Bài giảng Macroeconomics - Chapter 21: Exchange Rates, International Trade, and Capital Flows

Chapter 21: Exchange Rates, International Trade, and Capital FlowsDefine the nominal exchange rate and use supply and demand to analyze how the nominal exchange rate is determined in the short runDistinguish between fixed and flexible exchange rates and discuss the advantages and disadvantages of each systemDefine the real exchange rate and show how it is related to the prices of goods across pairs of countriesUnderstand the law of one price and apply the purchasing power parity theory of exchange rates to long-run equilibrium exchange rate determinationAnalyze the factors that determine international capital flows and how these factors affect domestic saving and the domestic real interest rateUse the relationship between domestic saving and the trade balance to understand how domestic saving, the trade balance, and net capital inflows are relatedNominal Exchange RatesThe nominal exchange rate is the rate at which two currencies can be traded for each otherConsider 3 currencies: $, C$, and £One dollar buys £ 0.5045 or C$ 1.0265The exchange rate between UK pounds and Canadian dollars can be calculated from this information£ 0.5045 = C$ 1.0265£ 1 = C$ 1.0265 / 0.5045£ 1 = C$ 2.035ORC$ 1 = £ 0.5045 / 1.0265C$ 1 = £ 0.4915Importance of Exchange RatesDomestic purchases are made with local currencyPurchasing goods abroad requires converting your local currency to their local currencyThe exchange rate measures the rate of conversionExchange rates are set in the foreign exchange market, with a small number of exceptionsRates are determined by supply and demandAffect the value of imported goods and the value of financial investments made across bordersChanges in exchange rates can have a significant effect on most economiesChanges in Exchange RatesAppreciation is an increase in the value of a currency relative to other currenciesDepreciation is a decrease in the value of a currency relative to other currenciesExchange RatesDefinitione = the number of units of foreign currency that each unit of domestic currency will buyDomestic currency appreciates if e increasesDomestic currency depreciates if e decreasesExchange Rate StrategiesThe foreign exchange market is the market on which currencies of various nations are tradedA flexible exchange rate is an exchange rate whose value is not officially fixed but varies according to the supply and demand for the currency in the foreign exchange marketA fixed exchange rate is an exchange rate set by official government policyCan be set independently or by agreement with a number of other governmentsFixed rates can be set relative to the dollar, the euro, or even goldFlexible Exchange Rate in the Short RunExchange rates are set by supply and demand in the foreign exchange marketDollars are demanded by foreigners who seek to purchase U.S. goods or financial assetsNumber of dollars foreigners seek to buyDollars are supplied by U.S. residents who need foreign currency to buy foreign goods or financial assetsNot the same as the money supply set by the FedNumber of dollars offered in exchange for other currenciesMonetary Policy and the Exchange RateMonetary policy affects interest rates which affect the exchange rateTighter U.S. monetary policy leads to a higher real interest rateHigher interest rates make U.S. assets more attractive than foreign assetsDemand for the dollar increases by foreignersDemand curve shifts to the rightSupply of dollars by U.S. decreasesSupply curve shifts to the leftDollar appreciatesTighter Monetary PolicyHigher real interest rates in U.S. increase demand for dollars and decrease supplyDollar appreciatesChange in quantity of dollars traded depends on Size of the two shiftsSlopes of the curvesQuantity of dollarsYen / dollar exchange ratee*'FSDe*ES'D'Monetary Policy and the Exchange RateFlexible exchange rates make monetary policy more effectiveWhen the Fed tightens monetary policy, it sets off a chain of domestic eventsAnd a chain of international eventsMonetary policy is more effective in an open economy with flexible exchange rates r  C, IP PAE  Y  r  e* NX  PAE Y Fixed Exchange RatesMost large industrial countries use a flexible exchange rateSmall and developing countries may use a fixed exchange rateFixed exchange rate system was set up after World War IIBegan to break down in the 1960sAbandoned by 1976Fixed exchange rates greatly reduce the effectiveness of monetary policy as a stabilization toolFixed Exchange RatesTo establish a fixed exchange rate system, the government states the