Transcript Document

INTERNATIONAL
INTERNATIONAL
FINANCE
FINANCE
CHAPTER 14
Money, Interest Rates, and
Exchange Rates
Money Defined:
a Brief Review

Money as a Medium of Exchange

Money as a Unit of Account

Money as a Store of Value

What Is Money?
How the Money Supply Is
Determined
R
3
3
3
0
5
Ms
Ms
Ms
An economy’s money supply is
controlled by its central bank.
The Demand For Money by
Individuals
 Expected
Return
The expected return the asset offers
 Risk
compared with the returns offered by
The
riskiness
other
assets of the asset’s expected return
 Liquidity
The asset’s liquidity
Aggregate Money Demand (I)
 The
Md
interest rate (R )
Figure 14-1 Aggregate Real Money Demand and the Interest Rate
-
= f (R)
A rise in the interest rate cause each
R
individual in the economy to reduce her
demand for money.
All else equal, aggregate money demand
therefore falls when the interest rate
rises.
Interest rate, R
R
L( R ,Y)
L
Aggregate real money demand
Aggregate Money Demand (II)
 The
price level ( P )
IfPthe
price
level
people
would like
is the
price
of rises,
a broad
reference
to
demand
for more
in order
to
basket
of goods
andmoney
services
in terms
maintain
the same level liquidity as
of currency.
before.
Therefore Md and P are positively correlated.
+
Md = f (P)
Aggregate Money Demand (III)

Real national income (Y )
Md
+
= f (Y)
When real national (GNP) rises, more
goods and services are being
Y sold in the
economy.
This increase in the real value of
transactions raises the demand for money,
given the price level.
Figure 14-2 Effect on the Aggregate Real Money Demand Schedule of a
Rise in Real Income
Interest rate, R
R
L(R, Y 21)
L 21
Aggregate real money demand

Aggregate Money Demand
(IV)
How is L(R,
Y) determined by the three main
+ +
d
or
M
=
f(R,
P,
Y)
factors, R, P and Y?
Md = P x L(R, Y)
(14-1)
The equivalent form of (14-1) is:
Md/P = L(R, Y)
(14-2)
where L(R, Y) is aggregate real money
demand.
The Equilibrium Interest Rate: The
Interaction of Money Supply And
Demand
 Equilibrium
in the Money Market
 Interest
Rates and the Money Supply
 Output
and the Interest Rate
Equilibrium
ins the Money Market
If M is the money supply, the condition
for equilibrium in the money market is:
Ms = M d
(14-3)
∵ Md = P x L(R, Y) ; Md/P = L(R, Y)
∴
The money market equilibrium
condition can also be express as
Ms/P = L(R, Y)
(14-4)
Equilibrium
in the Money Market
Figure 14-3 Determination of the Equilibrium Interest Rate
Ms/P = L(R, Y)
Interest rate, R
Real money
supply
1
2
R 21
Aggregate real
money demand
L(R,Y)
R
s
1
M /P ( = Q )
Real money holdings
Given P, Y and Ms/P, money market
equilibrium is at point 1.
Therefore the equilibrium interest rate is R1
Interest Rates
& the Money Supply
Figure 14-4 Effect of a Change in the Money Supply on the Interest Rate
Interest rate, R
1. 6%
Real money
supply
s
M /P
1. 2%
1
2
1
2
R
0. 8%
Aggregate real
money demand
L(R,Y)
0. 4%
0. 0%
3E+13
7E+13
1. 5E+14
1. 1E+14
1. 9E+14
2. 3E+14
2
M 1 /P
Real money holdings
Given P and Y, an increase in the money
supply reduces interest rate, and vice versus.
Output and the Interest Rate
Figure 14-5 Effect on the Interest Rate of a Change in Real Income
Interest rate, R
Y
R 21
1
1'
2
L(R,Y 12 )
M s /PQ( =Q
1 )
2
Real money holdings
Given Ms/P(=Q1), a rise in Y raises R,
while a fall in Y lowers R.
The Money Supply And the Exchange
Rate In the Shout Run
 Linking
Money, the Interest Rate, and
the Exchange Rate
 U.S. Money Supply and the Dollar/Euro
Exchange Rate
 Europe’s
Money Supply and the
Dollar/Euro Exchange Rate
Linking Money, the Interest Rate,
and the Exchange Rate
Figure14-6 Simultaneous Equilibrium in the U.S. Money
U.S. real
Figure14-6 Simultaneous Equilibrium in the U.S. Money MarketMarket
and the and the Foreign-Exchange Market
money supply
Foreign-Exchange Market
E $/€ 1
Foreign
exchange
market
Return on
dollar
deposits
1'
Return on
dollar
deposits
E $/€
E $/€ 1
Rates of return
(in dollar terms)
Expected
return on
euro deposits
1'
R $1
R$1
R$1
Rates of
return
(in dollar
terms)
Expected
return on
euro
deposits
1
Dollar/euro
exchange
rate,E $/€
Rates of return
(in dollar terms)
L(R$,Yus)
Money
market
M us /P us
U.S. real
money
supply
M us /Pus
1
L(R$,Yus)
Money-Market/
Exchange Rate Linkages
Federal Reserve
System (the Fed)
Msus
European System of
Central Banks (ESCB)
Ms E
USD money market
EUR money market
R$
R€
FX market
E$/€
U.S. Money Supply and the
Dollar/Euro Exchange Rate
Figure14-8 Effect on the Dollar/Euro Exchange Rate and
Dollar Interest Rate of an Increase in the U.S. Money
Supply
Dollar/euro
exchange
Dollar return
rate,E $/€
E $/€ 2
2'
1'
E $/€ 1
R $2
R $1
Expected
euro return
Rates of return
(in dollar terms)
L(R$,Yus)
M us 1 /P us
M us 2 /P us
1
2
M us /P us
U.S. real
money
holdings
Given Pus and Yus, when
the money supply rises
from M1us to M2us, the dollar
interest rate decline( as
money-market equilibrium
is reestablished at point 2)
and the dollar depreciates
against the euro( as
foreign exchange market
equilibrium is reestablished
at point 2’)
Dollar/euro
exchange
rate,E $/€
E 1 $/€
2
E $/€
Europe’s Money Supply and the
Dollar/Euro Exchange Rate
Figure14-12 (a) Short-run effects
Dollar
return
1'
2'
R $1
Expected
euro return
L(R $ ,Y u
s)
s
M us /P
us
U.S. real
money
holdings
1
M s€
By lowering the dollar return
on euro deposits( shown as a
leftward shift in the expected
euro return curve), an
increase in Europe’s money
supply causes the dollar to
appreciate against the euro.
Equilibrium in the foreign
exchange market shifts from
point 1’ to point 2’, but
equilibrium in the U.S. money
market remains at point 1.
Money, the Price Level, and the
Exchange Rate in the Long Run
Money and Money Price
 The Long-Run Effects of Money Supply
Changes
 Money and the Exchange Rate in the Long
Run

