Midterm + Final: MCQ + short answer questions (< 5)

Midterm 90% thi trong slide, nếu có thời gian thì đọc thêm textbook
Mang máy tính đi thi, có thi chap 5 nhưng chỉ hết phần ppp thôi (nhưng chỉ 2 câu thôi)
20-25 MCQ, 5 short answer questions 1 đến 2 dòng → draw graph, calculation (thầy bảo tính
toán dễ thôi)
Factor of production, factor of price
Chỉ sử dụng american term

CHAPTER 1: Introduction

International Economics = International Trade + International Finance

International Economics International Trade International Finance

how nations interact through: focuses on transactions of focuses on financial or

- Trade of goods and services real goods and services monetary transactions
- Flows of money across nations across nations.
- Investment Eg: purchase of USD or
financial assets by europeans

International Trade:
1. Gain:
- receive things both parties want and make it better off (export abundant resources and
import scarce resources)
- Produce the most efficient goods with finite resources, then trade to obtain desired
goods.
- Specialization in production leads to greater efficiency through large-scale production.
- Trading resources for future resources (lending and borrowing)
→ benefit a country as a whole, but may harm particular groups within a country → conflicts
between groups rather than between countries

2. Patterns:
a. Differences in climate and resources: JP ex automobiles, US ex aircraft
b. Differences in labour productivity
c. Supplies of capital, labour and land
 3. Effect of gov policy
a. To affect the trade, policy maker can use:
- tariff (tax on imp and exp)
- quotas (quantity restrictions on imp and exp)
- exp subsidies (payment to help producers to lower the price)
- Other policies

International Finance
1. National income accounts:
Government measure:
- The value of exports and imports
- The value of international financial capitals
- Official settlements balance (balance of payments): balance of funds that central banks
use for official international payments

2. Exchange rate
- Measure how much domestic currency can be exchanged for foreign currency
- Affect how much goods that are denominated in foreign currency (imports) cost
- Affect how much goods denominated in domestic currency (exports) cost in foreign
markets
Determinations of exchange rate:
International Policy Coordination:
- In an integrated world economy one country’s economic policies usually affect other
countries as well
- Differences in goals between countries often lead to conflicts of interest
- Coordination failure
International capital market:
- Functioning of global asset markets
- Balance of payment crisis
Chapter 2.1. National income accounts
National income account (NIA): records the value of national income that results from
production and expenditure = income earned by a nation’s factors of production
The amount of expenditure by buyers
= the amount of income for sellers
= the value of production

GNP (gross national product) GDP (gross domestic product)

value of al final goods and services produced value of al final goods and services produced
by a nation’s factors of production in a given within a country in a given time period
time period

Who produce Where is produced

Factors of production:
- Worker (L)
- Physical capital
- Natural resource
- Other factors used to produce
4 types of expenditure:
- Consumption (c) by domestic residents
- Investment (I): by firm on plants & equipment
- Gov purchase (G): expenditure by G on G&S
- Current account balance (CA) net expenditure by foreigners on domestic goods &
services (có thể âm vì imp > exp → trade deficit)

National inc = GNP - depreciation + net unilateral transfers (gift from foreigners)
GDP = GNP - factor payments from foreign countries + factor payments to foreign
countries
Subtracting income earned from abroad (since it's not domestic production).
Adding income sent to foreigners (since it's part of the value generated within the country).

Nếu mà nói national income nói chung thì là GNP

Current Account (CA) records exports and imports

CA = EX - IM = Y - (C + I + G) > 0 is good since
→ biểu thức này reflects changes in a country’s Net international Positions
→ sum of C, I, G is the total domestic expenditure
CA = ∆NFW (>0 → good since tiền ở trong nước nhiều hơn là đưa cho nc ngoài)

National saving (S): national income (Y) that is not spent on consumption (C) or government
purchases (G)
S=Y-C-G
= (Y - T - C) + (T - G) (t: tax)
= Sp (private save) - Sg (government save)

