lecture5WhatdeterminsER说课.ppt

ii. The role of the Expected Future Spot Exchange Rate (eex) Effects: If, eex increase—e increases If, eex decrease—e decreases What determines the expectations (eex ) a. Bandwagon Effects— “destabilizing” b. Exchange rates eventually return to values consistent with basic economic conditions (i.e. PPP)- “stabilizing” Road Map I. Introduction II. (The Short Run) Asset Market Approach to Exchange Rates III. The Long Run: Purchasing Power Parity (PPP) IV. The Long Run: Monetary Approach to Exchange Rate V. Short Run to Long Run: Overshooting III. Purchasing Power Parity (PPP) The law of One Price Absolute Purchasing Power Parity Relative Purchasing Power Parity Relative PPP: Recent Experience i. The law of One Price The law of one price posits that a product that is easily and freely traded in a perfectly competitive global market should have the same price everywhere, once the prices at different places are expressed in the same currency. P = Pf?e --or-- e = P/Pf The law of one price works well for heavily traded commodities BUT, for many products, the law of one price does not hold closely.—WHY? ii. Absolute Purchasing Power Parity Absolute Purchasing Power Parity posits that a basket or bundle of tradable products will have the same cost in different countries if the cost is stated in the same currency. P = Pf?e or e = P/Pf (P and Pf refer to the average product price or price level in the domestic and foreign country） iii. Relative Purchasing Power Parity Relative Purchasing Power Parity posits that the difference between changes over time in product-price levels in two countries will be offset by the change in the exchange rate over this time. (From time 0 to time t): ? Pt Pf,t . et P0 Pf,0 e0 iii. Relative Purchasing Power Parity or ? et Pt Pf,0 e0 P0 Pf,t ? or, approximately: Ra