Instructor Notes: 1) During the 1970s, fluctuations in the balance of payments were small, but during the 1980s, a large current account deficit arose. 2) That deficit decreased in the late 1980s but increase again after 1991. 3) The capital account balance mirrors the current account balance. 4) When the current account balance is negative, the capital account balance is positive--we borrow from the rest of the world. 5) Fluctuations in the official settlements balance are small in comparison with fluctuations in the current account balance and the capital account balance.
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23 Instructor Notes: 1) Net exports and the government budget deficit move in similar ways with a time lag of two years. 2) If the government sector deficit increases, as it did in 1980-1983 and again in 1990-1992, net exports two years later decrease.
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Instructor Notes: Other things remaining the same, if the exchange rate rises, the quantity of dollars demanded decreases and there is a movement upward along the demand curve for dollars.
40 Instructor Notes: A change in any influence on the quantity of dollars that people plan to buy, other than the exchange rate, brings a change in the demand for dollars.
Instructor Notes: Other things remaining the same, if the exchange rate rises, the quantity of dollars demanded decreases and there is a movement upward along the demand curve for dollars.
53 Instructor Notes: A change in any influence on the quantity of dollars that people plan to sell, other than the exchange rate, brings a change in the supply of dollars.
Instructor Notes: Other things remaining the same, if the exchange rate rises, the quantity of dollars demanded decreases and there is a movement upward along the demand curve for dollars.
Instructor Notes: Along the saving supply curve, the real interest rate changes but all other influences on saving remain the same.
Instructor Notes: Along the saving supply curve, the real interest rate changes but all other influences on saving remain the same.
Instructor Notes: Along the saving supply curve, the real interest rate changes but all other influences on saving remain the same.
Instructor Notes: Along the saving supply curve, the real interest rate changes but all other influences on saving remain the same.
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66 Instructor Notes: 1) Between 1994 and 1995, the dollar depreciated from 100 to 84 yen per dollar. 2) The exchange rate was expected to depreciate, which decreased the demand for dollars and increased the supply.
68 Instructor Notes: 1) Between 1995 and 1997, the dollar appreciated form 84 to 123 yen per dollar. 2) This appreciation occurred because a weak Japanese economy and low interest rates in Japan generated an expectation of a weak yen and a strong dollar. 3) The supply of dollars decreased, the demand for dollars increase, and the dollar rose in value.
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Transcript
1. CHAPTER 20: International Finance
2. <ul><li>Explain what is meant by a balance of trade deficit as well as its importance. </li></ul><ul><li>Explain why the US changed from being a lender to being a borrower in the mid-1980s. </li></ul><ul><li>Explain how the foreign exchange value of the dollar is determined. </li></ul>In this Chapter we will . . .
3. <ul><li>Balance of Payments Accounts </li></ul><ul><li>Definition: the record of all payments from/to residents of a country to or from residents of other countries. </li></ul><ul><li>Categories of the balance of payment accounts: </li></ul><ul><ul><li>1) Current Account : - records payments for imports/exports of goods and services, net interest and other factor payments from abroad, and net unilateral [unrequited] transfers. </li></ul></ul><ul><ul><li>2) Capital Account : - records foreign investments/loans into the US minus US investments/loans abroad. </li></ul></ul><ul><ul><li>3) Official Settlements Account : - records the change in official reserves in the US. </li></ul></ul>
4. Balance of Payments Accounts <ul><li>The current and capital accounts are financial accounts </li></ul><ul><li>Items therefore enter the accounts according to who gets the payment: exports are positives , because a US resident is paid ; imports are negatives , a foreigner is paid ; investment in the US from abroad is + , spending by Japanese tourists in Orlando is + , etc -- the payment comes in . </li></ul>