CA = Y - (C + I + G) = (Y - C - G) - I = S - I
S > I → CA > 0 → NFI and capital outflows are positive
CA = Sp + Sg − I = Sp − government deficit − I
Chapter 2.2. Balance of payments accounts
BOP accounts: accounts for its payments to and its receipts from foreigners
Debit: payment to foreigners
Credit: payment received from foreigners

BOP accounts:

Current account Financial account Capital account

goods and services (export Financial assets / financial Special categories of assets:
& import) capital: money non-produced, non-market,
intangible assets (debt
forgiveness, copyrights and
trademarks)

- merchandise Net unilateral transfers: Special asset transfers, but

- services gifts (transfers) across this is a minor account for the
- income receipts (interest countries that do not U.S.
and div payments, earnings purchase a good or service
of firms and workers nor serve as income
operating in foreign
countries)
current account + financial account + capital account = 0

Financial account = # sales of domestic assets to foreigners & purchase of foreign assets by
domestic citizens
- Inflow: Foreigners loan to domestic citizens by acquiring domestic assets
Foreign owned (sold) assets in the domestic economy are a credit
- Outflow: Domestic citizens loan to foreigners by acquiring foreign assets
Domestically owned (purchased) assets in foreign economies are a debit

Financial account: 3 categories

- Official (international) reserve assets: Foreign assets held by central banks to buffer
against int market instability (government bonds, currency, gold and accounts)
- Credit: owned by (sold to) foreign central banks
- Debit: owned by (purchased by) the domestic central bank
- All other assets:
- Financial derivatives (net)

Official Settlements Balance (or Balance of Payments): the negative value of the official reserve
assets when a country depletes reserves or debts to foreign central banks.

Statistical discrepancy: The account adjusted to balance the financial account with the current
and capital accounts. (since data come from different sources that differ in coverage, accuracy,
and timing)
W current account is not zero in reality:
- 1980 and 2003: negative (as incomplete reporting of international investment income?)
- 2004 - now: positive (as growing international trade in services?)
The U.S. has the most negative net foreign wealth in the world, and so is therefore
the world’s largest debtor nation
Chapter 3: Exchange rate & foreign exchange market

1. Exchange rate: price of one currency in terms of another

- Foreign/ Domestic currency (dollar): European term (1đ nội tệ đổi được bao nhiêu yên)
- Domestic/ Foreign currency: American Term (để mua 1đ yên thì cần bnh đồng nội tệ)

Q1. How many British pounds would it cost to buy a pair of American designer jeans costing
$45 if the exchange rate is 1.60 dollars per British pound? = 45/1.6
Q2. What is the exchange rate between the dollar and the British pound if a pair of American
jeans costs $50 in New York and £100 in London? $1 = 2 pounds, 1 pound = $0.5

Depreciation is a decrease in the value of a currency relative to another currency

→ Currency is less valuable, and therefore it can buy fewer foreign produced goods that are
denominated in foreign currency

Appreciation is an increase in the value of a currency relative to another currency

An appreciated currency is more valuable, and therefore it can buy more foreign
produced goods that are denominated in foreign currency

Depreciation Appreciation

A decrease in the value of a currency An increase in the value of a currency

relative to another currency relative to another currency

Currency is less valuable → buy fewer Currency is more valuable → can buy more
foreign produced goods that are foreign produced goods that are
denominated in foreign currency denominated in foreign currency

ví dụ giá đô giảm, thì giá người nhật mua vào An appreciated currency raises the price of
sẽ rẻ hơn --> mua nhiều hơn --> imp increase exports relative to the price of imports
us có thể bán được nhiều hơn --> exp
increase
==> nên là depreciation làm giá export giảm
nhưng giá import tăng

2. Market participants in foreign exchange market:

 - Commercial banks and other depository institutions: buying/selling of bank deposits
in different currencies for investment
- Non bank financial institutions: buy/sell foreign assets
- Private firms: to buy/sell goods, assets or services
- Central banks: conduct official international reserves transactions

Characteristics of foreign exchange market:

- Buying and selling in the foreign exchange market are dominated by commercial
banks
- Characteristics of the FX (foreign exchange) market:
+ Trading occurs mostly in major financial cities: London, NY, Tokyo, Frankfurt, Singapore
+ FX market is the largest market in the world
+ The volume of foreign exchange has grown: 04/1989: $600 billion, 04/2019: $6.6
trillion
+ About 88.3% of transactions in April 2019 involved U.S. dollars
- Computers transmit information rapidly and have integrated markets: there is no significant
arbitrage between markets ($/ krw, $/ er, krw/ er)

Exchange rate is determined by foreign exchange market (demand/ supply)

Spot rate: exchange rate on the spot or trading now/ in the present
Forward rate: exchange rate occurring in the future date (rate in the present, but exchange in
the future)

Spot rate Forward rate

ER on the spot or trading now/ in the ER occurring in the future date (rate in the
present present, but exchange in the future)

Set today Set today, exchange in the future

Eurocurrency: để chỉ một khoản tiền gửi bằng ngoại tệ tại một ngân hàng nằm ngoài quốc gia
của đồng tiền đó.
VD: đồng yên gửi ở dallas thì là euroyen, đồng đô gửi ở london thì là eurodollar

Factors affecting the demand of deposits denominated in domestic or foreign currency:

 - Rate of return
- Risk of holding assets
- Liquidity of an asset, or ease of using the asset to buy goods and services (liquidity của
er và dollar là như nhau)

Rate of return: gần bằng interest rate, là % tiền nhận được trong tương lai so với hiện tại
Real rate of return: inflation adjusted rate of return.
Ví dụ: ROR = 2%, inflation rate = 0.5% → RROR = 2-0.5 = 1.5%

For bank deposits in different currencies, price are often assumed to be given at some level (no
flation). Giả định này chỉ dùng trong ngắn hạn vì trong ngắn hạn, giá cả ít có biến động

Determination of ROR:
- Interest rate
- Expectation of appreciation and depreciation

R$: 2%, Re: 4%, St = $1/e, Se t+1 = $0.97/e

If deposit in dollar:
$100 today → $102 in the future → ROR = 2%
If deposit in euro:
$100 today = E100 → E104 in the future
E104 → $100.88 → ROR = 0.88%
→ should deposit in dollar
→ the expected appreciation of euro is: (0.97 - 1)/1 = -0.03 %

Dollar ROR on euro deposits = interest rate of euro + expected rate of appreciation of euro
= re + (Se - S)/S

ROR$ - RORe:
positive → dollar has higher expected ROR
negative → euro has higher expected ROR

VD: Dollar Deposits or Euro Deposits?

1 R$ = 10%, Re = 6%, Expected rate of dollar depreciation = 0% → 10% vs 6% + 0% → dollar
2 R$ = 10%, Re = 6%, Expected rate of dollar depreciation = 4% → 10% vs 10% → both good
3 R$ = 10%, Re = 6%, Expected rate of dollar depreciation = 8% → 10% vs 14% → euro
 UIP (Uncovered Interest Parity) CIP (Cover Interest Parity)

The exchange market is equilibrium <-> Want to buy foreign currency deposit with
same ROR of all currency deposits certain number of domestic currency (để
tránh rủi ro):
- Buying euro deposit
- Selling the principal and interest
forward for dollars
the ROR on dollar deposits and covered
foreign deposits must be the same

R$ = Re + (Se - S)/S R$ = Re + (F - S)/S

(S là đô/ euro) (S, F là đô/ euro)

Giả sử R$ > Re + (Se - S)/S Forward premium on euros against dollars:

→ investor no interest in euro → decrease (F - S)/S
euro → decrease price Annualized forward premium:
→ $ appreciate, euro depreciate (F - S)/S * 360/(# of maturity days) *100
Công thức CIP dùng để thiết lập tỷ giá kỳ hạn
(forward rate)

UIP và CIP có thể ngang bằng nhau nếu: F = Se nhưng thường k xảy ra trong thực tế vì:
Covered transactions do not involve exchange rate risk, whereas uncovered
transactions do
→ UIP ít được sử dụng trong ngắn hạn vì tỉ giá trong ngắn hạn có nhiều biến động

