forex sfls part 2
TRANSCRIPT
Introduction to Exchange Rates
(part 2)
Introduction to Exchange Rates:
3.) Change in Equilibrium – Appreciate vs Depreciate
1.) Classical Dichotomy - Nominal vs. Real
2.) Equilibrium - LoOP vs. PPP
4.) Change in Equilibrium – Reasons
5) Foreign Exchange regimes 制度
A fall in the value of a currency compared to other currencies.
It now buys less then before.
ex. - £1 = € 1.50 £1 = € 1.45
the balance of payments should ‘improve’
Depreciation Appreciation
A rise in the value of a currency compared to other currencies. It now buys more then before.ex. - £1 = $1.85 £1 = $1.91the balance of payments should get ‘worse’
This will depend on elasticity of imports and exports
(Weak) (Strong)
3.) Change in Equilibrium – Appreciate vs Depreciate
All the people in this land only use this money
All the people in this land only use this money
Marvel Land
DC Land
FOREX graph example
(Country B)(Country A)
Tony Stark has a motorcycle for sale in his country
Batman wants to buy it
But first he has to exchange his money
So he is going to go to the FOREX market to exchange the money
Marvel Land
DC Land
FOREX graph example
(Country B)(Country A)
Marvel Land
DC LandThe FOREX market is an
imaginary market that shows the supply and demand for both currencies
Amount
of B to
get an
A
Marvel Land
MoneyDC land
Money
Amount
of A to
get an
B
(Country B)(Country A)
FOREX graph example
Marvel Land
DC Land
Amount
of B to
get an
A
Marvel Land
MoneyDC land
Money
Amount
of A to
get an
B
(Country B)(Country A)
FOREX graph example
For B to get A stuffB has to get A money
D from B D from A
For A to get B stuffA has to get B money
Marvel Land
DC Land
Amount
of B to
get an
A
Marvel Land
MoneyDC land
Money
Amount
of A to
get an
B
(Country B)(Country A)
FOREX graph example
D from B D from A
For B to get A moneyB has to supply B money
S from BS from A
For A to get B moneyA has to supply A money
Marvel Land
DC Land
Amount
of B to
get an
A
Marvel Land
MoneyDC land
Money
Amount
of A to
get an
B
(Country B)(Country A)
FOREX graph example
D from B D from A
S from BS from A
If B wants to buy the motorcycle, will demand more A money
Marvel Land
DC Land
Amount
of B to
get an
A
Marvel Land
MoneyDC land
Money
Amount
of A to
get an
B
(Country B)(Country A)
FOREX graph example
D from B D from A
S from BS from A
This also means that he will supply more money in the open FOREX market
Marvel Land
DC Land
Marvel Land
MoneyDC land
Money
(Country B)(Country A)
FOREX graph example
D from B D from A
S from BS from A
So A money = more valuable
B/A A/B
And B money = less valuable
Marvel Land
DC Land
(Country B)(Country A)
FOREX graph example
So …..
Country B buys a motorcycle from country A means…
Exchange rate valueExchange rate value
Trade surplus Trade deficit
Appreciation Depreciation
Current Account Current Account
This is true from the point I started at
However
This process is like a circle so if I started at a different point then the opposite would happen
FOREX graph example
Marvel Land
DC Land
(Country B)(Country A)
FOREX graph example
so …..
This is step one in a circular process
This exchange rate system will “automatically” fix itself and his depreciatedcurrency will then fix the trade deficit
They have a trade deficit
They also have a depreciated currency
Marvel Land
DC Land
(Country B)(Country A)
FOREX graph example
Since B’s currency is depreciatedIt is now possible for A’s money to buy more of B’s money
They have a trade deficit
They also have a depreciated currency
So for example…
Marvel Land
DC Land
(Country B)(Country A)
FOREX graph example
B/A
Country A Money
A/B
Country B Money
D from AD from B
S from BS from A
Start here now…
Marvel Land
DC Land
(Country B)(Country A)
FOREX graph example
B/A
Country A Money
A/B
Country B Money
D from AD from B
S from BS from A
Things in country B now look much cheaper for the people in country A
Marvel Land
DC Land
(Country B)(Country A)
FOREX graph example
B/A
Country A Money
A/B
Country B Money
D from AD from B
S from BS from A
So A will buy more things from B which means he will first demand more of B’s money
Marvel Land
DC Land
(Country B)(Country A)
FOREX graph example
B/A
Country A Money
A/B
Country B Money
D from AD from B
S from BS from A
But to do that, country A will supply more of it’s own money in the FOREX
so we should go back to the same (PPP) because of LoOP
Marvel Land
DC Land
(Country B)(Country A)
FOREX graph example
So …..
