港大英文课件iparity.ppt

* * * * * * * * * * * * * * * * * * * * * * * * * * * * * * * * * * * * * Fixed exchange rate regime To maintain the exchange rate at a fixed level, CB has to commit to buying whatever the market supply of home currency and selling whatever the market demand for home currency Uncovered Interest Parity ? fixed exchange rate regime If Rt [Et (et+1 ) - et ] / et + Rt* = Rt* both home and foreign investors will deposit in home currency and supply foreign currency and demand home currency CB is committed to a fixed exchange rate and hence has to sell home currency and buy foreign currency official foreign reserves increase Uncovered Interest Parity ? fixed exchange rate regime Both home and foreign investors will deposit in home currency I.e., larger supply of home deposit and smaller supply of foreign deposit hence, home interest rate Rt decreases, i.e. towards equality Rt* increases, i.e. towards equality until Rt = Rt* Effect of an increase in the foreign deposit interest rate et RHS Return on home deposit has to increase Uncovered Interest Parity ? fixed exchange rate regime Note that only interest rate will adjust to restore the equality Can the CBs fix the interest rates at some desired level? No. Not without restrictions on capital flow. Under pure fixed exchange rate regime a CB does not have monetary policy. Uncovered Interest Parity ? floating exchange rate regime Recall that in Rt = [Et (et+1 ) - et ] / et + Rt* investors faces exchange rate risk when invested in foreign deposits. Investors are generally not risk-neutral. In general, Rt ? [Et (et+1 ) - et ] / et + Rt* Rt = [Et (et+1 ) - et ] / et + Rt* + risk premium investors spend huge amount of money trying to forecast et+1 Forecasting et+1 Uncovered interest parity: Rt = [Et (et+1 ) - et ] / et + Rt* implies a forecast of et+1 is Et (et+1 ) =et [(Rt - Rt* )+1] Na?ve forecast (random walk): et+1 = et + ut+1 Et (et+1 ) =et Forecasting et+1 Use linear time