【正文】 onship Between PPP and the Law of One Price ? The law of one price applies to individual modities, while PPP applies to the general price level. ? If the law of one price holds true for every modity, PPP must hold automatically for the same reference baskets across countries. ? Proponents of the PPP theory argue that its validity does not require the law of one price to hold exactly. Purchasing Power Parity 8 ? Absolute PPP and Relative PPP ? Absolute PPP – It states that exchange rates equal relative price levels. ? Relative PPP – It states that the percentage change in the exchange rate between two currencies over any period equals the difference between the percentage changes in national price levels, namely: –E$/€ /E$/€, t –1 = ?US / ?E, where: ?t = inflation index – So that Er = E t –1 * ?US / ?E – If less 1 in both 2 sides Purchasing Power Parity 9 –(E$/€ ,t E$/€, t –1)/E$/€, t –1 = (?US, t ?E, t )/ ?E, t – If ?E, t is smaller ， Relative PPP between the United States and Europe would be: (E$/€ ,t E$/€, t –1)/E$/€, t –1 = ?US, t ?E, t (152)..\..\中國的名義和實際 .ppt 10 ? Moary approach to the exchange rate ? A theory of how exchange rates and moary factors interact in the long run. ? The Fundamental Equation of the Moary Approach ? Price levels can be expressed in terms of domestic money demand and supplies: – In the United States: PUS = MsUS/ L (R$, YUS) (153) – In Europe: PE = MsE/L (R€, YE) (154) – So that: E = PUS / PE = MsUS* L (R€, YE) / MsE *L (R$, YUS) A LongRun Exchange Rate Model Based on PPP 11 ? The moary approach makes a number of specific predictions about the longrun effects on the exchange rate of changes in: – Money supplies – An increase in the . (European) money supply causes a proportional longrun depreciation (appreciation) of the dollar against the euro， if Y is given. – Interest rates – A rise in the interest rate on dollar (euro) denominated assets causes a depreciation (appreciation) of the dollar against the euro. – Output levels – A rise in . (European) output causes an appreciation (depreciation) of the dollar against the euro, if M is given. A LongRun Exchange Rate Model Based on PPP 12 ? Ongoing Inflation, Interest Parity, and PPP ? Money supply growth at a constant rate eventually results in ongoing inflation (., continuing rise in the price level) at the same rate. – Changes in this longrun inflation rate do not affect the fullemployment output level or the longrun relative prices of goods and services. ? The interest rate is not independent of the money supply growth rate in the long run. A LongRun Exchange Rate Model Based on PPP 13 ? The international interest rate difference is the difference between expected national inflation rates: R$ R€ = ?eUS ?e (155) A LongRun Exchange Rate Model Based on PPP 14 ? The Fisher Effect ? A rise (fall) in a country’s expected inflation rate will eventually cause an equal rise (fall) in the interest rate that deposits of its currency offer. – Figure 151 illustrates an example, where at time t0 the Federal Reserve unexpectedly increases the growth rate of the . money supply to a higher level. A LongRun Exchange Rate Model Based on PPP 15 Slope = ? + ?? Slope = ? + ?? t0 MUS, t0 Slope = ? (a) . money supply, MUS Time Slope = ? Slope = ? t0 Slope = ? + ?? t0 t0 R$2 = R$1 + ?? R$1 Figure 151: LongRun Time Paths of . Economic Variables after a Permanent Increase in the Growth Rate of the . Money Supply (d) Dollar/euro exchange rate, E$/€ Time (b) Dollar interest rate, R$ Time (c) . price level, PUS Time A LongRun Exchange Rate Model Based on PPP 16 ? In this example, the dollar interest rate rises because people expect more rapid future money supply growth and dollar depreciation. ? The interest rate increase is associated with higher expected inflation and an immediate currency d