Current account
If you have a trade deficit…
Exchange rate value
Trade deficit
Depreciation
A depreciation currency will make you stuff look cheap for others…
So it should “automatically” fix the deficit
Trade deficit gets smaller
Marvel Land
DC Land
(Country B)(Country A)
FOREX graph example
Current account
The same thing will be true on the other side too just the opposite…
Exchange rate value
Trade surplus
Appreciation
An appreciated currency tends to reduce a trade surplus.
Trade surplus gets smaller
But with “floating” exchange rates everything should “smooth” out in the long run
Surplus
Time
Deficit Long Run
Short Run
So in the short run things go up and down and can be quite volatile
Of course we always live in the short run causing things to be volatile but we usually drift back and move towards the long run because of (LoOP)
FOREX graph example
Introduction to Exchange Rates:
3.) Change in Equilibrium – Appreciate vs Depreciate
1.) Classical Dichotomy - Nominal vs. Real
2.) Equilibrium - LoOP vs. PPP
4.) Change in Equilibrium – Reasons
5) Foreign Exchange regimes 制度
Mostly things that change in demand for imports and exports
Mostly things that change the demand for investments
1.) Consumer Tastes
2.) Relative incomes (booms and recessions)
3.) Relative prices (PPP) (Inflation)
5.) Speculation
4.) Interest rates
4.) Change in Equilibrium – Reasons
Reasons that change on the Current Account side
Reasons that change on the Financial Account side
6.) Government debt
7.) FDI or Portfolio investment
- Increased preferences for imports increases demand and visa versa.
Country B’s Demand for Country A’s goods
Appreciation in Country A
Example:
1.) Consumer Tastes
B/A
Country A
D from B
S from A
D from B1
Country B
A/BS from B
S from B1
4.) Change in Equilibrium – Reasons
- Recessions lowers demand for imports, booming economies raise demand for imports.
Example:
2.) Relative Incomes
Country AEcon good times
Appreciation in Country B
Country BEcon bad times
A Demands more B money
B Supplies less B money
4.) Change in Equilibrium – Reasons
- Recessions lowers demand for imports, booming economies raise demand for imports.
Example:
2.) Relative Incomes
Country AEcon good times
Appreciation in Country B
Country BEcon bad times
A Demands more B money
B Supplies less B money
A/B
Country B Money
D from A
Country B Money
A/B
*** for country A everything would be the exact opposite
** notice both these graphs are really the same graph for the same country
4.) Change in Equilibrium – Reasons
Example:
D from A
3.) Relative Prices(PPP) (Inflation)
- If a nation’s price level is rising faster then another nations, consumers seek cheaper goods.( Real vs. Nominal changes important to note)
Country A’s prices in their economy
Appreciation
in country B
Country B’sstay the same
A demands more B money
B demands less A money
B supplies less B money
A supplies more A money
Deprecation
in country A
4.) Change in Equilibrium – Reasons
Example:
D from A
4.) Interest Rates - Increased interest rates means larger investment income by investors.
Country A’s interest rates
Appreciation
in country A
Country B’sstay the same
A demands less B money
B demands more A money
B supplies more B money
A supplies less A money
Deprecation
in country B
4.) Change in Equilibrium – Reasons
Country A’s interest rates
B Demands less A money
A supplies more A money
Deprecation
in country A
Since currencies can be traded as assets, investors seek profit buying low and selling high.
Country B’sstay the same
4.) Speculation
Example:Less desire to have A money since the possible income from having it falls.
*3.) interest rates
4.) Change in Equilibrium – Reasons
Country A’s interest rates
B Demands less A money
A supplies more A money
Deprecation
in country A
Since currencies can be traded as assets, investors seek profit buying low and selling high.
Country B’sstay the same
4.) Speculation
Example:Less desire to have A money since the possible income from having it falls.
B/A
Country A Money Country A Money
B/A
** notice both these graphs are really the same graph for the same country
*3.) interest rates
4.) Change in Equilibrium – Reasons
Country A’s national debt is a problem
B Demands less A money
A supplies more A money
Deprecation
in country A
Since currencies can be traded as assets, investors seek profit buying low and selling high.
Country B’sstay the same
4.) Speculation
Example:Less desire to have A money since investors worry that the debt can be causing a problem for growth in the country.