5. U.S. Balance of Payments Accounts in 1999, $ billions <ul><li>Current account </li></ul><ul><li>Imports of goods and services -1,221 </li></ul><ul><li>Exports of goods and services +956 </li></ul><ul><li>Net factor income from abroad –18 </li></ul><ul><li>Net transfers (mostly private) –48 </li></ul><ul><li>Current account balance –331 </li></ul><ul><li>Capital account </li></ul><ul><li>Foreign investment in the United States +711 </li></ul><ul><li>U.S. investment abroad -442 </li></ul><ul><li>Statistical discrepancy +12 </li></ul><ul><li>Capital account balance +281 </li></ul><ul><li>Official settlements account </li></ul><ul><li>Increase in official reserves (both US +50 </li></ul><ul><li>and foreign held in the US) </li></ul>
6. The Balance of Payments: 1975-1996
7. <ul><li>Balance of Payments Accounts (cont.) </li></ul><ul><li>The balance of payments accounts add up to zero. </li></ul><ul><ul><li>In 1999 we had a “ trade deficit ” as we imported more goods than we sold abroad (exported). </li></ul></ul><ul><ul><li>We paid for the deficit by: </li></ul></ul><ul><ul><ul><li>1) Borrowing net from abroad which translates into a capital account surplus. </li></ul></ul></ul><ul><ul><ul><li>2) Investing less abroad than foreigners invested in the US. </li></ul></ul></ul>
8. <ul><li>Balance of Payments Accounts (cont.) </li></ul><ul><li>A country that in aggregate over its entire history has borrowed more from the rest of the world than it has lent is a debtor country . </li></ul><ul><ul><li>A partial list of debtor countries : </li></ul></ul><ul><ul><li>- Mexico </li></ul></ul><ul><ul><li>- Brazil </li></ul></ul><ul><ul><li>- The United States </li></ul></ul>
9. <ul><li>Balance of Payments Accounts (cont.) </li></ul><ul><li>Is there any reason to be concerned that the US is a debtor country ? </li></ul><ul><li>- No , if the borrowing is financing investment that is generating economic growth and higher income. </li></ul><ul><li>- Yes , if the money is being used to finance consumption. </li></ul><ul><ul><li>This could result in higher interest payments to foreigners and lower consumption sometime in the future. </li></ul></ul>
10. Is the US a debtor? <ul><li>The official data show the US as a debtor </li></ul><ul><li>This is dubious; actual loans are fairly accurately measured, but ‘direct investment’ -- e.g. the value of General Motors’ or Ford’s investments in Europe and Australia -- is very hard to estimate. </li></ul><ul><li>Much US foreign direct investment is older than most foreign direct investment in the US -- so probably more valuable; estimates of US foreign assets are probably too low. </li></ul>
11. <ul><li>The US has a large current account deficit, why? </li></ul><ul><ul><li>Our discussion of national income and product accounting taught us that expenditures and income are equal, when properly measured. </li></ul></ul><ul><ul><li>Expenditure = C + I + G + X - M </li></ul></ul><ul><ul><li>Income [uses of income] = C + S + T </li></ul></ul><ul><li>Balance of Payments Accounts (cont.) </li></ul>C + I + G + X - M = C + S + T - or - (X - M) = (S - I) + (T - G) - or -
12. <ul><li>This says that a balance of trade deficit </li></ul><ul><li>Balance of Payments Accounts (cont.) </li></ul>(X - M) < 0 is due to: <ul><ul><li>1) A government sector deficit: (T - G) < 0 </li></ul></ul><ul><ul><li>and/or </li></ul></ul><ul><ul><li>2) A private sector deficit: (S - I) < 0 </li></ul></ul>(X - M) = (S - I) + (T - G)
13. Numbers for 1999 [ approximate, national income account estimates] <ul><li>Variables </li></ul><ul><li>Exports X 956 </li></ul><ul><li>Imports M 1221 </li></ul><ul><li>Gov’nment purchases G 1,536 </li></ul><ul><li>Net Taxes T 1,710 </li></ul><ul><li>Investment I 1,670 </li></ul><ul><li>Saving S 1,231 </li></ul>Symbols United States in 1999 (billions of dollars)
14. Net Exports, the Government Budget, Saving and Investment <ul><li>Net Exports X - M = 956 – 1221 = -265 </li></ul><ul><li>Government sector T - G = 1,710 – 1,536 = +174 </li></ul><ul><li>Private sector S - I = 1,231 – 1,670 = –439 </li></ul>Surpluses and deficits, 1999
