What is an exchange rate?
The price of one currency in terms of another.
What is a forward exchange rate?
The exchange rate agreed upon today for future exchange.
What is a spot exchange rate?
The exchange rate for immediate (two-day) delivery.
What is the nominal exchange rate?
The price of one currency in terms of another.
Why is the real exchange rate important?
It measures international competitiveness.
What is the real exchange rate?
The price of domestic goods relative to foreign goods.
What is appreciation?
An increase in the value of a currency.
What happens to imports when a currency appreciates?
Imports become cheaper.
How is the exchange rate viewed in the short run?
As the price of domestic assets relative to foreign assets.
What happens to exports when a currency appreciates?
Exports become more expensive.
What does PPP imply about the real exchange rate in the long run?
It equals 1.
What does PPP state?
Identical goods should cost the same in all countries in a common currency.
Does PPP hold in the short run?
No.
How do higher domestic prices affect the currency?
Cause depreciation.
How do higher trade barriers affect the currency?
Cause appreciation.
How does higher productivity affect the currency?
Leads to appreciation.
Why is the supply of domestic assets vertical?
It is fixed in the short run.
What happens when domestic interest rates rise?
Currency appreciates.
What happens when foreign interest rates rise?
Domestic currency depreciates.
How does expected inflation affect the currency?
Causes depreciation.
What is autonomous consumption?
Consumption independent of income.
What are the four components of aggregate demand?
C, I, G, NX.
Why does investment fall when interest rates rise?
Borrowing becomes more expensive.
What are financial frictions?
Factors that raise the effective cost of borrowing.