Money and Money Price
If the price level and output are fixed in
the short run, the condition ( 14 - 4 ) of
money market equilibrium,
+
Ms/P = L(R,Y)
(14-4)
(14-5)
All else equal, an increase in a country’s
money supply causes a proportional
increase in its price level.
The Long-Run Effects of Money
Supply Changes
P = Ms /L(R,Y)
(14-5)
Permanent increase
A permanent increase in the money supply
causes a proportional increase in the price level’s
long-run value. In particular, if the economy is
initially at full employment, a permanent increase
in the money supply eventually will be followed by
a proportional increase in the price level.
Money and the Exchange Rate in the
Long Run
A permanent increase in a country’s money
supply causes a proportional long-run
depreciation of its currency against foreign
currencies. Similarly, a permanent decrease
in a country’s money supply causes a
proportional long-run appreciation of its
currency against foreign currencies .
Inflation and Exchange Rate Dynamics
 Short-Run
Price Rigidity versus
Long-Run Price Flexibility
 Permanent Money Supply Changes and
the Exchange Rate
 Exchange
Rate Overshooting
Short-Run Price Rigidity versus
Long-Run
Price
Flexibility
(I)
Since output prices depend heavily on
production costs, the behavior of the
overall price level is influenced by the
sluggishness of wage movements.
In extremely inflationary conditions,
such as those seen in the 1980s in
some Latin American countries, longterm contracts specifying domestic
money payments may go out of use.
Short-Run Price Rigidity versus
Long-Run
Price
Flexibility
(II)
Although the price levels appear to display
short-run stickiness in many countries, a
change in the money supply creates
immediate demand and cost pressures that
eventually lead to future increases in the
price level. These pressures come from
three main sources:
• Excess demand for output and labor.
• Inflationary expectations.
• Raw materials prices.
Permanent Money Supply Changes
and the Exchange Rate (I)
Figure14-12 (a) Short-run effects
Dollar/euro
exchange
rate,E $/€
Figure14-12 (b) Adjustment to long-run equilibrium
E $/€
Dollar
return
Dollar
return
ee E-1)
R
R
2
$$=R
€€+(E //EE $/€
InHi!
the
Short
This
part Run
is
1)
1'
12
E $/€
$/€
Expected
euro return
E $/€ 3
1
R $$2
1
R $$2
L(R $ ,Y us )
M us 21 /P us
M us /P us
U.S. real
money
holdings
L(R $ ,Y us )
1
2
M us
us /P us
us
2
1
M us / P us
Rates of return
(in dollar terms)
2
1
M
M/
/P
P == L( R$,Y)
M/P
L(R$,Y)
Rudi Dornbusch
(a) Short-run
adjustment of the
asset markets.
(b) How the R$, Pus, and E$/€
鲁迪·多恩布什
move over
time as the
economy approaches its
long-run equilibrium
about the theory of
exchange rate over
shooting put
forward by me.
In the Long Run
Permanent Money Supply Changes
and the Exchange Rate (II)
(a) U.S. money supply, Mus
R$
Mus
(a) U.S. money supply, Mus
R$
Mus
As the time goes
s
by, M
At remains
t0, Ms
unchanged
at a
increases
higher level.
R$1
M us 1
M us 1
R $1
Time
tTime
(c) U.S. price level, Pus
E $/ €
P us
When Ms
As increases
the time goes
by,and
P keeps
R falls
rising
until
down at t0, P
M2/P
2=M1/P1
remains
unchanged.
超调
(b) Dollar interest rate, R $
(b) Dollar interest rate, R $
is an important When
phenomenon
Ms
As
P keeps
at
rising
R rises
because it helpsincreases
explain
why
, R its
falls
original
0move
exchange ratestuntil
so
sharply
Time
down.
level is reached.
from day to day.
(d) Dollar/euro exchange rate, E $/ €
t
Time
Only if the dollar/euro exchange
E $/ €
P us
P us 1
E $/ € 1
P us 1
E $ / €1
Time
rate overshoots E initially will
As R
falls
rises,aE
market participants
expect
down
keepsat
falling
t0of, Ethe
subsequent appreciation
jumps
until itsup.
long-run
dollar against
the
euro.
Time
level is reached.
Time
(c) U.S. price level, Pus
Exchange rate overshooting
Time
(d) Dollar/euro exchange rate, E $/ €
Question
Thanks