Money , Interest Rates , & Exchange Rates

1. Money, Interest Rates, & Exchange Rates • Determination of exchange rates: • How interest rates are determined; • How expectations of future exchange rates are formed.

2. money supply Exchange rates • Interest rate • Expectation money demand

3. Money? • Distinguish money from other assets • As a Medium of Exchange • As a Unit of Account • As a Store of Value 马克思的货币概念

4. Money Supply = the monetary aggregate the Federal Reserve calls M1. =the total amount of currency and checking deposits held by households and firms.

5. Demand for money by individuals Amount of money an individual desire to hold • Expected return(money and other assets) • Riskiness of the asset’s expected return • The asset’s liquidity

6. Aggregate Money Demand→ →Md • The interest rate → → R • The price level → → P • Real national income → → Y L(R, Y) = aggregate real money demand

7. R Increase in real income Y, cause the whole demand schedule to shift upward. For a given real income level, Y, real money demand rises as the interest rate falls. L(R,Y)

8. Money Supply Equilibrium in the money market: The money supply schedule is verticalat Ms/Pbecause Ms is set by the central bank while P is taken as given.

9. R Real money supply If there is an excess supply of money, then R↓ If there is an excess demand of money, then R↑ Aggregate real money demand L(R,Y)

10. R Real money supply An increase in real output raises the interest rate, and vice versa, given the price level and money supply. Aggregate real money demand ② ① L(R,Y)

11. Money supply & exchange rate in the short run • The previous assumption: price level (real output) given: • In the short run: • money supply↑→interest rate & exchange rate • In the long run: • money supply ↑→price level & exchange rate and other macroeconomic variables

12. Linking money, interest rate, & exchange rate • P375 • Simultaneous equilibrium in money market and the foreign exchange market.

13. exchange rate return on domestic deposit ③本币贬值↑ Foreign exchange market expected return on foreign deposit ②影响本国利率 domestic interest Rates of return L (R, Y) money supply Money market ①本币货币供应增加 假定：两国价格水平与国民收入不变。 money holdings

14. Conclusions • An increase in a country’s money supply causes its currency to depreciate in the foreign exchange market • A reduction in a country’s money supply causes its currency to appreciate in the foreign exchange market.

15. Money, price level, & exchange rate in the long run • Monetary factors →price level in the long run. • An economy’s long-run equilibrium is reached if prices were perfectly flexible and always adjusted immediately to preserve full employment. • Tool: the theory of aggregate money demand.

16. exchange rate return on domestic deposit Foreign exchange market ①外国货币供给增加 ②本币贬值 domestic interest Rates of return L (R, Y) money supply Money market ③本国货币市场维持原状。 money holdings

17. Money & Money Prices • If the price level & output are fixed in the short run, money market equilibrium: Money supply = Money demand ①P, Y, R can vary in the long run. ②Price level depends on …

18. Proportional Change • All else equal, an increase in a country’s money supply causes a proportional increase in its price level. Remain Unchanged

19. The long-run effects of money supply changes • A change in the supply of money has no effect on the long-run values of the interest rate or real output. e.g. currency reform • A permanent increase in the money supply causes a proportional increase in price level’s long-run value. If the economy is initially at full employment, a permanent increase in the money supply eventually will be followed by a proportional increase in the price level.

20. Empirical evidence: Relation between Ms and P: • No proportional relationship over long period; • A clear-cut positive association between them.

21. Case in Industrialized Countries P Long term; Positive correlation; Proportional changes Ms

22. Case in Latin America-time series Price level Strong positive relationship Money supply

23. Money & Exchange Rate in the long run • A permanent increase in a country’s money supply causes a proportional long-run depreciation of its currency against foreign currencies and vice versa.

24. Short-run price rigidity vs. long-run price flexibility • Prices are written into long-term contracts; • The most important prices are workers’ wages; • Workers’ wages do not enter indices of the price level directly, but they constitute the cost of production; • Wages influence the overall price level; • The short-run “stickiness” of price level; (Chinese presumptions)

25. The exchange rate is much more variable than relative price level; The price levels are relatively rigid in the short run and they will not jump in response to policy changes.

26. There are some exceptions of short-run stickiness of price levels • Excess demand for output and labor; • Inflationary expectations; • Raw materials prices;

28. Permanent money supply changes & the exchange rate • P. 389 • Notice that the dollar depreciation is greater than it would be if the future dollar/euro exchange rate stayed fixed(as it might if the money supply increase temporary rather than permanent). If the expectation did not change, the new short-run equilibrium would be at point 3’ rather than at point 2’.

29. Start from MS ↑ Adjustment to long-run equilibrium Short-run effects

30. Exchange rate overshooting • The exchange rate is said to overshoot when its immediate response to disturbance is greater than its long-run response. Exchange rate overshootingis an important phenomenon because it helps explain why exchange rates move so sharply from day to day. • The explanation comes from the interest parity condition.

31. Time paths of U.S. economic variables after a permanent increase in the U.S money supply 中文翻译

32. Overshooting • Overshooting is a direct consequence of the short-run rigidity of the price level. • In a hypothetical world where the price level could adjust immediately to its new long-run level after a money supply increase, the dollar interest rate would not fall because prices would adjust immediately and prevent the real money supply from rising.

33. Development of “Overshooting” • Chinese version由于商品价格粘性的存在，当货币供给一次性增加以后，本币汇率的瞬间贬值程度大于长期贬值程度，该现象为汇率超调。 • 在短期内，总供给曲线是水平的，价格水平不发生调整，货币供给的一次性增加只是造成本国利率的下降，本币汇率的贬值超过长期平衡水平，本国产出超过充分就业水平。

34. 预期的未来汇率水平不变，导致汇率调整的主要因素是本国利率的调整。预期的未来汇率水平不变，导致汇率调整的主要因素是本国利率的调整。 • 随着利率的逐步提高，实际汇率也逐步升值并向其长期平衡水平趋近。 • 一直持续到均衡状态：价格水平发生与货币供应量的增加同比率上涨。此时，购买力平价成立。

35. 超调模型的评价 • 创立了动态汇率学； • 会使购买力平价短期不成立；