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24 Cards in this Set
- Front
- Back
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In order to free up its financial markets and join the world financial and monetary system, a country needs to:
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1. Open up currency transactions
2. Open up capital movements 3. Open up movement of goods |
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Rate of exchange used in the settlement of forward transactions
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Forward Rate
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Foreign currency worth more in the forward market than in the spot market
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Premium
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Currency is worth less in the forward market than in the spot market
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Discount
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Uncovered Interest Rate Parity (UIRP) - Fixed exchange rates
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Interest rate differential equals expected rate of depreciation
No expectations of depreciation Interest rates equal between countries |
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If US interest rate > Japan interest rate
Dollar expected to depreciate If Japan interest rate > US interest rate Yen expected to depreciate Expected returns equalized |
Uncovered Interest Rate Parity (UIRP) - Flexible exchange rates
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The value of domestic securities held by a central bank is called domestic credit
Foreign securities are denominated in foreign currency. Most frequently these are bonds issued by foreign governments. Foreign securities are foreign reserves. |
Assets of the Central Bank
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Currency in circulation
Bank Reserves held by commercial banks Mostly required by the Fed |
Liabilities of the Central Bank
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Goal of Monetary Policy: Policy Targets
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Real GDP growth
Low unemployment Price stability New Zealand England European Central Bank: Price stability with inflation under 2% High employment consistent with stable prices (“Taylor Rule”) - Federal Reserve System |
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Central Bank purchases domestic credit with currency
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Open Market Operations
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Central bank purchases foreign reserves with currency
Both affect the money supply and interest rates Increase the money supply to decrease interest rates Decrease the money supply to increase interest rates |
Foreign Exchange Intervention
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How to fix exchange rates with free movement of capital?
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Central Bank needs to direct monetary policy towards keeping the domestic interest rate equal to the world interest rate
Keep expected depreciation equal zero Cannot direct monetary policy towards other objectives |
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Fixed exchange rates and free movement of capital
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Cannot have independent monetary policy
Monetary policy directed towards fixing the domestic interest rate at the world interest rate Cannot be directed towards other objectives such as inflation or unemployment |
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China
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Fixed exchange rate, independent monetary policy, but controls on capital
Pressure to allow more exchange rate flexibility Mostly by US to let Yuan appreciate Fueled by trade deficit Not much response so far (2%) |
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The Federal Reserve Bank uses open market operations to directly affect:
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The money supply
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Suppose that the one year Swiss franc interest rate is 5% and the one year U.K. interest rate is 4%. If the one year forward rate is 0.45 pounds per francs what must the spot exchange rate be (£/Sfr) if covered interest parity holds?
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0.4545
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Assets of the central bank include:
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c) Domestic Credit
d) Foreign Reserves c and d. |
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A country can operate a fixed exchange rate and practice independent monetary policy if and only if
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it restricts inflows and outflows of financial capital
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The difference between covered and uncovered interest parity is that
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the former uses forward contracts to eliminate interest rate risk; the latter is based on the expectations about exchange rates
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With a flexible exchange rate and free movement of capital, the role of monetary policy is directed towards:
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a) inflation
b) unemployment a and b |
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In the case of fixed exchange rate, the Uncovered Interest rate Parity reduces to:
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Interest rates are equal between countries
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With a fixed exchange rate and free movement of capital, the role of monetary policy is directed towards:
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keeping the domestic interest rate at the world interest rate
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Given a system of floating exchange rates, an expansionary monetary policy by the Federal Reserve will cause
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the dollar to depreciate and will increase U.S. net exports
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In the Eurozone, the ___________ policies include free movement of capital, single currency but no independent national monetary policies while the ____________ policies include free movement of capital, independent monetary policy, and flexible exchange rates:
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Internal, External
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