Mô tả:
VI Other Exchange Rate Models
1000 realizations of yt = c + yt −1 + vt
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Stationary „white noise“ process
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Contents
1. Monetary Approach to Exchange Rates
2. Portfolio Balance Approach to Exchange Rates
3. Conclusion
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1. Monetary Approach to Exchange
Rates
Basic ideas:
Exchange rate between two currencies is determined by the
relative demand and supply of money in two countries.
Assumptions
• Perfect capital mobility and stable money demand
• The country is small and open (international prices and
interest rates are given)
• In the long term the PPP holds
• With equal returns demestic and foreign assets
(securities) are perfect substitutes
• Investors are indifferent between investment in domestic
or foreign currency
• There is no risk premium for an investment in foreign
country and the uncovered interest rate parity holds
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1. Monetary Approach to Exchange
Rates
Central Bank Behaviour
• The central bank controls the money supply (M) by
altering the monetary base (multiplier)
• The monetary base can be divided into national and
international components (domestic credit and
international reserves)
• The exchange rate is fully flexible
Implications
If the domestic money supply (with constant domestic
price) rises above the output growth, the domestic
currency will depreciate
A high inflation rate in foreign country and a high real
growth in domestic country would counteract this trend
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1. Monetary Approach to Exchange
Rates
The flexible price model
The Dornbusch overshooting model
The interest rate differential by Frankel
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The Dornbush Overshooting Model
Disadvantages of „the flexible price model“ does not
explain why exchange rat departures from PPP,
especially under the flexible exchange rate regime
because the assumption that prices of goods and
services change in short run → PPP holds in the short
term
Dornbusch overshooting model (sticky price)
• How is the adjustment path of the exchange rate to the
new equilibrium after an exonenous shock
• Why exchange rates are so volatile
• Why exchange rates departure from PPP
• The strong correlation between nominal and real
exchange rats (EUR/USD)
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The Dornbush Overshooting Model
Emprical Observations:
• In the short run PPP does not hold and the exchange rat
shows considerably more volatility than goods prices and
inflation differentials would imply
• Prices of goods and services adjust very slowly (sticky
prices). Exchange rats and interest rates adjust fast
Assumption
• PPP and the quantity theory of money hold in the long
run
• Goods prices and wages are fixed in the short run
• Prices react to exogenous shocks with lags
• The covered interest rate hold at any time t (full
foresight)
• Expections are rational
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The Dornbush Overshooting Model
Money Market Equilibrium
• Money supply = money demand: M=D
• Real money demand function: D/P=aY + bi (Y output, P
price level, i interest rate)
Short Run Adjustment to Monetary Expansion
• In the short run, output and prices are constant when
the money supply expands
• The interest rate has to decline in order to equal money
supply and money demand
• The exchange rate has to rise sharply (domestic
currency depreciate)
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The Dornbush Overshooting Model
Long Run Adjustment to Monetary Expansion
• In the long run prices will rise and therefore nominal
interest rate rise as well
• With rising interest rates the exchange rate has to
decline (appreciation) to maintain the uncovered interest
rate parity
• Therefore the exchange rate (e) „overshot“ its long term
level and only approaches its equilibrium in the long run
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The Dornbush Overshooting Model
Eo
t
Po
t
io
t1
t
t0
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2. Portfolio Balance Approach to
Exchange Rates (Branson 1977)
Basic idea
• The relative supply and demand in financial markets as
well as the relative conditions in money markets
determines exchange rates
• In contrast to the monetary exchange rate model,
investors have a preference for domestic investments
and hold foreign assets only for a premium
• The approach is based on divercification of portfolios and
has a requirement that markets balance explains its
name, portfolio-balance approach
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2. Portfolio Balance Approach to
Exchange Rates
Hence
•
•
The uncovered interest rate parity holds only with a risk
premium
The absolute change of net foreign assets is equal to
the current account balance of a country
NF t − NF t −1 = CA t
•
•
With flexible exchange rate the central bank does not
intervene in foreign exchange markets. The current
account is equal to the capital account
Because goods and services are considerably slower
than capital flows, variations of the capital account do
not immediately result in adjustment of the current
account
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2. Portfolio Balance Approach to
Exchange Rates
Adjustment to Money Supply Shock
Short term adjustment (e.g the same day)
• If the interest rate declines in the domestic market
(expansion of the money supply), domestic agents want to
hold more assets in the foreign markets
• This is not possible because the current account stays
unchanged in the short term (adjustment of production etc...)
• The net foreign assets are constant in the short term as well
• The exchange rate has to adjust immediately to give an
incentive to hold more domestic assets
• The depreciation of the domestic currency makes foreign
assets more expensive and reduces the incentive to hold
them
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2. Portfolio Balance Approach to
Exchange Rates
Long Term Adjustment
• In the long run the depreciation leads to a current
surplus and a capital account deficit
• The exchange rate converges to its original level
(appreciation)
• The adjustment process continues until agents hold the
desired level of foreign assets
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3. Conclusion
1.
2.
3.
4.
5.
Exchange rates are random processes, which are not
predictable. Short term and long term volatility is very
high
In the short term, PPP does not contain any explanatory
content
The monetary approach explains the exchange rat as
ratio between two money supplies
The overshooting solution result from the lagged
adjustment of goods prices to exogenous shocks
In the portfolio-balance approach the current account
surpluses are correlated with appreciation pressure
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