TCQT3 factor influence exchange rate

III Factors Affecting Exchange Rate Contents Factor Affecting exchange rate Exchange rate and international competitiveness Nominal exchange rate (NER) and real exchange rate (RER) Nominal effective exchange rate (NEER) and real effective exchange rate (REER) Conclusion TS Nguyễn Phúc Hiền - ðại học Ngoại thương Factors Affecting Exchange Rates Note: The equilibrium exchange rate will change over time as supply and demand schedules change The factors that cause currency supply and demand schedule S 20830VND/$ D TS Nguyễn Phúc Hiền - ðại học Ngoại thương Q Factors Affecting Exchange Rates e = f(IT, IC, INF, INT, INC, EXP, GC) International trade (import-export) (IT) International capital movements (short and long term) (IC) Inflation rate differential (INF) Interest rate differential (INT) Income level differential (INC) Expectations (EXP) Government controls (GC) TS Nguyễn Phúc Hiền - ðại học Ngoại thương Factors Affecting Exchange Rates International Trade (Import-Export) IMvnd ↑ → D$↑, Svnd↑ → VND↑/$ depreciation VND, appreciation $ EXvnd ↑ → Dvnd ↑, S$↑ → VND↓/$ appreciation VND, depreciation $ S S 21500VND/$ S‘ 20830VND/$ 20830VND/$ D‘ 20830VND/$ D D Q TS Nguyễn Phúc Hiền - ðại học Ngoại thương Factors Affecting Exchange Rates International capital movements CapEXvnd ↑ → D$↑, Svnd ↑ → VND↑/$ depreciation VND, appreciation $ CapIMvnd ↑ → Dvnd ↑, S$↑ → VND↓/$ appreciation VND, depreciation $ S S 21500VND/$ S‘ 20830VND/$ 20830VND/$ D‘ 20830VND/$ D D Q TS Nguyễn Phúc Hiền - ðại học Ngoại thương Factors Affecting Exchange Rates Relative inflation rates Pvnd ↑ → D$↑, Svnd ↑ → VND ↑/$ depreciation VND, appreciation $ Pvnd ↓ → Dvnd ↑, S$↑ → VND ↓/$ appreciation VND, depreciation $ Relative interest rates ivnd↑ → CapIMvnd↑ → Dvnd ↑, S$↑ → VND↓/$ appreciation VND ivnd↓ → CapEXvnd↑ → D$↑, Svnd ↑ → VND↑/$ depreciation VND TS Nguyễn Phúc Hiền - ðại học Ngoại thương Factors Affecting Exchange Rates Relative income levels InCvnd ↑ → D$↑, Svnd ↑ → VND ↑/$ depreciation VND, appreciation $ InCvnd ↓ → Dvnd ↑, S$↑ → VND ↓/$ appreciation VND, depreciation $ Expections ExPvnd ↑ → Dvnd ↑, S$↑ → VND ↓/$ appreciation VND, depreciation $ ExPvnd ↓ → D$↑, Svnd ↑ → VND ↑/$ depreciation VND, appreciation $ TS Nguyễn Phúc Hiền - ðại học Ngoại thương Factors Affecting Exchange Rates • • • Government controls Impose foreign exchange barriers Impose foreign trade barriers Interventions in the foreign exchange market TS Nguyễn Phúc Hiền - ðại học Ngoại thương Exchange rate and international competitiveness Exchange rate effects on international competitiveness of and vice versa Appreciation of home currency • Domestic goods become more expensive in term of foreign currency (foreign markets) exports decrease • Foreign goods become cheaper in domestic market import increase Trade balance deteriorates Depreciation of home currency • Domestic goods become cheaper in term of foreign currency (foreign markets) exports increase • Foreign goods become more expensive in domestic market import decrease Trade balance improves TS Nguyễn Phúc Hiền - ðại học Ngoại thương 10 Nominal and Real Exchange Rates Change of the term currency T= - E1 − E0 E0 100% = E0 − E1 100% E1 T > 0, means E0 > E1 the term currency appreciate T < 0, means E0 < E1 the term currency depreciate TS Nguyễn Phúc Hiền - ðại học Ngoại thương 15 Nominal and Real Exchange Rates A depreciation or appreciation does not necessarily imply that the country become more or less competitive on international markets due to inflation differentials between two countries