Chapter 15 Price Levels and the Exchange Rate in the Long run
Chapter 15 ▪ Price Levels and the Exchange Rate in the Long Run
Chapter organization Introduction The law of one price Purchasing power parity A Long-Run Exchange Rate Model Based on PPP Empirical Evidence on PPP and the Law of One Price Explaining the Problems with PPP Copyright C 2003 Pearson Education, Inc Slide 15-2
Copyright © 2003 Pearson Education, Inc. Slide 15-2 ▪ Introduction ▪ The Law of One Price ▪ Purchasing Power Parity ▪ A Long-Run Exchange Rate Model Based on PPP ▪ Empirical Evidence on PPP and the Law of One Price ▪ Explaining the Problems with PPP Chapter Organization
Chapter organization Beyond Purchasing Power Parity: A General Model of Long-Run Exchange Rates International Interest Rate Differences and the real Exchange Rate Real Interest parity Summary Appendix: The Fisher Effect, the Interest Rate, and the Exchange rate Under the Flexible-Price Monetary Ap pproach Copyright C 2003 Pearson Education, Inc Slide 15-3
Copyright © 2003 Pearson Education, Inc. Slide 15-3 ▪ Beyond Purchasing Power Parity: A General Model of Long-Run Exchange Rates ▪ International Interest Rate Differences and the Real Exchange Rate ▪ Real Interest Parity ▪ Summary ▪ Appendix: The Fisher Effect, the Interest Rate, and the Exchange Rate Under the Flexible-Price Monetary Approach Chapter Organization
Introduction The model of long-run exchange rate behavior provides the framework that actors in asset markets use to forecast future exchange rates a Predictions about long-run movements in exchange rates are important even in the short run a In the long run, national price levels play a key role in determining both interest rates and the relative prices at which countries' products are traded The theory of purchasing power parity(PPP) explains movements in the exchange rate between two countries' currencies by changes in the countries' price evels Copyright C 2003 Pearson Education, Inc Slide 15-4
Copyright © 2003 Pearson Education, Inc. Slide 15-4 Introduction ▪ The model of long-run exchange rate behavior provides the framework that actors in asset markets use to forecast future exchange rates. ▪ Predictions about long-run movements in exchange rates are important even in the short run. ▪ In the long run, national price levels play a key role in determining both interest rates and the relative prices at which countries’ products are traded. • The theory of purchasing power parity (PPP) explains movements in the exchange rate between two countries’ currencies by changes in the countries’ price levels
The law of one price Law of one price Identical goods sold in different countries must sell for the same price when their prices are expressed in terms of the same currency This law applies only in competitive markets free of transport costs and official barriers to trade Example: If the dollar/pound exchange rate is $1.50 per pound a sweater that sells for $45 in New York must sell for 530 in London Copyright C 2003 Pearson Education, Inc Slide 15-5
Copyright © 2003 Pearson Education, Inc. Slide 15-5 The Law of One Price ▪ Law of one price • Identical goods sold in different countries must sell for the same price when their prices are expressed in terms of the same currency. – This law applies only in competitive markets free of transport costs and official barriers to trade. – Example: If the dollar/pound exchange rate is $1.50 per pound, a sweater that sells for $45 in New York must sell for £30 in London