15. Net Exports, the Government Budget, Saving, and Investment <ul><li>National accounts Y = C + I + G + X – M </li></ul><ul><li> = C + S + T </li></ul><ul><li>Rearranging X – M = (S – I) + (T – G) </li></ul><ul><li>Net exports X – M –265 </li></ul><ul><li>equals: </li></ul><ul><li>Government sector T – G +174 </li></ul><ul><li>plus </li></ul><ul><li>Private sector S – I –439 </li></ul><ul><li>Overall balance [+174 -439] = -265 = ‘Net exports’ </li></ul>Relationship among surpluses and deficits
16. The Twin Deficits
17. Borrowing for what? <ul><li>Is the U.S. Borrowing for Consumption or Investment? </li></ul><ul><ul><li>Net exports were –$265 billion in 1999 </li></ul></ul><ul><ul><li>Governments in the US buy structures (e.g. highways, schools, dams) worth more than $200 billion/year. </li></ul></ul><ul><ul><li>Governments also spend on education and health care—increases human capital. </li></ul></ul><ul><ul><li>Looks like mostly investment, not consumption. </li></ul></ul>
18. Foreign Exchange Markets <ul><li>In the US, we use the US dollar as currency </li></ul><ul><li>Most countries have their own currencies </li></ul><ul><li>To exchange one currency for another, a price for one currency in terms of the other is needed -- hence “foreign exchange markets.” </li></ul>
19. <ul><li>Exchange Rate Measures </li></ul><ul><li>The foreign exchange market is the market in which the currency of one country is exchanged for the currency of another. </li></ul><ul><li>The foreign exchange rate is the nominal price for which one currency is exchanged for another. </li></ul>111.33 .00898 Per dollar quotes = Foreign currency US Dollar = Yen US Dollar = Ex: Japan 11/26/0 Per foreign currency quotes = Foreign currency US Dollar = Yen US Dollar = Ex: Japan 11/26/0
20. Wall Street Journal 9/98
21. An Example: <ul><li>Suppose you can buy a CD in Canada or in the US, where should you buy it? </li></ul><ul><ul><ul><li>P US = US $ 15.00 </li></ul></ul></ul><ul><ul><ul><li>P CA = C$ 20.00 (CAN) </li></ul></ul></ul>
22. <ul><li>Exchange Rate Measures (cont.) </li></ul><ul><ul><ul><li>P US = $ 15.00 P CA = C$ 20.00 (CAN) </li></ul></ul></ul>1.51 .65 Per US dollar quotes = CAN Dollar US Dollar e ( ) = Per CAN dollar quotes = US Dollar CAN Dollar e ( ) =
23. <ul><li>In order to make a decision, you must convert the Canadian CD to US dollars: </li></ul><ul><li>Recall the price of the same CD in the U.S. was US $15.00. </li></ul><ul><li>Since the price of the US CD was more than the US Dollar price of the Canadian CD, you buy the CD in Canada. </li></ul>Price of Canadian CD in US = P CAN US Dollar CAN Dollar e ( ) * C$20 (CAN) X C$1.00 (CAN) $0.65 (US) 1 = $13.00 (US)
24. Reality Check <ul><li>This ignores transaction costs </li></ul><ul><li>Transaction costs on LARGE exchanges -- millions of $s -- are small, fractions of a % </li></ul><ul><li>Transaction costs on small exchanges -- for tourists or travelers -- can be large; in North America and Western Europe, a fixed fee (say $5) per exchange plus commission of 1 or 2 per cent. Travelers be warned! </li></ul>
25. <ul><li>Currency depreciation : - a currency depreciates if its value in terms of foreign currency goes down. </li></ul><ul><li>That automatically means it costs more of the depreciated currency to buy a unit of the foreign currency - i.e. the price of the foreign currency has gone up in terms of domestic currency. </li></ul><ul><li>Some Terminology: </li></ul>
26. <ul><li>Currency depreciation : ( an example ) </li></ul><ul><li>The US dollar buys less and has thus depreciated. </li></ul><ul><li>Example: Say that currently one US dollar is worth 2 DM ( German currency ), </li></ul><ul><li>or , </li></ul><ul><li>If the new exchange rate is then one US dollar buys 1 DM. </li></ul>
27. Depreciation and Appreciation <ul><li>One DM used to cost $0.50, 50 cents, but now it costs a dollar -- the price of the DM in dollars has gone up, the price of the $ in DM has gone down (from DM2 to DM1) </li></ul><ul><li>The DM appreciated, the $ depreciated. </li></ul><ul><li>German goods, priced in DM, now cost more in $’s; so are more expensive compared to US goods, so German exports, [US imports], go down. US goods, priced in $’s, now cost fewer DM’s, US exports [German imports] go up. </li></ul>
28. <ul><li>Exchange Rate Measures (cont.) </li></ul><ul><li>The real exchange rate is the nominal exchange rate adjusted for prices </li></ul><ul><li>That means we multiply the nominal exchange rate by the ratio of the US and foreign price indices: </li></ul>Real Exchange Rate: = e Foreign currency US Dollar ( ) Re Foreign currency US Dollar ( ) X P FC P US
