International Economics
particular proportion of wealth. The sum
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Dominick-Salvatore-International-Economics
particular proportion of wealth. The sum a + b + c = 1. That is, the total wealth of the nation (W) equals M + D + RF (Equation (15A-12)). Specifically, the foregoing model postulates that M, D , and RF are fixed proportions of W . In addition, M is inversely related to i and i ∗ . D is directly related to i and inversely related to i ∗ . RF is inversely related to i and directly related to i ∗ . An increase in i raises D but reduces M and RF . An increase in i ∗ raises RF but reduces M and D . Through savings, W increases over time, and an increase in W increases M, D , and F . According to the portfolio balance approach, equilibrium in each financial market occurs only when the quantity demanded of each financial asset equals its supply. Assuming that each financial market is in equilibrium to begin with and solving for RF in Equation (15A-12), we get RF = W − M − D (15A-13) Substituting Equation (15A-9) for M and Equation (15A-10) into Equation (15A-13), we get RF = W − a(i, i ∗ )W − b(i, i ∗ )W RF = (1 − a − b)W (15A-14) Equation (15A-14) can be rewritten as RF = (1 − a − b)W − f (i, i ∗ )W (15A-15) Thus, R = f (i, i ∗ )W /F (15A-16) From Equation (15A-16) we can postulate that the exchange rate is directly related to i ∗ and W and inversely related to i and F . That is, an increase in wealth resulting from an increase in savings increases the demand for all three financial assets, but as the nation exchanges the domestic currency for the foreign currency to purchase more of the foreign bond, the exchange rate will rise (i.e., the domestic currency will depreciate). Similarly, when the interest rate rises abroad, domestic residents purchase more of the foreign bond and R rises. On the other hand, an increase in the supply of F will lower its price and reduce the wealth of domestic residents. When this occurs, they will reduce their holdings of all financial assets, including the foreign bond. But as foreign bonds (which are denominated in Salvatore c15.tex V2 - 10/18/2012 12:45 A.M. Page 500 500 Exchange Rate Determination the foreign currency) are sold and the foreign currency exchanged for the domestic currency on the exchange market, the exchange rate falls (i.e., the domestic currency appreciates). The same is true if the domestic interest rate rises. Download 7.1 Mb. Do'stlaringiz bilan baham: |
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