International Dimensions of Macro Policy

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International Dimensions of Macro Policy

• Fixed Exchange Rates
• In this case, the central bank (the government)
  decides the value of the currency.

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International Dimensions of Macro Policy

• Flexible Exchange Rates
• In this case demand and supply of the dollar
  determine the value of the dollar

/
Re
Quantity of demanded and supplied
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International Dimensions of Macro Policy

• Flexible Exchange Rates
• In this case demand and supply of the dollar
  determine the value of the dollar

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Surplus
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Re
Quantity of demanded and supplied
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International Dimensions of Macro Policy

• Flexible Exchange Rates
• In this case demand and supply of the dollar
  determine the value of the dollar

/
Re
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Deficits
Quantity of demanded and supplied
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Foreign Exchange Risk

• There are three sources of risk
• accounting riskAnytime there is a change in the
  value of the dollar, value foreign currency
  denominated assets change in the same direction.
  Assume an American owns a Bond with a face value
  of 1000 pound sterling. Its value in dollar is
• at 1.50/ 1500.00
• at 1.60/ 1600.00 Devaluation of the
• at 1.40/ 1,400.00 appreciation of the

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Foreign Exchange Risk

• There are three sources of risk
• Transaction risk Assume you buy a BMW for 45000
  DM
• Its Dollar price
• _at_ .8/DM 36000
• _at_ .88/DM 39,600 Devaluation of the
• _at_ .72/DM 32.400 Appreciation of the

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Foreign Exchange Risk

• There are three sources of risk
• Currency risk The higher the variability of a
  currency, the higher is the possibility that the
  value of an asset denominated in that currency
  will change. This means that assets denominated
  in that currency are riskier than others.

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Macro adjustment Under the fixed ER regime

• Increase the money supply

LM
BP
LM
i
a
i1
b
i2
IS
income
y1 y2
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Macro adjustment Under the fixed ER regime

• Real income increases which leads to increase in
  imports. Lower interest rates will lead to
  outflow of money. LM will shift back where it
  was.

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Macro adjustment Under the fixed ER regime
LM
BP
LM
i
a
i1
b
i2
IS
income
y1 y2