Đi thi phải chép uip condition vào k được quên

Suppose Se$/e = $1.05/e and R$ = Re = 5%

Expected returns on dollar deposits and euro deposits?
1 S$/e = 1.07 → expected return of euro < dollar (1.05-1.07)/1.07 <0
2 S$/e = 1.05 → equally
3 S$/e = 1.03 → expected return of dollar > euro
4 S$/e = 1.02 → expected return of dollar > euro
5 S$/e = 1.00 → expected return of dollar > euro
Increase interest rate:
- Increase rate of return
- Appreciation on that currency

Rise in dollar interest rate Rise in euro interest rate

Điểm E1 cao hơn điểm E2 → mất ít đô hơn để Điểm E1 ở thấp hơn điểm E2 → cần nhiều đô
mua 1 euro → đô appre, euro depre hơn để mua 1 euro → đô depre, euro appre

Expected appreciation: if pp expect a currency to appreciate in the future → make investment

→ expected return on euro increase
→ expected return can lead to actual appreciation/ depreciation → self-fulfilling prophecy (dự
báo trước)
Chapter 4: Money

Monetary policy: điều chỉnh supply của money

Liquidity: how fast an assets can be converted to money → most liquidity assets is money

Money in short run: price fixed or stable

Money in long run: price are flexible
*không phải cứ 1 ngày là short run, 10 năm là long run. Behavior của short run & long run sẽ
khác nhau về mức độ biến đổi về giá

Definition of money: is an asset that is widely used and accepted as a means of payment

Functions of money:
- Store of value: transfer purchasing power from present to future (giữ tiền hôm nay và
mua hàng hóa trong tương lai)
- Unit of account: terms in which prices are quoted and debts are recorded (là thước đo
để định giá hàng hóa và ghi nhận các khoản nợ)
- Medium of exchange: what we use to buy goods and services (công cụ để mua hàng
hóa và dịch vụ)

Types of money:
- Flat money: money having no intrinsic value (dollar bills)
- Commodity money: money having intrinsic value (gold)

Quantity of money measurement:

M1 = Currency + demand deposits + travelers’ checks
*cheque: là một dạng phiếu kí để thanh toán ở nc ngoài, tuy nhiên k còn thịnh hàng và bị thay
thế bằng card

Quality of money controlling:

- Delegate to a partially independent institution: central bank (ở mỹ là fed)
- Federal reserve (Fed), Federal Open Market Committee (FOMC): là 1 phần của Fed,
thường đưa ra các policy làm tăng hoặc giảm cung tiền (?)
 - Open market operation: the purchase and sale of gov bonds *most fav policy → có thể
gây ra inflation nhưng chính phủ có thể adjust và ảnh hưởng của nó khá nhỏ. Cách hđ:
fed sells bond → decrease money trong dân, fed buys bond → increase money

Demand of money: is the amount of assets that pp are willing to hold as money (instead of
illiquid assets)
*factors influence aggregate demand (tổng cầu) for money:
- Interest rate: r ↑ → opportunity cost of holding money ↑ (vì gửi tk có lãi) → demand ↓
- Price: price ↑ → cần nhiều tiền hơn để mua hàng hóa → demand ↑
- Income: income ↑ →needs ↑ → demand ↑

Trong đó: Y - real national income (GNP)

*change in Y:
 Y2 > Y1 → more income → more demand in case interest rate are fixed

Equilibrium in the money market:

→ Ms = Md or Ms/P = Md/P
→ Ms = L(R,Y)

Changes in Ms Change in Y

MS tăng → R giảm, M/P tăng Y tăng → R tăng

 Short run
*price is fixed

Equilibrium in money market and foreign exchange market:

Depreciation of domestic currency → ↓ expected return in foreign currency

Appreciation of domestic currency → ↑ expected return in foreign currency

Changes in domestic money supply Changes in foreign money supply

supply tăng từ S1 --> S2 khi Ms euro tăng --> r euro giảm
--> r1 giảm xuống r2 --> depreciate --> expected return euro giảm
--> tăng spot exchange rate trong khi dollar giữ nguyên
--> S $/euro giảm --> $ appre, e depre

