Nominal Exchange Rate
the rate at which two currencies can be traded for each other (aka: exchange rate); abbreviated as "e
Flexible Exchange Rate
value is determined freely in the foreign exchange market; vary continually with changes in the supply of and demand for national currencies; EX: USA
Fixed Exchange Rate
value set by the government at a constant level
Foreign Exchange Market
the market on which currencies of various nations are traded for one another
Real Exchange Rate
the rate at which one country's goods trade for another's
Appreciation
an increase in the value of a currency relative to other currencies (a rise in nominal exchange rate)
Depreciation
a decrease in the value of a currency relative to other currencies (a fall in nominal exchange rate)
Who is the principle supplier of dollars to the foreign exchange market? Why?
US households and firms; to purchase foreign goods or services and to purchase foreign assets
Supply and Demand Curve for Dollars in the Yen-Market
The supply of dollars to the foreign exchange market is upward-sloping because an increase in the number of yen offered for each dollar makes Japanese goods, services, and assets more attractive to US buyers. Similarly, the demand for dollars is downward-
Market Equilibrium Value of the Exchange Rate (e*)
the exchange rate that equates the quantities of the currency supplied and demanded in the foreign exchange market; is not constant but changes with shifts in the supply of and demand for dollars in the foreign exchange market
Factors that INCREASE the supply of dollars, shifting the supply curve for dollars to the RIGHT
-increased preference for Japanese goods
-increase in US real GDP
-increase in the real interest rate on Japanese assets or a decrease in the real interest rate on US assets
Factors the REDUCE the supply of dollars to the foreign exchange market and shifting the supply curve to the LEFT
-reduced demand for Japanese goods
-lower US GDP
-lower real interest rate on Japanese assets
-a higher real interest rate on US assets
An ___________ in the supply of dollars lowers the value of the dollar
increase
Factors that INCREASE the demand for dollars
-an increased preference for US goods by foreign customers
-an increase in real GDP abroad
-increase in the real interest rate on US assets or a reduction in the real interest rate on Japanese assets
Does a strong currency imply a strong economy?
No- an appreciating currency (increase in e*) tends to hurt a county's net exports; a strong dollar may imply lower sales and profits for US industries that export, as well as for US industries (like car manufacturers) that compete with foreign firms for
Tighter monetary policy in the US __________ the domestic real interest rate, ________ the demand for US assets by foreign and American savers.
raises; increasing (shifts the demand curve to the right; shifts the supply curve to the left)
The tightening of monetary policy by the Fed raises the ___________ for dollars and reduces the __________ of dollars, causing the dollar to depreciate.
demand; supply
When the exchange rate is ______________, a tighter monetary policy reduces net exports as well as consumption and investment spending.
flexible
Devaluation
a reduction in the official value of a currency (in a fixed-exchange-rate system)
Revaluation
an increase in the official value of a currency (in a fixed-exchange-rate system)
Overvalued Exchange Rate
an exchange rate that has an officially fixed value greater than its market equilibrium value
Undervalued Exchange Rate
an exchange rate that has an officially fixed value less than its market equilibrium value
International Reserves
foreign currency assets held by a government for the purpose of purchasing the domestic currency in the foreign exchange market
Balance-of-Payments Deficit
the net decline in a country's stock of international reserves over a year
Balance-of-Payments Surplus
the net increase in a country's stock of international reserves over a year
International Monetary Fund
established after World War II, partly as a response to the disastrous exchange rate policies of the 1930s, controlled by a 24 person executive board
Suppose a US made computer costs $2,400 and a Japanese made computer costs 242,000 yen. If the nominal exchange rate is 110 yen per dollar, which computer is the better to buy?
Price in yen= price in dollars x value of dollar in terms of yen
price in dollar= price in yen
----------
yen - dollar exchange rate
=Y242,000
--------
Y110/$1
=$2,200
SO, the Japanese computer is cheaper than the US computer by $200
Real Exchange Rate
the price of the average domestic good or service relative to the price of the average foreign good or service, when prices are expressed in terms of a common currency
Real exchange rate= price of domestic good
-------------------
price of foreign good, i
The nominal exchange rate e was Y110/$1, the domestic price P (of a computer) was $2,400, and the foreign price P^f was Y242,000. What is the real exchange rate (for computers)?
0
Law of One Price
if transportation costs are relatively small, the price of an internationally traded commodity must be the same in all locations
Purchasing Power Party
the theory that nominal exchange rates are determined as necessary for the law of one price to hold