– Instability
• Depreciation of dollar = more exports
= higher prices (inflation)
• Appreciation of dollar = more
imports/less exports = more
unemployment
Exchange Rate Regimes
Flexible Exchange Rate- The market
determines the value of the country’s
currency
Fixed Exchange Rate- The government
actively manages the country’s currency
Some governments attempt to
depreciate their country’s currency in
order to promote exports
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Fixed Exchange Rates
• Government intervention
– Alter Supply/Demand
• Use of reserves (show on graph)
– Selling pounds = transfer of assets
• Trade policies – tariffs, subsidies
• Exchange controls and rationing
– Distorted trade lessens advantages
– Favoritism to certain importers
– Restricted choice for consumers
– Black markets – LEVIS!
38-25
Macroeconomic Adjustments to
maintain fixed exchange rates
• Use Monetary/Fiscal Policy
–Trade deficit with Britain
–Reduce demand for British Pounds
by undertaking contractionary
policy, reducing American incomes
and thus imports of British goods
–The cost?
–Recession.
Exchange Rate Systems
• Gold standard 1879-1934
–Fixed exchange rate system
• Bretton Woods 1944-1971
–Fixed exchange rate system
indirectly tied to gold
–International Monetary Fund
• Managed float 1971-present
38-28
Managed Float
• Dependence on foreign exchange
markets
• Occasional intervention (IMF)
– Tsunami
• In support of managed float
– Track Record
• Concerns with managed float
– Volatility
– Manipulation
38-29
5 Key Graphs
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Macro Review
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