Điểm yếu của short run là giá sẽ được viết vào các hđ dài hạn và khi giá thay đổi thì k thể thay
đổi hợp đồng

Long run
*price is flexible:
- Giá của factors of production thay đổi sẽ được điều chỉnh theo cung và cầu:
- Ms do not influence of real output (bị ảnh hưởng bởi các yếu tố như nslđ, công nghệ và
các nguồn lực khác) or interest rate (bị ảnh hưởng bởi tiết kiệm và đầu tư). Ms chỉ ảnh
hưởng đến mức gía
→ Trong dài hạn cung tiền chỉ ảnh hưởng đến lạm phát chứ k làm thay đổi kinh tế thực
- P = Ms/L(R, Y) prices of output and inputs adjust proportionally to changes in the
money supply
→ %∆P = %∆Ms - %∆L (công thức inflation growth rate)
Change in supply → price of input như thế nào:
- Excess demand:
+ ↑ money supply → pp have more fund to pay for goods and services
+ To meet strong demand → hire more & ↑ wage
+ Price ↑ vì cost ↑
- Inflationary expectations:
+ Workers expected the price ↑ → want to compensate (đền bù: có thể là tăng
lương)
+ Producers also expect price ↑ → ↑ salary

Exchange rate are more volatile (biến đổi nh trong thời gian ngắn) than price

Exchange rate of euro ↑ vì niềm tin về lạm phát:

- Dollar sẽ giảm giá trị vì lạm phát → mất ít tiền khi mua bằng euro hơn
- Dollar depreciate → more deposits in euros

→ price ↑ → real money supply ↓ → interest rate trở về mức dài hạn
* Lãi suất ở mức dài hạn là mức lãi suất cân bằng mà nền kinh tế hướng tới sau khi các yếu tố
ngắn hạn như cú sốc kinh tế hoặc thay đổi chính sách đã ổn định, phản ánh tăng trưởng bền
vững và lạm phát ổn định.

Exchange rate sẽ overshoot (biến đổi nhanh và mạnh) khi có sự thay đổi ví dụ như thay đổi lãi
suất hoặc chính sách tiền tệ > so với mức phản ứng ổn định về lâu dài.
→ overshoot giải thích lý do tại sao exchange rate lại có biến động lớn

Khi tăng cung tiền permanently (vĩnh viễn) → giá cả hàng hóa tăng → mất giá trị của đồng tiền
so với các nước khác → lạm phát trong dài hạn
Tuy nhiên, theo mô hình động, tỷ giá ban đầu sẽ mất giá mạnh hơn, rồi sau đó tăng nhẹ để đạt
mức cân bằng dài hạn. (ban đầu tăng lên M2/P1 sau đó giảm xuống thành M2/P2 theo hình)
Tương tự: khi MS tăng, trong ngắn hạn, lãi suất, giá cả và tỉ giá sẽ biến đổi rất mạnh rồi cố định
xung quanh 1 mức giá cân bằng:
- MS tăng → interest giảm rồi tăng lại về giá trị dài hạn
- MS tăng → giá tăng và ổn định quanh 1 điểm cân bằng
- MS tăng → tỉ giá tăng mạnh rồi giảm mạnh và ổn định quanh 1 điểm cân bằng
Chapter 5: Price level and exchange rate in the long run

1. Law of one price (LOOP):

- LOOP: giá cả ở các thị trường là bằng nhau, các yếu tố như market barrier hay chi phí
vận chuyển k phải là 1 yếu tố quan trọng:
⇒ Ppizza US = Susd/cad × Ppizza Can
2. Purchasing power parity (PPP): mở rộng ý tưởng của LOOP ra không chỉ cho từng hàng
hóa mà còn cho tất cả hàng hóa và dịch vụ trong nền kinh tế của nhiều quốc gia.
Price level measures:
⇒ Pus = Susd/cad × Pcan
Susd/cad = Pus / Pcan
Ví dụ 1 cái rổ ở mỹ là $200, ở can là CAD400 → S = 200/400 = 1/2

Theo pp của Cassel:

- Khi nghiên cứu ppp, nên sử dụng mức giá chung của nền kinh tế (general price level)
- Chỉ số CPI (consumer price index) nên được đưa vào sử dụng thực tế nhiều hơn

Theo pp Commodity-Arbitrage Approach (phương pháp chênh lệch hàng hóa):

- LOOP holds for all internationally tradable goods
- Price index should cover only tradable goods
- PPI (producer price index) is a better choice of studying PPP: đo lường giá cả của hàng
hóa và dịch vụ mà nhà sản xuất nhận được.