value of its currency in terms of a major currency May use an average of the currencies of its major trading partnersGovernment attempts to maintain the fixed exchange rate at its existing levelThe government may change the value of its currency in response to market eventsExchange Rates and Monetary PolicyFlexible exchange rates strengthen the effectiveness of monetary policy for stabilizationFixed rates require the central bank to choose between defending the currency and stabilizing the economyFixed rates can be beneficial for small economiesArgentina fought hyperinflation by valuing its peso on par with the dollarInflation quickly decreased and stayed stable for more than 10 yearsFixed exchange system broke down because unsound domestic policies created fears that Argentina would default on international loansReal Exchange RatesIn the short run, domestic prices of goods are fixedIn the long run, this assumption is relaxedThe real exchange rate is the price of the average domestic good relative to the price of the average foreign good when prices are expressed in a common currency The nominal exchange rate, e, is the number of units of foreign currency per dollarTo convert a foreign price, Pf, to the dollar price, Pf$, divide Pf by ePf / e = ¥ 242,000 / (¥ 110/$1) = $2,200Law of One PriceThe law of one price states that if transportation costs are relatively small, the price of an internationally traded commodity must be the same in all locationsSuppose wheat in Sydney was half the price of wheat in MumbaiBuy wheat in Sydney, increasing demand and priceSell wheat in Mumbai, increasing supply and decreasing the priceThe law of one price implies that real exchange rates prevail in the long runPurchasing Power Parity (PPP)Purchasing power parity is the theory that nominal exchange rates are determined as necessary for the law of one price to holdIn the long run, the currencies of countries that experience significant inflation will tend to depreciateThe theory works well in the long run but not the short runNot all goods and services are traded internationallyNot all internationally traded goods and services are perfectly standardized commoditiesPPP ExaminedTrade BalanceTrade balance is another name for net exports (NX)Value of a country's exports minus the value of its importsA trade surplus is a positive trade balanceExports > importsA trade deficit is a negative trade balanceImports > exportsCapital FlowsInternational capital flows are purchases or sales of real and financial assets across international bordersCapital inflows are purchases of domestic assets by foreign households and firmsCapital outflows are purchases of foreign assets by domestic households and firmsNet capital inflows (KI) are capital inflows minus capital outflowsCapital flows are not counted as imports or exports since they refer to the purchase of existing assets rather than currently produced goods and servicesInternational Capital FlowsHighly developed financial markets allow borrowing and lending across bordersTransactions are subject to laws in the originating country and the target countrySize of international flows for a country depend on its regulations and lawsAlso depend on economic integration and political stabilityLending is acquiring a real or financial assetBuying a share of stock or a government bond or a parcel of landBorrowing is selling a real or financial assetTwo Roles of International Capital FlowsTrade ImbalancesInternational capital flows compensate for trade imbalancesTrade surplus means net capital outflowsTrade deficit means net capital inflowsEfficient Allocation of SavingsInternational capital flows allow savers to invest in the most profitable opportunitiesIndependent of location Fills savings gap in destination countrySavings, Investment, Capital InflowsDefinition of outputY = C + I + G + NXSolve for IY – C – G – NX = INational savings, S, is (Y – C – G)S – NX = IAlsoNX + KI = 0 OR KI = – NXSoS + KI = IS + KI = ISavings plus net capital inflows equals investment in new capital goodsForeign savings can supplement domestic savings to create capital goods to support economic growthIn a closed economy,S = IIn an open economy,S + KI = ICapital inflows mean more investment and lower interest ratesSaving and investmentReal interest rate (%) IS + KIS, Ir*Exchange Rates, International Trade, and Capital FlowsExchange ratesNominal and realFixed and flexibleShort run and long runPurchasing power parityMonetary policy and the exchange rateTrade balance and net capital inflowsInternational capital flowsThe saving rate and the trade deficit