29. <ul><li>The Demand for Dollars is a derived demand -- it comes from holders of other currencies wanting US dollars to make payments in dollars -- e.g. to buy US goods, services, or assets. </li></ul><ul><li>What determines the quantity of dollars demanded in the foreign exchange market? </li></ul><ul><ul><li>The exchange rate, the price of the $ in terms of the other currency. - other things remaining the same, an increase in the exchange rate reduces the quantity demanded (of dollars) and causes a movement along the demand curve (for dollars in the foreign exchange market). </li></ul></ul>
30. <ul><li>Quantity demanded for dollars ( an example ) </li></ul><ul><li>The price of a dollar has gone up, so less will be demanded. </li></ul><ul><li>Suppose the current exchange rate is - - - This means that 100 yen ( Japanese currency ) will buy you $1.00. </li></ul><ul><li>Suppose the exchange rate increases to 200 yen. Now someone in Japan has to give up twice as many yen to get $1.00. </li></ul>
31. The Demand for Dollars 100 1.3 Quantity (trillions of $ per day) 50 150 1.1 1.2 1.4 1.5 0 Exchange Rate (Yen for $) D 1.3 100 Other things remaining the same, a rise in the exchange rate decreases the quantity of dollars demanded...
32. <ul><li>Other determinants cause the demand for dollars curve to shift </li></ul><ul><li>1) Interest rates in the US and other countries. </li></ul>Example: Suppose US interest rates go up. What will happen to the demand for the dollar? <ul><li>At the same exchange rate, Japanese investors will want to take advantage of the higher returns by investing more in (lending more to) the US. </li></ul><ul><li>This means more US dollars will be purchased and the demand for dollars will shift to the right. </li></ul>
33. <ul><li>Other determinants cause the demand for dollar curve to shift (cont.) </li></ul><ul><li>2) relative prices in the United States and other countries [affects X and M, which require currency transactions]. </li></ul><ul><li>3) GDP in the foreign country [affect our exports -- income effect] </li></ul><ul><li>4) the expected future exchange rate [affects asset holdings -- foreigners won’t hold $’s if they expect the value to fall] </li></ul>
34. Changes in the Demand for Dollars Quantity (trillions of dollars per day) Exchange rate (yen per dollar) 50 100 150 1.1 1.2 1.3 1.4 1.5 0 D 0 D 2 D 1 Increase in the demand for dollars Decrease in the demand for dollars
35. Summary: Changes in the Demand for Dollars <ul><li>The U.S interest rate differential increases </li></ul><ul><li>Japanese prices rise, relative to US prices. </li></ul><ul><li>Japanese GDP rises. </li></ul><ul><li>The expected future exchange rate rises </li></ul><ul><li>The U.S. interest rate differential decreases </li></ul><ul><li>Japanese prices fall, relative to US prices. </li></ul><ul><li>Japanese GDP falls. </li></ul><ul><li>The expected future exchange rate falls </li></ul>The demand for dollars increases if: The demand for dollars decreases if:
36. <ul><li>The Supply of Dollars is derived -- it arises from holders of dollars wanting foreign currency to make payments in foreign currency -- e.g. to buy goods, services, or assets abroad. </li></ul><ul><li>What determines the quantity of dollars supplied in the foreign exchange market? </li></ul><ul><ul><li>The exchange rate, i.e. the $’s price - other things remaining the same, if the exchange rate rises, the quantity of dollars supplied increases and causes a movement along the supply curve (of dollars in the foreign exchange market). </li></ul></ul>
37. <ul><li>Quantity supplied of dollars ( an example ) </li></ul><ul><li>Japanese goods are cheaper so you will supply more dollars in order to get the yen needed to purchase the cheaper Japanese goods. </li></ul><ul><li>Suppose the current exchange rate is - - - And, further, suppose that 1.3 trillion dollars are supplied. </li></ul><ul><li>If the exchange rate increases to 200 yen. One dollar buys more yen. </li></ul>
38. The Supply of Dollars 100 1.3 Quantity (trillions of $ per day) 50 150 1.1 1.2 1.4 1.5 0 Exchange Rate (Yen for $) Other things remaining the same, a rise in the exchange rate increases the quantity of dollars supplied... S 1.3 100
