1. Foreign Exchange Markets
ECO Money & Banking - Dr. D. Foster

2. Perspective! The U.S. We want to buy foreign exchange.
We don’t really want the “money.”
We want the goods/services/financial assets
We pay $ to get foreign exchange.
When the $ appreciates, we can buy more i.e. the price is lower.
When the $ appreciates, the £ depreciates.
When $ depreciates … price is higher.

3. Perspective! The U.S. We demand foreign exchange - £, Ұ, € $ (per £)
The market for pounds (£)
E = $2
Demand shows: our demand for British goods and services (our imports)
E = $1
D £
At higher prices…
it takes more dollars to buy a pound,
British goods are more expensive,
the dollar is depreciating (and the £ is appreciating).
At lower prices … Q£

4. Perspective! The U.S. $ (per £)
What would shift the demand for British pounds?
The market for pounds (£)
The Fed may buy pounds!
A change in our tastes and preferences for their goods.
A change in our income.
A change in trade restrictions.
A change in monetary policy...
D’£
D £
D”£ Q£

5. Perspective! The U.S. Foreigners supply foreign exchange - £, Ұ, € S £Q£
E = $2
E = $1
Supply shows: British demand for dollars to buy our goods (our exports). To acquire $ they must supply £.
The market for pounds (£)
At higher prices…
pounds buy more dollars,
American goods are cheaper,
the dollar is depreciating (and the £ is appreciating).
At lower prices …

6. Perspective! The U.S. S £ $ (per £) Q£ S’£
What would shift the supply of British pounds?
S’£
A change in their tastes and preferences for our goods.
A change in their income.
A change in trade restrictions.
A change in monetary policy...
The Fed may sell pounds!
The market for pounds (£)

7. Perspective! The U.S. $ depreciates; the price rises; we buy less
$ appreciates; the price falls; we buy more
D £
S £
$ (per £) Q£ E
Equilibrium in the market for pounds (£)
Exchange rate changes as S & D change . . .

8. Perspective! The U.S. Q - What if we want less British goods?
A - Increase Demand; E rises; $ depreciates E’ S’
A - Increase Supply; E falls; $ appreciates E’ D’
A - Decrease Demand; E falls; $ appreciates
D £
S £
$ (per £) Q£ E
Q - What if our incomes rise?
Q - What if Brits want more US goods?

9. Exchange rate changes as S & D change . . .
Perspective! Britain
£ depreciates; the price rises; we buy less
D $
S $
£ (per $) Q$
1 𝐸
$ appreciates
£ appreciates; the price falls; we buy more
$ depreciates
Exchange rate changes as S & D change . . .

10. Perspective! Britain Q - What if we want less British goods?
A - Increase Demand; 1/E rises; $ appreciates
1/E’ D’
1/E’ S’
A - Increase Supply; 1/E falls; $ depreciates
1/E’ S’
A - Decrease Supply; 1/E rises; $ appreciates
Q - What if U.S. incomes rise?
D $
S $
£ (per $) Q$
1/E
Q - What if Brits want more US goods?

11. Current Exchange Rates

12. Real Exchange Rates Nominal: What we see reported.
Real: Adjusted for price level changes.
Real = Nominal*(CPIUS/CPISFr)
SFr/US $: – – 1.171
CPI (Swiss):
CPI (US):
1.1825
Nominal %Δ: – 4.72%
Real %Δ: – 3.785%
(1.171−1.229) 1.229
1.171∗
(1.1825−1.229) 1.229

13. Foreign Exchange Markets
ECO Money & Banking - Dr. D. Foster