What is the effect of a revaluation??

Transcription

1 Two issues for Econ What is the effect of a revaluation?? What is the effect of raising interest rates?

2 Topical 2012/2015: Japanese PM Shinzo Abe intentionally devalues the Yen Liberal Democratic Party PM, with Finance Minister Taro Aso, March , NY Times photo

3 Theoretical effects of exchange rate adjustments (goods/services only) A devaluation (decline in value) of the $ should encourage exports (our goods are cheaper) discourage imports (their goods are more expensive) (The previous slide tells us that Hondas should be more expensive in the U.S. after 1985). A revaluation (rise in value) of the $ should encourage imports (their goods are cheaper) discourage exports (our goods are more expensive)

4 Case Japan: The impact of devaluing exchange rates upon prices Examples of $ Revaluation - Devaluation Impact Impact upon U.S. Dollar import prices Impact upon U.S. Dollar export prices Exchange rate in: Nikon D7100 worth 120,000 Fanuc Robot worth 60m Corvette worth $65,000 California wine worth $ $1,538 $769,231 5,070,000 1, $1,017 $508,475 7,670,000 2,950 Because the Yen devalued, this will tend to cause an decrease in the prices of imported goods from Japan (which may spread to domestic goods as well). It will also raise the cost of U.S. exports in Japan. [This is much more serious for a developing or emerging nation than it is for a large economy.]. The price effect is not guaranteed, or can be mitigated. The Japanese exporters would almost certainly raise their Yen prices to some degree to fatten their operating profit margins. For example if Fanuc (which in 2015 has operating profit margins at a staggering g 40% [Financial Times Feb 19, 2015]) raises their robot price to 80m, it would still be priced at only $678,966!

5 An elementary model of the EUR/USD [ /$] exchange rate $ price of Euro Exchange Rate Supply of Euro (Demand for $) This perspective treats the Euro as the commodity and the $ as the price A rise in this equilibrium price would represent a strong Euro and a weak $. Demand for Euro (Supply of $) Volume This model's equilibrium will be affected by major macroeconomic variables (relative) like interest rates, inflation rates, economic growth, changes in policy, trade status, and so forth.

6 Factors that affect exchange rates (seen from the perspective of the U.S. $) Impact upon the Goods & Services side Demand for the $ Surge in overseas demand for US products and services due to pricing, quality differentials, technology, new products, etc. (+) Surge in US demand d for overseas products and services due to () (-) pricing, quality differentials, technology, new products, etc. Financial / Investment side Rising interest rates in U.S. relative to those overseas. (+) Rising inflation rates in U,S, relative to those overseas. (-) General perceptions of deltas in relative economic strength (vague but real). (+) (+) Flight to quality: In times of global crisis, money flows to U.S. and to U.S. Treasury securities in particular (robust). Repatriations (money sent home). () (-)

7 What variables move these markets? After trading a lot in the FOREX, you teacher sees foreign exchange, in a modeling sense, as essentially two markets: (a) an intermediate to long-term market [measured in weeks to months] where fundamental textbook economic variables determine exchange rates, and (b) a very short term market [measured in minutes to days] that is hypersensitive and responds in a rational expectations format to minute data releases (globally), official speeches, rumors, or anything that might show that the longer term picture is changing, that monetary policy is changing, or that anything influencing interest rates is changing. Both markets are sensitive to nominal interest rates and other investment returns... the short-term market on expectations, the longer-term market more on realizations (sometimes referred to as confirmation). ) In general, emerging evidence of relative economic strength will strengthen a currency (partly because it raises the prospect of rising interest rates). The markets pay little attention these days to the U.S. trade position (our commodity gluttony is so habitual that it is universally expected).

8 Financial flows chasing high yields What impact does an increase in interest rates or other investment yields have upon the exchange rate of a currency? For example, what should happen to the Dollar price of the Pound or Euro if interest rates rose suddenly in the United States relative to those in Europe because of either FRS policy intentionallyraisingi ii rates of the RATEX of thesame? The FOREX is driven by rational expectations, so this effect will likely materialize even if tentative data emerges that this rise in rates is simply more likely (more probable)!

9 The effect of a relative increase in interest rates in the United States... $ Exchange Rate price of Supply of Euro Euro (Demandf for $) D 1 This perspective treats the Euro as the commodity and the $ as the price. D 2 S 1 S A drop in this equilibrium price would represent a strong $ and a weak -a 1.00 Euro devaluation. Demand for Euro (Supply of $) Volume This would produce an effect similar to what we have seen in Japan, increasing the price of our exports, discouraging them, and eating into the profits of global U.S. companies.

10 ... by (realistic) example: Examples of Devaluation - $ Revaluation Impact Impact upon U.S. Dollar import prices Impact upon U.S. Dollar export prices Deere lawn Audi worth French wine tractor worth California wine Exchange rate in: 30, worth 25 $4,000 worth $ $1.50 $45,000 $ , ? $1.00 $30,000 $ , Can the FRS allow this to happen?? Will politicians allow it??

11 ... which even begs the question about whether they can control them!!

12 Read the Martin Wolf article...