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Session 19

Session 19. What Determines Exchange Rate ?. Movements of Exchange Rate. 1. Long-term Trends. The movement of exchange rate over the entire period. 2. Medium-term Trends. The movement of exchange rate over periods of several years. These are sometimes counter to the longer trends.

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Session 19

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  1. Session 19 What Determines Exchange Rate ?

  2. Movements of Exchange Rate 1. Long-term Trends The movement of exchange rate over the entire period. 2. Medium-term Trends The movement of exchange rate over periods of severalyears. These are sometimes counter to the longer trends. 3. Short-term Variability The movement of exchange rate over short periods. These are the exchange rates from month to month (and indeed, from day to day , hour to hour, and evenminute to minute.)

  3. Exchange Rates in the Short-run This depends on the demands and supplies of assets denominated in different currencies. 1. The basic return on the bond itself (the interest rate) 2. The expected gain and loss on the currency exchanges

  4. The Role of Interest Rates Malaysia What happen to Malaysia currency ? Bond Interest = 5% Thai Exchange Money Bond Interest = 10 % High Demand for the “Thai” currency will occur. The amount of “Thai” currency will be reduced from the system. The value of “Thai” currency will appreciate. ( i.e. from 1 dollar/25 baht to 1 dollar/24) The value of “Malaysia” currency will depreciate.

  5. The Role of the Expected Future Spot Exchange Rate Expected FutureSpot Rate Current Spot Rate Singapore Singapore Hong Kong Hong Kong 1 USD / 25 SGD $ 1 USD / 20 SGD 1 USD / 25 HKD 1 USD/ 30 HKD High Demand for the “Singapore” currency will occur. The amount of “Singapore” currency will be reduced from the system. The value of “Singapore” currency will appreciate. ( i.e. from “1 USD /25 SGD” to “1 USD/24 SGD”)

  6. Exchange Rates in the Long-run Price Level (i.e., + transport cost, tariff, bribe, and etc) Suppose : $1 = £1 (at the outset) U.S. U.K. Export = $1 > $1 Export > £1 = £1 Continue on the next slide

  7. U.S. Afterward Importing Price > £1 (Let’s say “£1 + XXX”) $1 + XXX U.K. £1 + XXX £1 Bank £1 + XXX

  8. Suppose : 25 Bath = Australia $1 = U.S. $1 (at the outset) 75 baht/ $1AUS = Australia $1 75 Baht Australia U.S. Thailand 50 Baht = U.S. $1 50 baht/ $1US

  9. Inflation Rate U.S. Thai = 25 Baht Export = $1 = $2 Inflation = 50 Baht Thai people buy less The market system will impact on the exchange rate. Countries with relatively high inflation rates have currencies whose valuestend to depreciate in the foreign exchange market.(i.e., from “1 dollar/25 baht” to “1 dollar/15 bath”)

  10. U.S. Thai = 25 Baht Deflation Export = $1 = $ 0.5 = 12.5 Baht Thai people buy more The market system will impact on the exchange rate. Countries with relatively low inflation rates have currencies whose valuestend to appreciate in the foreign exchange market.(i.e., from “1 dollar/25 baht” to “1 dollar/30 bath”)

  11. 15 baht /1 dollars 11 baht/1 dollars 10 baht/1 dollars The values of baht tend to depreciate.

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