review schedule (check web page for room numbers)
DESCRIPTION
Review Schedule (check web page for room numbers). Tomorrow 8 or 10am : meet with your TAs Tomorrow 7-8pm : usual weekly review Saturday : 12-2 Macro review, 2-4 Micro review Sunday : 12-2 Macro review, 2-4 Micro review Monday , 9am-5pm: office hours - PowerPoint PPT PresentationTRANSCRIPT
Review Schedule (check web page for room numbers)
• Tomorrow 8 or 10am: meet with your TAs• Tomorrow 7-8pm: usual weekly review• Saturday: 12-2 Macro review, 2-4 Micro review• Sunday: 12-2 Macro review, 2-4 Micro review• Monday, 9am-5pm: office hours
– Taylor: “Open house” style in Econ building
• Tuesday: Exam for Gates lecture people• Wednesday: Exam for Kresge lecture people • Everyday: JohnTayl@leland on “email alert”
Exchange rate determination• Exchange rate is the price of one currency in terms of
another– example: the price of a dollar is 120 yen, or 1.6 DM, or 1.05
euros
• Like any price, the exchange rate is determined in markets by the forces of supply and demand
• But foreign exchange markets are quick moving, like bond or stock markets
• Hence, to determine the price we use “arbitrage type” reasoning
Purchasing power parity (PPP)
• Based on Law of One Price– Basic idea: the price of the same commodity should
be about the same in different countries
• Example:• Golf ball $1.50 in U.S. (PUS = 1.50 dollars)
• Golf ball 200 yen in Japan (PF = 200 yen)
– Implies that purchasing power parity exchange rate is 133 yen per dollar (133x 1.50 = 200)
• In general, E x PUS = PF
How well does PPP work?
• Very well for large differences in inflation in different countries (large differences in PUS versus PF)
– German mark depreciated sharply during hyperinflation of 1920s
– Russian ruble depreciates sharply today during current inflation in Russia
• Very well for long periods of time – (see chart)
31_04
PERCENT
Japan France Italy U.K.Germany
8
6
4
2
0
2
4
6
Inflation rate in each country minus U.S. inflation rate
Appreciation (+) or depreciation (–) of the dollarcompared with each currency (percent per year)
But PPP does not explain exchange rates very well over
shorter periods of time• Short-run deviations of exchange rates from
PPP are due to interest rate differentials.
• If U.S. interest rate rises (falls) relative to interest rate in Japan or Europe, then the dollar will tend to appreciate (depreciate)
• Reason: Financial capital is highly mobile– People move their funds around quickly to get
the highest rate of return: “hot money”
Some evidence that interest rate differentials help explain exchange rate movements
31A
INTEREST RATE
19941974 1982 19901978 1986
6
4
2
0
-2
-4
160
140
120
100
80
60
Interest rate (left scale)
Exchange rate (right scale)
EXCHANGE RATE
Major policy question:Fixed versus flexible exchange rates• Examples of fixed exchange rate systems
– Bretton Woods, Argentina today, European monetary system from mid 1980s till Jan ‘99
– common feature: country fixes (pegs) exchange rate to another currency
• Key Idea: Keeping exchange rates fixed requires that interest rates move together in different countries (car with 2 steering wheels)– loss of international monetary independence
• Example: U.K. dropping out of peg with Germany
– but advantages of certainty and credibility
Marks and franks per dollar before and after Bretton Woods
31_05
19951955 19801970 19851965 1975 19901960
8
7
6
5
4
3
2
1
12.5
10.0
7.5
5.0
2.5
Francs per dollar(right scale)
Marks per dollar(left scale)
MARKS PER
DOLLAR
FRANCS PER
DOLLAR
End of BrettonWoods system
Marks per frank before and after Bretton Woods
31_06
FRANCS PER
MARK
19951955 19801970 19851965 1975 19901960
5
4
3
2
1
0
France and Germany exchangerates fixed
End of BrettonWoods system
WELCOME TO
A school for central bankers.Dedicated to teaching the science
and art of monetary policy.
Listen again to how Kelly McGillis explains monetary policy to Tom Cruise
Monetary policy rule 27_05
Monetary policy rule
7
6
5
4
3
2
1
0 1 2 3 4 5 6
INFLATION RATE (PERCENT)
INTEREST RATE (PERCENT)
Interest rate when inflation is on target
Inflation target
Trying to affect the exchange rate without changing the interest rate• Exchange market intervention
– Example, U.S. government buys yen to keep the yen from depreciating
– But capital flows are so quick and large these interventions are not very effective
• Resorting to capital controls– China, and now Malaysia
European Monetary Union• Goal is to permanently fix exchange rates within
Europe by moving to a single currency: the Euro• Eleven countries participating: Germany, France,
Italy, Spain, Netherlands, Ireland,...– U.K., Sweden not in
• Euroland will have one central bank: – the ECB will set interest rates just like the Fed– Starts operation in January 1999
• Biggest challenge for ECB will be political
Stages: Euro deposits will exist in January 1999, but paper money does not come until 2002
Five parts of macro
END OF COURSE
GOOD LUCK and
LOVE ECON