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CH12: exchange rate - Coggle Diagram

- - - - a. Relative interest rate
        
        hot money
        
        when country A short-term interest rises above the interest rate in most other countries, this will attract inflow os speculative or “hot money” form abroad (as foreigners decide to shift their funds into the country A currency to earn higher interest)
        
        there will be a greater demand fo ty country A currency and its exchange rate will increase
        
        conversely, if the country A has a interest rate lower than most ther countries, there will be a depreciation in the currency as its demand decrease (citizens in A will shift their currency into other countries’ currency in order to earn a higher interest)
      - b. Relative income changes
        
        as income increase, the country A’s consumers will buy more of both domestically poduced goods and services and foreign goods. Hence the country A’s import from country B, and therefore the A’s demand of B’s currency, will increase.
        
        the country A’s currency has dedicated relative to the B’s
        解释：A从B那里买东西，A对B货币的的求增加，所以B的价值 in terms of A’s currency will increase.
        
        thus, if the growth of a nation’s income is more rapid than that of other countries, its imports from other countries are likely to increase and hence its currency is likely to depreciate
      - c. Relative change in price level (domestic rate of inflation compared to inflation in other countries )
        
        the purchasing power parity (PPP) theory says that relative inflation rates are major causes of foreign exchange rate adjustments in the long run.
        
        in the long run, the foreign exchange rate between 2 countries would tend to settle at that point which expresses equality between the respective purchasing power of the 2 currencies.
        
        the country with a higher rate of inflation relative to other countries will find its currency depreciate in terms of other currencies.
        
        why? Because the high inflation in country A makes the B’s goods relatively cheaper. Hence, the country A will seek out the lower-priced country B’s goods and services, increase the demand of B’s currency and increase the supply of A’s currency. At the same time, country B will buy less country A’s goods, reduce the demand of country A’s currency, reducing the supply of B’s currency.
        
        the combination of changed of demand and supply will make A to dedicate while B to appreciate
        
        Its limitations
        
        the theory ignore the effect of trade restrictions
        Changes in tariffs and quotas can upset the PPP predictions e.g. when A prices increase faster than B but at the same time, tariffs are imposed to keep B’s goods out of A, the currency value may not change
        
        not all goods are internationally traded
        hence for some, domestic inflation rates may have little bearing on the exchange rates
        
        lack of homogeneity of products
        The theory assumes all goods are uniform which may not be true. If consumers perceive the quality of different goods in different countries differently
        
        relative price level is not the only determinant of exchange rates
        other factors such as capital flow
      - d. the balance of payments performance
        
        if a country is running a large balance of payments deficit, it is likely that there will be an overall excess supply of its currency in the foreign exchange market (as the country is making more payments to other countries than its receipts from other countries )
        
        thus, countries running persistent deficit are likely to see a depreciation of its currency of their exchange rate
        
        on the other hand, countries having balance of payment surplus are likely to see an appreciation in their exchange rate
      - e. FDI
        
        firms take into accounting all factors including political stability and profitability
        
        ppl and firms invest by buying shares of foreign companies, by setting up business in foreign countries (e.g. country A)
        
        the demand of currency of country A will hence increase
      - f. change in tastes or references
        
        alter the demand of the supply of something, hence alter the demand of the currency of the supplier country
        
        e.g. teh technological advance in computers make contry A more attractive to country B, there will be increasing supply of currency B into the forex market while the demand of currency A will increase.
      - g. Speculation
        
        if the foreign currency speculators expect the country’s exchange rate to fall in the future (depreciation), they will sell the currency now in order avoid future loss
        
        this will have the effect of bringing about an immediate fall in the exchange rate as the selling of the currency to the market will cause the supply to increaes hence the price will fall
        
        other expcatations such as:
        
        lower real interest rate in country A than B
        
        faster rate of growth of the A economy relative to B
        
        higher inflation rate in A than in B
        will tend to lead speculators to believe that in future the A currency will depreciate relative to the B currency, holders of the currency A will attempt to convert it into currency B, this will tend to incraese the demand fo currency B and results in the B appeciation, while A will eventually depreciate
- - - - demand e.g. of sgd
        
        foreigners’ purchase of Singapore goods and services (i.e. exports)
        
        foreigner’s setting up business in Singapore i.e. foreign direct investment
        
        foreigners’ purchasing of financial assets such as stocks and bonds in Singapore
        
        foreigners’ depositing their money with financial institutions in Singapore
        
        overseas residents making transfers and remittances to Singapore
        so they will need to exchange their own currencies into sgd, raise the demand of the sgd
        