Absolute PPP Relative PPP

Exchange rates equal price levels across Changes in exchange rates equal changes
countries: in prices (inflation) between 2 periods:

Thường hay sử dụng relative ppp vì dễ thỏa mãn điều kiện hơn

Kết luận:
- PPP có thể k đúng với ngắn hạn
- Relative PPP có thể đúng với dữ liệu nhưng khả năng dự đoán exchange rate còn kém
- PPP đúng với dài hạn
Lý do mà PPP không phải là 1 lý thuyết tốt là:
1. PPP k quan tâm đến trade barrier và non-tradable goods and services:
- Chi phí vận chuyển và các chính sách hạn chế thương mại → trade more expensive hoặc
còn k thể trade
- Services thường k trade đc
- Chi phí vận chuyển cao → exchange rate lệch khỏi PPP càng lớn
2. Cạnh tranh k hoàn hảo → phân biệt giá theo thị trường.
→ Doanh nghiệp cần sd giá khác nhau cho thị trường khác nhau → maximize profit
3. Khác biệt do price level measure:
- Cách đo mức giá chung của mỗi nước khác nhau (đb là cách chọn giỏ hàng) → k nhất
thiết phải sử dụng giá giống nhau cho các thị trường

Price level in poor country thường thấp hơn do mối quan hệ tích cực giữa mức giá và thu nhập
thực tế bình quân đầu người.
Lý thuyết Balassa-Samuelson: NSLĐ có thể thương mại thấp hơn ở các quốc gia nghèo → mức
lương và chi phí sản xuất thấp hơn cho hàng hóa không thể thương mại → làm giảm giá hàng
hóa không thể thương mại so với các quốc gia giàu.
Hàng hóa không thể thương mại sử dụng nhiều lao động hơn so với hàng hóa có thể thương
mại, dẫn đến việc hàng hóa không thể thương mại rẻ hơn ở các quốc gia nghèo.

⇒ tuy nhiên PPP vẫn là một mô hình quan trọng trong mô hình kinh tế mở

3. Monetary approach to exchange rates: use monetary factors to predict how exchange
rate adjust in a long run
- Absolute PPP
- Price adjust in long run
- Money market equilibrium
Pus = Mus / L(R$, Yus)
Peu = Meu / L(Re, Yeu)
Được xây dựng từ công thức giá cả trong dài hạn và cầu tiền trong nền kinh tế mở:
P = Ms/L(R, Y)
Md = P * L(R, Y)
Exchange rate is determined in the long run by prices, which are determined by:
- relative supply of money across countries
- relative real demand of money across countries
Predictions:
MS ↑ —LR—> P ↑ —PPP—> S ↑ → depre
R ↑ → L ↓ —LR—> P ↑ —PPP—> S ↑ → depre → D ↓
Output ↑ —LR—> P ↓ —PPP—> S ↓ → appre → D ↑

Fisher effect: Interest rate is not really independent of money supply growth rate in the long
run:
- MS change → price level change
- Change in MS growth rate → Change in price growth rate
→ Fisher effect: nominal interest rate and inflation (*nominal ir - inflation = real ir)
From UIP: R$ − Re = (S$e/e − S$/e) / S$/e
From relative PPP: (S$e/e − S$/e) / S$/e = πUS − πEU
⇒ R$ − Re = πUS − πEU
→ rise in the domestic inflation rate causes a rise in the interest rate on deposits of domestic
currency in the long run, if other things constant

Giả sử: The Fed unexpectedly increases the money growth rate at t0,
πUS is π before t0 and π + ∆π after this time (πEU = 0):

