Module The Foreign Exchange Market KRUGMAN'S MACROECONOMICS for AP* 42 Margaret Ray and David Anderson.

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Mechanics of Foreign Exchange (FOREX)

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Module The Foreign Exchange Market KRUGMAN'S MACROECONOMICS for AP* 42 Margaret Ray and David Anderson

What you will learn in this Module : The role of the foreign exchange market and the exchange rate The importance of real exchange rates and their role in the current account

The Role of the Exchange Rate The Market for Loanable Funds shows us how financial capital flows into or out of a nation’s capital account. The Financial Account = movement of capital. The Current Account = movement of goods and services What ensures that they balance? The Exchange Rate Determined in the Foreign Exchange Market

Understanding Exchange Rates Understanding Exchange Rates Exchange Rates – a price Appreciate - $ may buy more of a foreign currency (stronger) Depreciate - $ may buy less of a foreign currency (weaker) US $JP ¥€ $ ¥ €

The Equilibrium Exchange Rate The Equilibrium Exchange Rate Equilibrium Exchange Rate = Qd$ = Qs$ FOREX = foreign exchange market follows the Laws of S and D D for euro means US S more $

Understanding Exchange Rates Increase in capital flows into the US Stronger dollar Decrease in US net exports Costs more to buy our goods Decrease in capital flows into the US Weaker dollar Increase in US net exports Costs less to buy our goods

Inflation and Real Exchange Rates Inflation and Real Exchange Rates Real Exchange Rates – exchange rates adjusted for international differences in aggregate price levels Example Number of Mexican pesos per US dollar Real exchange rate = Mexican pesos per US dollar * (US exchange rate/Mexican exchange rate) Nominal Exchange Rates – unadjusted for aggregate price level