Exchange Rates II Flashcards

Flashcards for Exchange Rates II: The Asset Approach in the Short Run

Asset Approach

An approach to explain short-run exchange rate behavior, treating currencies as assets.

Spot Exchange Rate

The price of one unit of foreign currency.

Uncovered Interest Parity (UIP)

The concept that expected returns on deposits in different currencies must be equal when adjusted for expected exchange rate changes.

FX Market Equilibrium

Achieved when domestic and foreign returns are equal after adjusting for expected exchange rate changes.

Money Market Equilibrium

Occurs when money supply equals money demand, determining the nominal interest rate.

Liquidity Preference

Money demand that is inversely related to the interest rate.

Capital Mobility

The ability of investors to easily move funds between countries in response to interest rate differentials.

Fisher Effect

A permanent expansion of the money supply raises long-run interest rates.

Exchange Rate Overshooting

The exchange rate initially moves more than its long-run equilibrium value in response to a shock.

Trilemma (Impossible Trinity)

The concept that a country cannot simultaneously have a fixed exchange rate, free capital mobility, and monetary policy independence.

Purchasing Power Parity (PPP)

The idea that a basket of goods should cost the same everywhere when measured in a common currency.

Monetary Approach

An exchange rate theory that explains long-run movements based on money supply and price levels.

Nominal Money Supply (M)

The total amount of money in an economy.

Price Level (P)

The average of current prices across the entire spectrum of goods and services produced in an economy.

Real Income (Y)

A measure of income that reflects the quantity of goods and services it can buy.

Expected Future Exchange Rate (E^e_{$/€})

The anticipated exchange rate at a future point in time.

Current Spot Exchange Rate (E_{$/€})

The prevailing exchange rate for immediate delivery.

Interest Rate on Dollar Deposits (i_$)

The return on investments held in US dollars.

Interest Rate on Euro Deposits (i_€)

The return on investments held in Euros.

Fixed Exchange Rate Regime

A system where a country's central bank intervenes to maintain a specific exchange rate.

Exchange Rate Forecasting

The prediction of future exchange rates using economic fundamentals, political factors or technical analysis.

Monetary Policy Independence

The ability of a central bank to set interest rates.

Floating Exchange Rate

An exchange rate regime where the exchange rate is determined by market forces.

Capital Controls

Restrictions on the movement of capital in and out of a country.

Short-Run

A time horizon in which some variables are fixed, such as price levels.

Long-Run

A time horizon in which all variables are flexible and can adjust fully.

Endogenous

Determined within the model.

Sticky Prices

Prices that do not adjust rapidly to changes in supply or demand.

Arbitrage

Exploiting price differences to make a profit.

Depreciation

A decrease in the value of one currency relative to another.