Exchange rates influences trade

Demand for the currency influences exchange rates. Also expectations are important

Washington concensus – from midterm, read more

USD king

Changes in exchange rates over the world get arbitraged (Rothschilds)

What influences demand of a currency:

 Chasing interest rates

o Investors are concerned about the rates of return of currency deposits
o Expectations about appreciation or depreciation
o Interest rate parity effect
o Monetary effects – if interest rates are risen in the us, the dollar will get stronger. Big
differentials lead to currency wars
 Liquidity -dollar backed assets are very liquid
 Risk – Swiss frank vs Russian ruble

Participants:

 Commercial banks carry out the majority of foreign exchange transactions

 Non-bank financial institutions (Goldman Sachs)
 Multinational corps
 Central banks

Forward rates – insurance for exchange rate risk

Terms of trade – how much can you import by exporting the same amount. Relative prices of imports vs
exports

Money * velocity (constant in the short run) = Price (constant in the short run) * Quantity → more
money= more stuff, but over time prices would rise and we would be able to buy the same amount of
stuff, but at higher prices.

It doesn’t go back to the same levels because the money supply has been permanently increased

Carry trade - It is not arbitrage because it is not risk free.

Dutch disease – newly found gas reserves killed the factories, because the exchange rate appreciated
due to gas exports so much that it was hard to export for factories.