1

Simple View of Exchange Rate Simple View of Exchange Rate DeterminationDetermination

2

Foreign Exchange Rates Series: EUR (European Monetary Union Euro) 10 AM

00.20.40.60.8

11.21.41.6

1/4/

1999

7/4/

1999

1/4/

2000

7/4/

2000

1/4/

2001

7/4/

2001

1/4/

2002

7/4/

2002

1/4/

2003

7/4/

2003

1/4/

2004

7/4/

2004

1/4/

2005

7/4/

2005

1/4/

2006

EUR exchange rate against the dollar: EUR value in USD

3

USD exhcnage rate against the Canadian Dollar

00.20.40.60.8

11.21.41.61.8

1/2/

1997

1/2/

1998

1/2/

1999

1/2/

2000

1/2/

2001

1/2/

2002

1/2/

2003

1/2/

2004

1/2/

2005

1/2/

2006

Source: FRB, NY

4

The ForEx marketThe ForEx market

Supply of the USD Imports to the US

Goods (trade) Services (tourism)

US investment abroad Foreign Financial

Markets Direct investment abroad

Central Banks Speculation

Demand for the USD US Exports

Goods Services (tourism)

Foreign Investment into US US Financial markets Direct investment

Central Banks Speculation

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The Interesting 90’sThe Interesting 90’s 1991-92: Collapse of the USSR Block, beginning of the Transitional

Recession in Eastern Europe 1994 Mexican Currency Crisis 1991(2)-95 The Balkan Wars 1998 Recession in Japan 1997 (July) Beginning of the Asian Financial Crisis 1998 major Rouble Crisis

US ECONOMY

  average % rates

  1992-2000 2001-2004

Real GDP 3.7 2.5

Gross Domestic Private Investment 8.7 1.8

Non-Residential Investment 9.1 0.2

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The market for USD in the The market for USD in the 90’s90’s

D S

Influx of investment stimulated Demand

Increase in imports stimulated Supply

Demand Effect Dominated(thus positively effecting consumers’ standard of living)

P of USD

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The post 90’s eraThe post 90’s era United Europe

10 New Countries Entered the Union on May 1st of 2004, bringing the total number of member states to 25, with combined population of over 430 million (US population is 293 million).

Growth in Russia and China nearing double digits Emerging Economies of Brazil and India Threat of Terrorism to the US Continuous Growth in US Trade Deficit

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Should We Be Concerned With The Should We Be Concerned With The Fluctuating Dollar?Fluctuating Dollar?

TRADE and Currency Fluctuations Price Changes Standard of Living Commodity Prices

Date USD per EURO USD Price of OIL Euro Price of OIL

March 1, 2002 0.8652 22.40 25.89

March 3, 2003 1.0835 35.88 33.11

March 1, 2004 1.2431 36.86 29.65

March 1, 2005 1.3189 51.68 39.18

% change over the period 52.44 130.71 51.35

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Can the Government Influence the Can the Government Influence the Value of the Dollar?Value of the Dollar?

Monetary Policy Changes in Interest Rate and Investment

Flow

Fiscal Policy Borrowing leading to changes in Interest

Rate

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Currency Trade and Exchange Currency Trade and Exchange RegimeRegime

Floating Exchange Rate Regime Currency Trade by Central Banks

Fixed Exchange Rate Regime Does Recent Dollar Depreciation Impact

the Trade Deficit with CHINA? Price Stabilization and Fixed Exchange

Rate Regime Risk to CB

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The BIG pictureThe BIG picture

Rise in Imports Increase in Supply Depreciation Rise in Exports Increase in Demand Appreciation Influx of Investment Increase in Demand Appreciation Outflow of Investment Increase in Supply Depreciation

BALANCE OF PAYMENTS – An Economy’s International Balance Sheet (www.bea.gov)

12

Balance of PaymentsBalance of Payments

Current Account Trade Income flow

Financial Account Investment Flow

• Paying for Foreign Goods with Domestic Financial Assets – the US Example(US BoP)