For such we have to look at the real exchange rate Assumed e change of rates (appreciation - e >0 or depreciation – e e international competitiveness becomes worse • ∏-∏* < e international competitiveness improves (e change of rate; ∏ home inflation rate; ∏* foreign inflation rate) TS Nguyễn Phúc Hiền - ðại học Ngoại thương 16 Nominal and Real Exchange Rates (2)Real Exchange Rate-RER Concept The real exchange rate is the nominal exchange rate adjusted for relative prices (inflation differentials) between the countries under consideration Real exchange rate (static form) P* er = E P er real exchange rate E nominal exchange rate P* foreign price level P domestic price level TS Nguyễn Phúc Hiền - ðại học Ngoại thương 17 Nominal and Real Exchange Rates Real exchange rate represents the index form The RER reflects a relative comparison of domestic against foreign price levels in term of home price Example a basket of goods and services in the U.S: 1000 USD (P*=1000), in Vietnam 20.000.000VND (P=20.000.000) • If E=20000, er = E.P*=P purchasing power parity PPP • If E=21000, er > E.P*>P one unit VND purchase less goods and services in foreign country than in Vietnam VND real undervalued • If E=19000, er < E.P*

100) ↓ relative purchasing power of home currency, real depreciation of home currency ↑ international competitiveness Real rate↓ ( 100 home currency (VND) depreciate against a basket of currencies NEER < 100 home currency (VND) appreciate against a basket of currencies NEER versus CPI Semilar calculation method, CPI for normal goods and services, NEER for special goods (foreign currency) Like NER, NEER does not take account of the effect of exchange rate changes on comptitive position In order to get a better idea of changes in a country‘s comptitive position overtime we could need compile the real effective exchange rate index TS Nguyễn Phúc Hiền - ðại học Ngoại thương 25 Nominal and Real Effective Exchange Rate (4) Real Effective Exchange Rate - REER Weighted average of bilateral rates adjusted by inflation differentials n REERi = ∑ erij wj j =1 erij real bilateral exchange rate j number of currencies, i the period TS Nguyễn Phúc Hiền - ðại học Ngoại thương 26 Nominal and Real Effective Exchange Rate Time RER Index e rij RER Index (USD/VND) (Euro/VND) (w=0,6) (w=0,2) RER Index (JPY/VND) (w=0,2) REER 100 100 100 100 105 110 110 107 115 110 115 114 120 115 115 118 TS Nguyễn Phúc Hiền - ðại học Ngoại thương 27 Source: Keith Pileam TS Nguyễn Phúc Hiền - ðại học Ngoại thương 28 Conclusion • • • • The exchange rate is affected by international trade, international capital flow, inflation, interest rate, income expection and government controls The exchange rate influences international trade competitiveness Real depreciation of home currency encourages exports and declines imports The NER, RER, NEER and REER help to understand further the exchange rate and international trade competitiveness TS Nguyễn Phúc Hiền - ðại học Ngoại thương 29 ...Contents Factor Affecting exchange rate Exchange rate and international competitiveness Nominal exchange rate (NER) and real exchange rate (RER) Nominal effective exchange rate (NEER) and... Exchange rate –NER Real Exchange rate- RER Nominal Effective Exchange rate- NEER Real Effective Exchange rate REER TS Nguyễn Phúc Hiền - ðại học Ngoại thương 12 Nominal and Real Exchange Rates (1)Nominal... of rate; ∏ home inflation rate; ∏* foreign inflation rate) TS Nguyễn Phúc Hiền - ðại học Ngoại thương 16 Nominal and Real Exchange Rates (2)Real Exchange Rate- RER Concept The real exchange rate