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Business Economics: Exchange Rates: Michael Kitson
Business Economics: Exchange Rates: Michael Kitson
Business Economics: Exchange Rates: Michael Kitson
Michael Kitson
Reading
MANKIW, N.G., MACROECONOMICS Worth 5th edition 2003, BS 540, Chapter 5
Michael Kitson
Structure
Nominal and real exchange rates Trade accounts Exchange rate adjustment Exchange rate regimes
Michael Kitson
Exchange Rate
Nominal Price of one currency in terms of another currency (bilateral) Effective Average exchange rate over several other currencies
Trade weighted When averaging, use amount
4% Singapore Dollar 4% Danish Krone 4% Hong Kong Dollar 5% Korean Won 6% Sw edish Krona
Michael Kitson
18% Euro
Michael Kitson
/$
Michael Kitson
120
100
80
60
Real Rate
40
20
Nominal Rate
0 1970
1975
1980
1985
1990
1995
2000
2005
2010
Michael Kitson
Implies real rate = 1 (or 100 if using an index) Based on idea of arbitrage
Michael Kitson
UK Price Level
Real Rate = 1
Michael Kitson
Michael Kitson
Trade Accounts
Current account (X)- (M)
Records net transactions in goods and services Exports Imports Income and transfers from abroad
Current Account
Exports Imports
Goods Services
Michael Kitson
Capital Account
Capital transfers Financial account
Direct investment Portfolio investment Other investment Reserve Assets
Michael Kitson
GBP (billions)
Michael Kitson
billions
35
35
30
30
25
GBP (billions)
25
20
20
15
15
10
10
0 80
82
84
86
88
90
92
94
96
98
00
02
04
06
Michael Kitson
billions
25
Trade in Services
25
0
Billion (billions)
-25
Current account
-25
-50
Trade in Goods
-50
-75
-75
-100
97 98 99 00 01 02 03 04 05 06 07
-100
Michael Kitson
billions
Michael Kitson
Michael Kitson
Michael Kitson
Assume an initial exchange rate of 1 = $1.50. There are rumours that the UK is going to increase interest rates Investing in the UK would now be more attractive and demand for would rise
1.75 1.50
Shortage
D1 D
Q1
Q3
Q2
Michael Kitson
B
Fixed Rate
A C
D1
D2
Q1 Michael Kitson
Michael Kitson
Michael Kitson
Michael Kitson
Michael Kitson
Michael Kitson
Michael Kitson
Keynes on Speculation
"Professional investment may be likened to those newspaper competitions in which the competitors have to pick out the six prettiest faces from a hundred photographs, the prize being awarded to the competitor whose choice most nearly corresponds to the average preferences of the competitors as a whole; so that each competitor has to pick, not the faces which he himself finds the prettiest, but those which he thinks likeliest to catch the fancy of the other competitors, all of whom are looking at the problem from the same point of viewIt is not a case of choosing those which, to the best of one's judgment, are really the prettiest, nor even those which average opinion genuinely thinks the prettiest. We have reached the third degree when we devote our intelligences to anticipating what average opinion expects the average opinion to be. And there are some, I believe, who practise the fourth, fifth and higher degrees." Keynes, J. M. (1936) The General Theory of Employment, Interest and Money. p156.
Michael Kitson
Summary
Exchange rates
Nominal, effective and real
Michael Kitson