Mgec61 Note - Chapter 13 Essay

Wong (2009) found that there exists a long-run relationship between real exchange rate and terms of trade in Malaysia and Thailand and also variation in real exchange rate is mostly explained by the movements in terms of trade. Bashir and Luqman (2014), however, concluded that terms of trade depreciates real exchange rate of Pakistan in the long run.

Thus the rationale behind changing the nominal exchange rate under a fixed or pegged exchange rate system is easy to follow provided that the set rate is found to be far away from the optimal or equilibrium rate. However, why does the central bank need to manage exchange rates which are determined by market forces in case of independent floating? This remains a contentious issue. Essentially, the central bank is believed to determine the appropriate level (or path) of the nominal exchange rate and then intervene in foreign exchange markets to bring the actual exchange rate close to the appropriate level. In practical sense, the appropriate level of the exchange rate may represent the rate which, when translated into a real exchange rate, is consistent with the long-run equilibrium real exchange rate. Many economists of neoclassical persuasion believe that the market determined exchange rates broadly represent the long-run equilibrium exchange rates and there is no need for managing exchange rates or intervention in foreign exchange markets.

The figure shows output y and exchange rate e. The line AA shows points at which the domestic rates equals the foreign rates. The line GG outlines the amount of output given a particular exchange rate. When a strong open economy effect is added to the model, a crisis occurs. For example, if foreign currency controls most debts of many firms in a country, the balance sheets will constrain their investment. This will lead to domestic demand having a direct dependence on the real exchange rate; y = D(y, i, eP*/P) + NX(eP*/P, y) . Under these circumstances, when the real exchange rates becomes unfavorable, the firms holding foreign current will not be able to invest. This will lead to triviality at the margin of the direct exchange rate effect. The corporate sector runs bankrupt but the small businesses benefit from weak currency. The effects can be so significant

5. Why do interest rates vary among countries? Why are interest rates similar for those European countries that use the euro as their currency?

In this paper, I will only focus on discussing the Purchasing Power Parity (PPP) and I will divide this paper into four sections. In section 1, I will come up with the definition of PPP and other theories behind it. For section 2, I will briefly introduce the absolute PPP and relative PPP and empirical evidence on PPP. Section 3 explains empirical test of PPP in practice and the problem of PPP. For the last section, there are conclusion and remarks.

Current account balances necessitate a one-way offsetting capital flow of equal magnitude to prevent exchange rate fluctuations. Capital flows are, however, not homogenous. Consequently, the financial media often falls into the trap of solely stressing the perceived power of interest rate differentials in driving capital flows and, therefore, exchange rates. The reality is, however, that the role of "hot money" flows between banking centres is much over-hyped in exchange rate determination, particularly during periods devoid of financial stress.

Globalization and liberalization have been promoting the integration of the global economy over the past decades. While the most significant change under this process is the increasing number of cross-border trades over the world, and it is obvious that exchange rates, as the quintessential international financial variable, plays a vital important role in the multinational transactions. For the last 25 years, worldwide economists have been studying the relationship between macroeconomic variables and exchange rates. One of the aims of the research is to make predictions based on the models (or links) they have found. However, many of them failed to uncover the link and tend to think that exchange rates movements may follow a random walk, but some of them still found some evidence that support the existence of such a link effective in the short-term and to a greater extent in the long-term. They, therefore, constructed their exchange rate determination models and made a calendar of expected macroeconomic announcements, and it has become a regular part of many financial Medias, such as The Economists and Financial Times. One of the most frequently discussed models is the flexible-price monetary model, and which is also the main discussion topic of this essay.

Exchange rate is the price of a nation’s currency in terms of another currency. Basically, it is the price of some foreign currency in terms of a home currency. Economist define the long-run as the period in which prices are flexible, and the short-run as the period in which prices are sticky. Therefore, the forces behind the exchange rate movements should be examined both in the long run and short run. Following a standard text-book description, I start with the long-run period.

The aim of this report is going to analyse the importance of forecasting future exchange rates and the relationship of Purchase Power Parity. Also is going to test if this is even possible by applying simple theory of the International Finance statistics. For many economists, governments and investors is very important the forecasting of exchange rate in order to organise their next strategical movements in order to invest money in a country in order to diminish the risks and increase the returns. By saying forecast future exchange rate is when we are able to predict the change in the exchange rates between two countries. Purchase Power Parity (PPP)

DISSERTATION TOPIC: THE RELATIONSHIP BETWEEN EXCHANGE RATE VOLATILITY AND TRADE (US TRADE IN GOODS, TRADE IN SERVICES AND TRADE IN GOODS AND SERVICES (1970-2014)

It is no surprise that there have been many literatures on the determination of exchange rates given the significant impact that movement in exchange rates have on a world’s political and economic stability as well as the welfare of individual countries. It plays an important role in international investments, company profits and a countries macroeconomic fundamental factor such as unemployment, wages and interest rates among others. This has led to the development of many models and economic theories, one of which is the monetary model. Despite this, economists still cannot agree as to which model best explains movement in exchange rates because the results obtained when testing different models often contradict one another.

In this paper I will be going over and discussing what international finance, exchange rates and also balance of payments. I will be talking about what they are, what they do, and how they affect us an economy and country. I will be discussing the basic definitions, and the basic concepts of their duties. First I will be going over international finance and the role it plays in our daily lives. Then I will discuss the price differences between items in the United States and Germany. I will add and compare them together. I will also go over what the concept balance of payments are.

Q3.Exhchange rate is the value of one currency toward another. In case if the currency of pound for instant decrease (weaken), therefore, all their export of goods will become cheaper. On the other hand, if UK want to import from outside USA they have to pay more to import products and services. When the services and product of UK is cheaper than the United States, therefore, it will arm wrestle UK to increase export volume. Which will lead to have a surplus of international balance of payment. In return the other country which import goods from UK will focus on importing cheaper goods than exporting which will lead to a deficit to their international balance of payment. For example in 2011 the value of £1 = $1.65 which it means the value of pound decreased, which leads to import goods from UK really expansive and also traveling outside, with that the exporting was the best option for outside countries like US to buy a cheap goods from UK.

The link between trade performances and exchange rate movements has been the matter of many practical studies. The literature review explains that the set of results, often in similar countries, might stem from practical proof being removed from diverse time periods and not the same methodologies. First, it clarifies whether exchange rate instability impedes trade flows. Second, it shows if the exchange rate depreciation develops the trade balance (J-curve effect).

Secondly, interest rates rise, can make the interest income increased, holding the currency to attract investors to buy the currency, therefore, support for the currency is good; if interest rates fall, holding the currency income will reduce, its appeal is diminished. Therefore, it can be said that "interest rates, currency is strong; interest rates fall, weak currency".