        The lower the exchange rate, the less the amount of money they have to give up for a unit of sgd. this makes the goods and services and assets in Singapore cheaper to buy and hence the higher the quantity demanded fo sgd. therefore, the demand curve fo sgd is downwards sloping.
      - supply e.g. of sgd
        
        imports of foreign goods and services
        
        Singapore firms investing abroad
        
        phase of financial assets such as stocks and bonds in other countries
        
        Singapore residents depositing their money in foreign currencies
        
        Singapore residents making transfers and remittance overseas
        So the Singapore firms and residents will supply sgd in the flex market, in order to obtain the foreign currency
        
        The higher the exchange rate, the cheaper the foreign goods and assets, the more sgd will be supplied in exchange for the other foreign currency, therefore the supply curve of the currencies is usually upward sloping.
      - Equilibrium: the eqlibrium exchange rate will be where the quantity demanded for sgd equals the quantity supplied of sgd in the forex markets
- - - - the J-curve effect
        
        given marshall-Lerner condition, devaluation should lead to an improvement in the BOP
        
        however if the price elasticity of demand of exports and imports are low (inelastic) in the very short run due to the fact that time is needed to make adjustment in deman, some for alternative suppliers or modify existing contracts
        
        as a result, the Marshall-lender condition may not be satisfied initially, lead to a worsening of the trade balance and will only improve the BOP after a time lapse when the demand and supply conditions have adjusted to the price changes
      - Devaluation as a measure of correcting BOP deficit
        
        (a) elasticity of demand for exports and imports (marshal-Lerner condition fulfilled)
        
        as long as one is elastic, the Marshall-Lerner condition is fulfilled
        
        e.g. if the demand for imports is price elastic, where the rise in price (in home currency) will lead to a more than proportionate fall in quantity demanded for imports, resulting a fall in import expenditure, BOP will be improved
        
        (b) price elasticity supply of exports and imports
        
        the Marshall-Lerner condition also assume that the supply and imports are perfectly elastic: why’d evaluation, the demand increase, and the country must have excess capacity to produce the extra output without causing price to increase
        
        otherwise, the increase in demand would simply bid up the price of exports as the country is unable to increase the supply to meet the increasing demand
        
        the higher price of exports will therefore negate the effect of devaluation
        e.g. primary products, the supply cannot be incraese immediately therefore the producers benefit little from the devaluation. While for manufacturing products, producers are in better position to benefit form devaluation since supply is more price elastic
        
        for imports, if the producer cannot cut their supply immediately as their supply is price inelastic (e.g. they are unable to find the alternative market easily), they will try to cu the price and the devaluation may not be effective since the demand and hence expenditure on imports are not influenced
        
        (c) devaluation should not create inflationary pressure
        
        as import are made more expensive in domestic currency - inflation
        
        if necessities are imported, the cost of living will increase
        
        imports of raw materials and capital goods are more expensive, higher cost of production - cost-push inflations
        
        worsen if trade union bargain for increase in wage - further increase in cost of production
        
        worsen if the production of exports needs raw materials from imports - the COP of exports will increase, price will increase, original lower export advantage will be reduced - no longer competitive - demand drop
        
        solution: use together with anti-inflationary measures
        
        (d) other countries do not retaliate
        
        as devalution creates competition with other countries
        
        other countries may also choose devaluation
        
        (e) confidence effect
        
        if the country continually devaluate its currency, it may indicate that it has serious structural and economic problems which are not being resolved - this could cause investors to lose confidence and leads to massive capital outflows - lead to fall in investment - lead to fall in AD