*5.) government debt
4.) Change in Equilibrium – Reasons
Country A’s national debt is a problem
B Demands less A money
A supplies more A money
Deprecation
in country A
Since currencies can be traded as assets, investors seek profit buying low and selling high.
Country B’sstay the same
4.) Speculation
Example:Less desire to have A money since investors worry that the debt can be causing a problem for growth in the country.
B/A
Country A Money Country A Money
B/A
*5.) government debt
** notice both these graphs are really the same graph for the same country
4.) Change in Equilibrium – Reasons
Direct Investment:
Portfolio Investment:
- Investors putting their funds into stocks and shares, government bonds and property. Strong inflows from overseas cause increased demand in the country’s cuurency/
- An economy that attracts high net inflows of capital investment from overseas will have increased demand for the country’s currency.
7.) FDI or Portfolio investment
Appreciation
in the country
Appreciation
in the country
4.) Change in Equilibrium – Reasons
Mostly things that change in demand for imports and exports
Mostly things that change the demand for investments
1.) Consumer Tastes
2.) Relative incomes (booms and recessions)
3.) Relative prices (PPP) (Inflation)
5.) Speculation
4.) Interest rates
Reasons that change on the Current Account side
Reasons that change on the Financial Account side
6.) Government debt
7.) FDI or Portfolio investment
4.) Change in Equilibrium – Reasons
A few examples…
Demand for country A’s goods
How would a change in consumer tastes cause Appreciation in country A ?
Appreciation in country A
Supply of A’scurrency How would Appreciation in country A cause a
change in consumer spending?
Appreciation in country ADemand for country A’s goods
Supply of A’s currency
4.) Change in Equilibrium – Reasons
How would an increase in relative prices (inflation) cause Deprecation in country A ?
Country A’sprices
Demand for A’s goods
Supply of A’scurrency
Deprecation in country A
How would Deprecation in country A effect the foreign exchange market?
Deprecation in country A
Demand for A’s goods
Supply of A’scurrency
*** But only if the deprecation is larger than the price increase
4.) Change in Equilibrium – Reasons
If country A is experiencing bad economic times (recession) how could that lead to appreciation of it’s currency?
Appreciation in country's FOREX
Country hasEcon bad times
Country’s supply of currency
How could appreciation effect an economy?
Appreciation in country's' FOREX
Demand exports
Demand imports
*** It depends on which effect is higher and what caused the bad times
4.) Change in Equilibrium – Reasons
If country A is experiencing bad economic times (loss of comparative advantage) how could that lead to deprecation of it’s currency?
Deprecation in country's' FOREX
Country hasEcon bad times
Demand of country’s goods
How could Deprecation effect an economy?
Deprecation in country's' FOREX
Demand exports
Demand imports
*** It depends on which effect is higher and what caused the bad times
4.) Change in Equilibrium – Reasons
If a country’s government decides to increase the interest rate it pays on bonds what will happen to the exchange rate?
Country’s interest rates
Demand for country’s currency
Supply of country’s currency
Appreciation in country’s
currency
4.) Change in Equilibrium – Reasons
So to summarize…
Law of One Price
- A unit of any currency should be able to buy the same quantity of goods in all countries.(should end up with same.nominal values everywhere )
- based on the law of one price.
Purchasing Power Parity( PPP)
(Nominal = Real)
2.) Equilibrium - LoOP & PPP
Long run – Everything should balance be worth the same
A fall in the value of a currency compared to other currencies.
It now buys less then before.
ex. - £1 = € 1.50 £1 = € 1.45
the balance of payments should ‘improve’
Depreciation Appreciation
A rise in the value of a currency compared to other currencies. It now buys more then before.ex. - £1 = $1.85 £1 = $1.91the balance of payments should get ‘worse’
This will depend on elasticity of imports and exports
(Weak) (Strong)
3.) Change in Equilibrium – Appreciate vs Depreciate
Marvel Land
DC Land
Marvel Land
MoneyDC land
Money
(Country B)(Country A)
FOREX graph example
D from B D from A
S from BS from A
So A money = more valuable
B/A A/B
And B money = less valuable
Mostly things that change in demand for imports and exports
Mostly things that change the demand for investments
1.) Consumer Tastes
2.) Relative incomes (booms and recessions)
3.) Relative prices (PPP) (Inflation)
5.) Speculation
4.) Interest rates
Reasons that change on the Current Account side
Reasons that change on the Financial Account side
6.) Government debt
7.) FDI or Portfolio investment
4.) Change in Equilibrium – Reasons
End of part 2
Thanks!