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    Money and Banking: Foreign Exchange & The International Monetary System Chapters 17, 18 Week 11

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    Mohit Singh Panwar
    The document discusses several topics related to foreign exchange markets and international monetary systems, including: 1) The foreign exchange market trades over $1 trillion daily, mostly to finance asset purchases rather than goods, and operates over-the-counter between hundreds of dealers, mostly banks. 2) Purchasing power parity theory calculates exchange rates to value currencies at rates where each can buy an equal basket of goods, in an attempt to balance trade. 3) Exchange rates are affected not just by purchasing power parity but also by factors like tariffs, import/export demand, and productivity.

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    Money and Banking: Foreign Exchange & The International Monetary System Chapters 17, 18 Week 11

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    Mohit Singh Panwar
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    The document discusses several topics related to foreign exchange markets and international monetary systems, including: 1) The foreign exchange market trades over $1 trillion daily, mostly to finance asset purchases rather than goods, and operates over-the-counter between hundreds of dealers, mostly banks. 2) Purchasing power parity theory calculates exchange rates to value currencies at rates where each can buy an equal basket of goods, in an attempt to balance trade. 3) Exchange rates are affected not just by purchasing power parity but also by factors like tariffs, import/export demand, and productivity.

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    The document discusses several topics related to foreign exchange markets and international monetary systems, including: 1) The foreign exchange market trades over $1 trillion daily, mostly to finance asset purchases rather than goods, and operates over-the-counter between hundreds of dealers, mostly banks. 2) Purchasing power parity theory calculates exchange rates to value currencies at rates where each can buy an equal basket of goods, in an attempt to balance trade. 3) Exchange rates are affected not just by purchasing power parity but also by factors like tariffs, import/export demand, and productivity.

    Copyright:

    Attribution Non-Commercial (BY-NC)
    Download as PPT, PDF, TXT or read online from Scribd
    Download as ppt, pdf, or txt
    27 views19 pages

    Money and Banking: Foreign Exchange & The International Monetary System Chapters 17, 18 Week 11

    Uploaded by

    Mohit Singh Panwar
    The document discusses several topics related to foreign exchange markets and international monetary systems, including: 1) The foreign exchange market trades over $1 trillion daily, mostly to finance asset purchases rather than goods, and operates over-the-counter between hundreds of dealers, mostly banks. 2) Purchasing power parity theory calculates exchange rates to value currencies at rates where each can buy an equal basket of goods, in an attempt to balance trade. 3) Exchange rates are affected not just by purchasing power parity but also by factors like tariffs, import/export demand, and productivity.

    Copyright:

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    Download as PPT, PDF, TXT or read online from Scribd
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    of 19

    Money and Banking

    Foreign Exchange & the International


    Monetary System
    Chapters 17, 18
    Week 11

    1
    Foreign Exchange Market
    • Abbreviation: FOREX
    • Over a trillion dollars
    worth are traded daily.
    • Most trading is to finance
    the purchase of assets
    • (e.g., bank deposits), not
    goods and services.
    • OTC (several hundred
    dealers, mostly banks)
    • Wholesale vs. retail
    2
    Quotes
    Euro-dollar quote of $1.2120

    The euro is the BASE currency.


    The dollar is the TERMS currency.

    3
    www.newyorkfed.org/markets

    4
    Purchasing Power Parity Theory
    A method of calculating exchange rates that
    attempts to value currencies at rates such
    that each currency will buy an equal basket
    of goods.
    Creates a balance in trade. When a country
    has an inflation, its currency depreciates.

    5
    Other factors affecting exchange
    rates
    • Tariffs and quotas
    • Import demand
    • Export demand
    • Productivity

    6
    Volatility in forex market not
    explained by PPPT
    Purchasing power changes gradually.
    Exchange rates change rapidly.

    7
    Asset Demand Theory
    Exchange rates adjust so that expected returns
    across assets of equal risk are equalized.

    So if the expected return on European assets


    is higher than ones in the U.S. assets, the
    value of the Euro will appreciate.

    In equilibrium all expected returns are equal.


    8
    Exchange Rate Overshooting
    • A change in money supply causes a short-run
    change in the real interest rate.
    • Eventually the real interest rate adjusts back to its
    original level and the exchange rate goes back as
    well.

    Purchasing power changes slowly.

    Most forex trading is not to finance import/export


    traded.
    9
    19th Century Gold Standard
    1 oz of gold = $20 = £4 Liberty Gold Dollar (1849-
    1854)

     £1 = $5

    Suppose £1 = $5.25.
    What’s the arbitrage
    opportunity?

    10
    Two types of exchange rate regime
    Flexible Fixed
    • Exchange rate determined by • Central bank buys and sells
    supply and demand. domestic currency at a fixed
    • Characterized by volatility. price.
    • Creates uncertainty in • The gold standard was a fixed
    conducting international exchange rate regime.
    business. • Bretton Woods was another.
    • Changes in value called • Provides more certainty in the
    appreciation and depreciation. short run but the system is
    susceptible to speculative
    attacks.
    • Changes in value called
    revaluation and devaluation.

    11
    Bretton Woods Agreement 1944
    Established a system of
    fixed exchange rates.

    Major architect of
    agreement J.M.
    Keynes called gold a
    “barbarous relic.”

    12
    Nixon Closes the Gold Window
    (1971)
    1960’s inflation in US
    Accumulation of $’s in
    ROW
    German CB requests gold
    for $’s.
    Nixon refuses to honor
    agreement signaling
    the beginning of the
    end of fixed exchange
    rates.
    13
    Exchange Rate Interventions
    Unsterilized Sterilized
    CB enters into forex CB enters into forex
    market to influence market and then
    value of currency. conducts OMO to keep
    E.g. Fed buys $ to keep money supply constant.
    value high. E.g. Fed buys $ in forex
    market and then
    conducts expansionary
    OMO.
    14
    Effect of Interventions
    Evidence shows sterilized interventions have
    little effect.
    Consider, Germany during final years of BW.
    Buying dollars, selling DM and then buying
    DM to prevent inflation.
    No matter how many dollars they bought they
    couldn’t get the exchange rate at BW levels.
    15
    George Soros vs. Bank of
    England
    Plus $1.1 billion Minus $1.1 billion

    16
    Common Currency
    Advantages Disadvantage
    Eliminates costs of Loss of control over
    exchanging currencies. monetary policy
    Facilitates price
    comparisons.
    Creates a larger market.

    17
    Euroland
    12 Member States of the European
    Union are participating in the
    single currency:
    • Belgium
    • Germany
    • Greece
    • Spain
    • France
    • Ireland
    • Italy
    • Luxembourg
    • The Netherlands
    • Austria
    • Portugal
    • Finland

    18
    Dollarization
    • A country abandons their domestic currency
    and uses the dollar.

    19

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