KOOTHS | BiTS: International Economics (winter term 2013/2014), Part 5 1

International EconomicsPart 5

Dr. Stefan KoothsBiTS Berlin

(winter term 2013/2014)www.kooths.de/bits-ie

KOOTHS | BiTS: International Economics (winter term 2013/2014), Part 5 2

Outline

1. Introduction and Overview2. Systemizing and Recording Cross-border

Economic Activity3. The Pure Theory of International Trade4. Trade Policy: Free Trade vs. Protectionism5. Foreign Exchange Markets and the Open

Macroeconomy Foreign exchange markets and currency systems International financial investment Determination of exchange rate movements Open-economy macroeconomics

6. Case Study: The Euro Area Crisis7. Summary: The Key Lessons Learnt

KOOTHS | BiTS: International Economics (winter term 2013/2014), Part 5 3

Exchange rates (spot vs. forward rate)

Exchange rate» Price of one nation‘s money (e.g. USD) …» … in terms of another nation‘s money (e.g. EUR)

Euro area view: 0,73 [€/$] United States view: 1,37 [$/€]

Time dimension» Spot rate: price for immediate exchange» Forward rate: price set now for an exchange in the future

KOOTHS | BiTS: International Economics (winter term 2013/2014), Part 5 4

Currency systems: Floating vs. fixed exchange-rate systems

KOOTHS | BiTS: International Economics (winter term 2013/2014), Part 5 5

Appreciation/revaluation and depreciation/devaluation

Floating exchange rate» Appreciation» Depreciation

Fixed exchange rate» Revaluation» Devaluation

KOOTHS | BiTS: International Economics (winter term 2013/2014), Part 5 6

Demand for and supply of foreign exchange

Demand-side» Imports of goods and services» Capital outflows

Supply-side» Exports of goods and services» Capital inflows

KOOTHS | BiTS: International Economics (winter term 2013/2014), Part 5 7

Arbitrage

Exploiting price differentials» Between trading centers (NY, London, Frankfurt, Tokyo, …)» Between multiple currencies

• 1,6 [USD/GBP]• 0,9 [USD/CHF]• 0,5625 [GBP/CHF]

• 1,6 [USD/GBP] 1,0227 GBP• 0,9 [USD/CHF] 1,6363 USD• 0,55 [GBP/CHF] 1 GBP = 1,8181 CHF

KOOTHS | BiTS: International Economics (winter term 2013/2014), Part 5 8

Pegged exchange rates

KOOTHS | BiTS: International Economics (winter term 2013/2014), Part 5 9

Defending the peg: Official interventions

KOOTHS | BiTS: International Economics (winter term 2013/2014), Part 5 10

Exchange control

KOOTHS | BiTS: International Economics (winter term 2013/2014), Part 5 11

International experience: From the Gold Standard until today

KOOTHS | BiTS: International Economics (winter term 2013/2014), Part 5 12

Outline

1. Introduction and Overview2. Systemizing and Recording Cross-border

Economic Activity3. The Pure Theory of International Trade4. Trade Policy: Free Trade vs. Protectionism5. Foreign Exchange Markets and the Open

Macroeconomy Foreign exchange markets and currency systems International financial investment Determination of exchange rate movements Open-economy macroeconomics

6. Case Study: The Euro Area Crisis7. Summary: The Key Lessons Learnt

KOOTHS | BiTS: International Economics (winter term 2013/2014), Part 5 13

Exchange rate risk and speculation

KOOTHS | BiTS: International Economics (winter term 2013/2014), Part 5 14

Hedging and forward exchange contracts

KOOTHS | BiTS: International Economics (winter term 2013/2014), Part 5 15

Futures, Options, Swaps

KOOTHS | BiTS: International Economics (winter term 2013/2014), Part 5 16

The “Lake” model

KOOTHS | BiTS: International Economics (winter term 2013/2014), Part 5 17

Covered and uncovered transactions

KOOTHS | BiTS: International Economics (winter term 2013/2014), Part 5 18

Interest parity

Covered interest parity Uncovered interest parity

KOOTHS | BiTS: International Economics (winter term 2013/2014), Part 5 19

Outline

1. Introduction and Overview2. Systemizing and Recording Cross-border

Economic Activity3. The Pure Theory of International Trade4. Trade Policy: Free Trade vs. Protectionism5. Foreign Exchange Markets and the Open

Macroeconomy Foreign exchange markets and currency systems International financial investment Determination of exchange rate movements Open-economy macroeconomics

6. Case Study: The Euro Area Crisis7. Summary: The Key Lessons Learnt

KOOTHS | BiTS: International Economics (winter term 2013/2014), Part 5 20

Short run vs. long run analysis

Short-run» Asset market approach to exchange rates

(capital flows)

Long-run» Low of one price Purchasing power parity

(trade in goods and services)

KOOTHS | BiTS: International Economics (winter term 2013/2014), Part 5 21

Asset market approach and interest rate parity

KOOTHS | BiTS: International Economics (winter term 2013/2014), Part 5 22

Purchasing Power Parity (PPP)

KOOTHS | BiTS: International Economics (winter term 2013/2014), Part 5 23

Absolute vs. relative PPP

KOOTHS | BiTS: International Economics (winter term 2013/2014), Part 5 24

Monetary approach

KOOTHS | BiTS: International Economics (winter term 2013/2014), Part 5 25

Exchange rate overshooting