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Exchange Rate Presentation

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Liam Kiribathgoda

on 18 April 2013

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Transcript of Exchange Rate Presentation

Buy Irish ? Beachhead Effect Intuitively it is clear that the real exchange rate will have a profound effect on trade, in particular on net exports The relationship between net exports and the real exchange rate The real exchange rate tells us how much two identical goods cost, in two different countries, when expressed in a common currency Liam
The Real Exchange rate & Exports
The Purchasing Power Parity
Why are some countries more expensive that others ? What’s on the menu ? Liam Kiribathgoda

Aoife Murphy

Holly Collins Exchange Rates and PPP Volatility & Uncertainty Factors affecting the Real Exchange Rate Trade Implications and Uses of exchange rate Exchange rates are the price of one country’s’ currency in terms of another Some Basics Exchange Rates & The Purchasing Power Parity What Is the Real Exchange Rate An Inverse Relationship ? Real Exchange Rate Net Exports But what is the nature of this relationship ? What is the real exchange rate The Real Exchange rate is equal to the nominal exchange rate, times the domestic price level, divided by the foreign price level Given by the formula What's on the menu ? Liam ~ The Real Exchange Rate Aoife ~ Purchasing Power Parity Holly ~ Why are some countries more expensive than others ? Terms of Trade If a country has had a high real exchange rate for a long period of time this can have lasting effects on trade patterns Importers will dominate the Home market, whilst exporters will have lost foreign customers and connections Cost of Living Policy Sounds Patriotic Devaluations will make exports cheaper and imports dear, but what are exports made of ? But does it make economic make sense ? Any Questions ? Something we all encounter in our daily lives Nominal Exchange Rate Government Policy Interest rate Inflation Political Stability Hysteresis of Imports Is devaluation the answer ? Frequent movements in exchange rate expectations cause interest rate volatility and financial instability An unstable real exchange rate causes more volatile relative prices, creates uncertainty, increases risk, and shortens investment horizons Big Mac Index Factor exchange rate determination Different Uses for PPP PPP- Purchasing Power Parity Any Questions? Under or over Value against the Dollar Most LOP deviation occur when a product is introduced Case Study RER=1 Currency Unions A motorbike costs 110,000 yen (=$1,000) in Japan and 15,000,000 dong (=$1,000) in Vietnam Absolute Verses Relative PPP Level of adjustment needed in the exchange rate A burger is 44% Cheaper in China than America Interpreting the Big Mac Index Produced by The Economist in 1986 What is the Big Mac Index? Large deviations for same goods outside currency unions even if NER is pegged Case Study CASE STUDY USA Australia An asset should have the same price, when exchange rates are taken into account Law of One Price What Is PPP ? Guide as to weather a country’s currency is at “correct” level In the long run, exchange rates should adjust to equal the price of a basket of goods (the Big Mac) LOP in eurozone is almost perfect, thus the RER=1 Online- identical traded goods What's pegging? Pressure of Imported inflation International Income Comparison Indicator of Competitiveness Pointer of the correct level of the exchange rate Both products should be the same price in each market Absolute PPP measures price levels Currency Unions May lead to arbitrage Bundles of goods should be the same price Determine relative value of a currency Currency Unions Eurozone- LOP holds for most goods Optimal Currency Areas- inflation should be synchronised Hong Kong is pegged to the dollar, but has a different LOP differential Dollarized Countries- LOP holds better even in Ecuador and Salvador Currency more important than language, culture, politics at defining market boundaries according to study By Alberto Cavallo, Roberto Rigobon (MIT) and Brent Neiman (University of Chicago) Best to have a good RER at the time of product introduction The chart should strong positive correlation between the Dollar price of a Big Mac and GDP pp Due to Cost of Labour Average Prices should be lower in Poor countries But cheap Big Mac’s in China do not mean that Yuan is massively undervalued Suggests that the Yuan is 44% undervalued against the dollar
Japanese inflation was 0% and Vietnamese inflation was 5%. Meanwhile, the dong depreciated 5% against the yen Relative PPP measures price changes Summary "A full lunch of rice, naan and three curries for about $1 is pretty great" India If a country, lets say Japan, gets better and more productive at making cars such as Toyota. Balassa and Samuelson explain that it must come down to worker’s productivity especially in the sectors that can trade their goods and services abroad.
For example… But how and why do incomes go from high to low? Cost of Living From a restaurant to a hairdressers, most jobs in the service sector have a local clientele. According to Planet Money, a nanny working in New York City last year made more than $200000. Why are some cities and countries more expensive than others? Why? Tradable versus Non-Tradable Goods and Service. This was thought of in 1964 by academics Bela Balassa, a Hungarian economist, and Paul Samuelson, a Nobel-Laureate economist. Balassa-Samuelson Effect When was the last time someone bought a pint outside of Ireland? Can anyone guess why? Why are some countries more expensive than others??? When was the last time someone went to a hairdressers and got their hair done outside of Ireland? Was it more/less expensive ? It explains why on average prices vary across countries. The difference these two are very important when understanding and explaining the Balassa-Samuelson effect. These goods are delivered locally and consumed locally. Examples: hair dresser or a pint. A good or service that is not tradable is called a non tradable good. Tradable goods have different levels of tradability however and most services are not tradable. Tradable goods and services, are goods and services that can be sold in a different location from where it was originally produced. Wages are high so families can afford it. How could a Manhattan Nanny be on this type of salary? In the market for locally delivered services or non tradable goods, like caring for a child, prices will rise as high as the clientele can afford to pay. You aren't going to travel to Spain just to get a hair cut because it is cheaper or travel to Poland to buy a pint. In cities where incomes are high, average price level will also be high. As income and investment flows into the country, incomes rise and prices rise for the non tradable goods and services across the board. It can then sell to foreign countries for money and it gets richer.
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