ECON 311 1st Edition Lecture 11 Outline of Last Lecture I Purchasing Power Parity Outline of Current Lecture I Factors that Affect Exchanges Rates in the Short Run II Interest Parity Condition III Short Term Exchange Rate Model IV Shifting the Demand for Dollar Assets V Function of Money VI Evolution of Cash VII Measuring Money Current Lecture I Factors that Affect Exchange Rates in the Short Run a An exchange rate is the price of domestic assets in terms of foreign assets b Dollar assets assets denominated in US II Interest Parity Condition iD domestic interest rate The return on dollar assets iF foreign interest rate The return on foreign assets a From US perspective i Expected return in assets iD e E t 1 Et ii Expected return in foreign assets i F Et b At equilibrium iD and iF should be e E t 1 Et i D i F Et These notes represent a detailed interpretation of the professor s lecture GradeBuddy is best used as a supplement to your own notes not as a substitute c Suppose US government bonds yield 6 and German government bonds yield 4 Assume 10 year bond e E Et i D i F t 1 Et Then the expected appreciation is 2 or the US dollar would depreciate 2 III Short Term Exchange Rate Model a Supply and Demand of dollar assets i In short run assume supply of dollar assets is fixed Suppose Et Eet 1 A 10 pesos 1 12 pesos 1 B 11 pesos 1 12 pesos 1 If exchange rate today increases expected return decreases When exchange rate is high expected appreciation is low Dollar is stronger E equilibrium exchange rate Et S E IV Shifting the Demand for Dollar Assets a If Et changes Demand curve does NOT shift b changes in iD iF and Eet 1 shift the Et demand curve 1 If iD increases the E2 Demand for dollar E1 assets increases 2 If iF decreases the Demand for dollar assets increases D Quantity of Dollar Assets S D2 D1 Quantity of Dollar Assets 3 If Eet 1 increases the Demand for dollar assets increases Chapter 7 What is Money V VI VII Function of Money a Medium of Exchange facilitates the exchange of goods and services b Store of Value retains its value over time not perfect because of inflation c Unit of Account an agreed upon measure for stating the prices of goods and services Evolution of Cash a Commodity money physical commodity that has value in its own right intrinsic value but also serves as money EX bananas gold b Convertible Paper Money paper claim to a commodity c Fiat Money commodity with no intrinsic value that also serves as money i Must also have general agreement among the public as well as government backing Measuring Money a Why are we interested i Changes in money supply in the economy are related to changes in inflation interest rates and economic growth b Monetary Aggregates M1 M2 Currency M1 Checking Deposits Small Savings Deposits Travelers Checks Small Time Deposits CDs Small Money Market Mutual Fund Deposits M1 is considered more liquid than M2