—> The increase in R$ decreases quantity of real money demanded

To maintain equilibrium in the money market, P must jump (maintain PPP)
To maintain PPP, S will then jump
M and P ↑ at rate π + ∆π & The domestic currency ↓ at rate π + ∆π

4. Without PPP, long run model: S won’t always adjust to maintain price parity between
nations.
 - ∆MS → ∆P
- No inflation in the LR, but only during the transition to the LR equilibrium (economy
adjusts to the new level of money supply and prices)
- During the transition, inflation causes the nominal ir ↑ until it reaches a new long-run
rate
- Expect of inflation → expected return on foreign currency ↑ → domestic currency depre
before the transition period
→ Expectations of inflation cause the exchange rate to overshoot its long run value

5. Monetary approach with PPP

- %MS ↑ permanently → %π ↑ permanently
- With persistent inflation, the monetary approach predicts ↑ in the nominal ir
- Expectations of higher domestic inflation → the PP of foreign currency ↑ → the
domestic currency dep
→ P adjusts with expectations of inflation → the domestic currency depreciate with no
overshooting

6. Real exchange rate (q)

Real ER: the rate of exchange for real goods and services across countries or the relative
value/price/cost of goods and services across countries

VD: giá dollar của rổ mỹ so với giá dollar của rổ ở euro

EU basket costs e100, US basket costs $120, and S$/e = $1.20/e
→ q = (1.2*100)/120 = 1

Real depreciation Real appreciation

↓ dollar’s purchasing power of EU products ↑ dollar’s purchasing power of EU products

relative to a dollar’s purchasing relative to a dollar’s purchasing
power of US products power of US products
US goods less expensive and less valuable US goods more expensive and more
relative to the EU goods valuable relative to the EU goods
Real exchange rate approach: exchange rates may also be influenced by the real
exchange rate
⇒ S$/e = q us/eu × Pus/Peu
Determinants of real ER:
- Relative Demand (RD): hàng hóa ở mỹ appre (có giá trị đắt hơn) → D giảm
- Relative Supply (RS): In the long run, the supply of goods and services in each country
depends on factors of production and technology exchange rates: productivity ↑ → real
expansion of output → thừa cung → lower P → depre (vì hàng hóa bị mất giá trị)

Real exchange rate Nominal exchange rate

Affected by: Affected by:

- Monetary factors: MS and inflation - ↑ relative demand for domestic products,
- Real factors: productivity, consumer real ER adjusts to determine nominal ER
preferences, and economic growth - ↑ relative supply of domestic products,
(i) Real ER adjusts to make the price/cost of
domestic goods depreciate
(ii) output ↑ → Pus decreases relative to Peu
⇒ The effect on the nominal exchange rate is
ambiguous

—> more general approach Change in LR real ER can affect nominal ER

→ When only monetary factors change and PPP holds,

→ No changes in the real exchange rate occurs
→ Nominal exchange rates are determined by PPP
Nominal interest rate differences:
(qe - q)/q = (Se-S)/S - ∆π (real = nominal - inflation)
R$ - Re = (Se-S)/S (UIP)
→ R$ - Re = (qe - q)/q + ∆π
→ (R$ - π$) + (Re - πe) = (qe - q)/q

Real interest rate: r = R - π

→ Real interest rate differentials: r$ − re = (R$ − πUS e ) − (Re − πEU e )
—> r$ − re = (qe-q)/q
Differences in real ir between countries = the expected change in the value/price/cost of goods
and services between countries

Case: Flexible-price monetary approach

The Fed raises future rate of dollar supply growth by the amount ∆π, this change will cause
• This will raise dollar interest rate from R to R = R + ∆π, in line with Fisher effect
• US price level will jump up from Plus to Pus
Money market equilibrium moves from point 1 to point 2 (Because Mus doesn't change
immediately)
PPP relationship shows that the US price level jumps up (while European price level remains
constant), depreciation of the dollar against the euro from Se to Se
$/€
It is shown as the movement from point 1' to point 2' in the exchange market
• Despite a rise in Rs, because increased expectations of future dollar depreciation against euro