39. <ul><li>Other determinants cause the supply of dollars curve to shift </li></ul><ul><li>1) Interest rates in the US and other countries. </li></ul><ul><li>2) relative prices in the United States and other countries. </li></ul><ul><li>3) GDP in the US </li></ul><ul><li>4) the expected future exchange rate </li></ul><ul><li>[reasoning is all symmetric to the demand curve shifts -- supply of $ ’s is demand for Yen if we just consider these two currencies] </li></ul>
40. The Supply of Dollars Quantity (trillions of dollars per day) Exchange rate (yen per dollar) 50 100 150 1.1 1.2 1.3 1.4 1.5 0 S 0 S 2 S 1 Decrease in the supply of dollars Increase in the supply of dollars
41. Summary: Changes in the Supply of Dollars <ul><li>The U.S interest rate differential decreases </li></ul><ul><li>Japanese price level falls relative to the US price level. </li></ul><ul><li>U.S. GDP increases. </li></ul><ul><li>The expected future exchange rate falls </li></ul><ul><li>The U.S. interest rate differential increases </li></ul><ul><li>Japanese price level increases, relative to the US price level. </li></ul><ul><li>US GDP decreases. </li></ul><ul><li>The expected future exchange rate rises </li></ul>The supply of dollars increases if: The supply of dollars decreases if:
42. Equilibrium Exchange Rate: <ul><li>The equilibrium exchange rate occurs where the quantity of dollars demanded is just equal to the quantity of dollars supplied . </li></ul>
43. Equilibrium Exchange Rate 100 1.3 Quantity (trillions of $ per day) 50 150 1.1 1.2 1.4 1.5 0 Exchange Rate (Yen for $) D S 1.3 100 Surplus at 150 yen per dollar Shortage at 50 yen per dollar Equilibrium at 100 yen per dollar
44. An Application: Interest rates fluctuate up. Quantity of $ 0 S 1 D 1 e 1 Q 1 <ul><li>If the US interest rate goes up, what will happen to the dollar? </li></ul><ul><li>With higher interest rates in the US, investors abroad demand more dollars with which to invest in the US. </li></ul><ul><li>With higher interest rates in the US, investors in the US are less willing to buy foreign currency (supply dollars) and more willing to invest at higher interest rates at home. </li></ul>D 2 S 2
45. An Application: Interest rates fluctuate up. Quantity of $ 0 S 1 D 1 e 1 Q 1 <ul><li>The equilibrium exchange rate occurs where the quantity of dollars demanded is just equal to the quantity of dollars supplied . </li></ul><ul><li>The new equilibrium results in a higher exchange rate (yen for $). </li></ul><ul><li>Prediction : The dollar should appreciate in relation to the yen . </li></ul>D 2 S 2 e 2 Q 2 =
46. An Application: Foreign Exchange Intervention. <ul><li>Suppose the Japanese yen is rising w/respect to the US dollar. </li></ul>Quantity of $ 0 S 1 D 1 e 1 Q 1 <ul><li>Foreign exchange intervention is when a govt. tries to maintain an exchange rate in the foreign exchange model. </li></ul><ul><li>The Fed could intervene in the market to “prop up” the dollar. </li></ul><ul><li>Without intervention, the exchange rate will fall to e 2 . </li></ul>D 2 e 2
47. An Application: Foreign Exchange Intervention. D 1 e 1 Quantity of $ 0 S 1 Q 1 <ul><li>In order for the Fed to intervene and attempt to maintain the exchange rate between dollars and yen at e 1 , it would have to demand (buy) dollars to shift the demand curve back to D 1 </li></ul>e 2 D 1 D 2 e 1
48. Reality Check <ul><li>Nowadays, intervention rarely works </li></ul><ul><li>The volume of foreign exchange transactions is of the order of $2 trillion a day </li></ul><ul><li>This is massively larger than any country’s foreign exchange reserves, so in most cases intervention alone is inadequate -- it does not shift the curves enough. </li></ul>
49. Changes in the Exchange Rate <ul><li>Why the Exchange Rate is Volatile </li></ul><ul><ul><ul><li>Supply and demand are not independent of each other. </li></ul></ul></ul><ul><ul><ul><li>A change in the expected future exchange rate or U.S. interest rate differential changes both supply and demand. </li></ul></ul></ul><ul><ul><ul><li>Day-to-day movements in exchange rates are dominated by the large amounts of internationally mobile liquid capital and changes in sentiment -- i.e. expectations about the future </li></ul></ul></ul>
50. Exchange Rate Fluctuations Quantity (trillions of dollars per day) Exchange rate (yen per dollar) 84 100 0 Q 0 D 94 D 95 1994 to 1995 S 94 S 95
51. Exchange Rate Fluctuations Quantity (trillions of dollars per day) Exchange rate (yen per dollar) 84 0 Q 0 S 95 D 95 123 1995 to 1997 S 97 D 97
52. The Exchange Rate <ul><li>Exchange Rate Expectations </li></ul><ul><ul><li>Three influences on expectations that affect the international value of a currency are: </li></ul></ul><ul><li>1) Purchasing power parity ideas </li></ul><ul><li>2) Interest rate parity expectations </li></ul><ul><li>3) Other influences on expectations about future exchange rates [e.g. political developments] </li></ul>
53. Influences on the Exchange Rate <ul><li>1) Purchasing Power Parity </li></ul><ul><ul><li>Money is worth what it will buy. </li></ul></ul><ul><ul><li>Purchasing power parity means equal value of money as purchasing power -- the idea that, ceteris paribus, $1 ought to buy the same amount of real goods and services anywhere. </li></ul></ul><ul><ul><li>PPP is misleading -- much of output is nontradable -- most services, most low value-to-mass or -to-bulk, or perishable, goods (e.g. haircuts, restaurant meals, fresh bread, housing, bricks, cement, gravel, etc) </li></ul></ul>
54. Purchasing Power Parity <ul><li>If prices [of traded goods] increase in Canada (for example) and other countries but remain constant in the United States, people will generally expect that the value of the U.S. dollar is too low and will expect it to rise. </li></ul><ul><ul><li>Supply of and demand for dollars change </li></ul></ul><ul><ul><li>The exchange rate should tend to change -- eventually . It may take some time, because buying habits and supply chains don’t change instantaneously, and other influences are at work. </li></ul></ul>
55. Influences on the Exchange Rate <ul><li>2) Interest Rate Parity </li></ul><ul><ul><li>“Money is worth what it can earn.” </li></ul></ul><ul><ul><li>Interest rate parity means equal interest rates -- i.e. , ceteris paribus, interest rates should be the same everywhere. </li></ul></ul><ul><ul><li>Again, they aren’t -- because risk differentials differ, there are transactions costs investing in other currencies, and because possible future changes in exchange rates have to be taken into account. </li></ul></ul>
56. Interest Rate Parity <ul><li>If the rate of return on the dollar is higher in the United States than the rate of return on local currencies in other countries, the demand for U.S. dollars rises and the exchange rate rises until interest rates are closer to equal. </li></ul><ul><ul><li>If you are the treasurer of a multinational (e.g. Ford), you will put your liquid funds (cash) in the market (and the currency) where you expect the biggest return, ceteris paribus [e.g. allowing for risk]. </li></ul></ul>
57. 3) Other Influences on Exchange Rates <ul><li>The problem is, small differentials in interest rates [a percent or two a year] can be swamped by small changes in exchange rates [a few percent right now] </li></ul><ul><li>So expectations about likely future changes in exchange rates tend to be much more powerful influences on supply and demand to foreign exchange markets in the short run than fundamentals like relative price levels and interest rate differentials. </li></ul>
58. Example: ‘Speculation’ & ‘Runs’ <ul><li>Suppose an exchange rate was stable for a long time -- e.g. $1 = 25 Thai Baht </li></ul><ul><li>Suppose lots of foreign investment goes into Thailand at that rate </li></ul><ul><li>Then suppose some bad financial and political things happen in Thailand -- the property market goes bad, some finance houses and banks get in trouble </li></ul>
59. ‘Speculation’ & ‘Runs’ <ul><li>A few investors figure the exchange rate might fall, and withdraw their money from Thailand </li></ul><ul><li>This increases demand for $’s and supply of baht, so the price of baht falls -- i.e. more baht per dollar </li></ul><ul><li>Others notice, and think they had better get dollars before the price of dollars gets even higher in baht </li></ul>
60. ‘Speculation’ & ‘Runs’ <ul><li>You get a ‘rush for the exit’ -- and the exchange rate collapses [July 1997: $1 = 25 baht; December 1997: $1 = 43 baht] </li></ul><ul><li>Conclusion: If there is a lot of so-called ‘liquid capital’ -- money that can be exchanged and transferred quickly -- exchange rates may be very volatile, i.e. can change a lot quickly. </li></ul>
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