Upload
john-jayanth-balantrapu
View
218
Download
0
Embed Size (px)
Citation preview
8/8/2019 Currency Appreciation and Depreciation Biblography
http://slidepdf.com/reader/full/currency-appreciation-and-depreciation-biblography 1/2
Currency Appreciation and DepreciationBIBLIOGRAPHY
In economics, the terms currency appreciation and currency depreciation describe the movements of the
exchange rate induced by market fluctuations. If a country is fixing the exchange rate, official adjustmentsto the fixed exchange rate are called currency revaluation and devaluation. Currency appreciates when its
value increases with respect to the value of another currency or a basket of other currencies. Currencydepreciates when its value falls with respect to the value of another currency or a basket of other currencies.
These special terms have to be used because exchange rates can be expressed in different ways, so that
using the words rise and fall, or increase and decrease, for changes in the exchange rate can be
confusing. For example, if the exchange rate between the U.S. dollar and the euro is expressed in dollars
per euro (e.g., 1.20 dollars per euro), an increase in the exchange rate (e.g., to 1.25 dollars per euro)
means that the dollar depreciates with respect to the euro and the euro appreciates with respect to the
dollar. In other words, the dollar becomes less valuable and the euro becomes more valuable. The same
exchange rate can be expressed in euros per dollar (e.g., 0.83 euros per dollar). In this case, an increase
in the exchange rate (e.g., to 0.9 euros per dollar) means that the dollar appreciates with respect to theeuro and the euro depreciates with respect to the dollar.
In the short run, currency appreciations and depreciations are driven by changes in demand and supply
for a currency in the foreign exchange market. The demand and supply of currency depend on a
countrys imports and exports, international financial transactions, speculations on the foreign exchange
market, and, under dirty float, government interventions in the foreign exchange market. In the long run,
currency appreciations and depreciations are determined by the inflation rate and economic growth of thecountry.
Forecasting currency appreciations and depreciations turns out to be a big challenge for economic
theorists. In a 1983 paper titled Empirical Exchange Rate Models of the Seventies: Do They Fit Out of
Sample? Richard Meese and Kenneth Rogoff demonstrated that a simple statistical model of the random
walk which states that the best forecast of the exchange rate tomorrow is the exchange rate today
does a better job at forecasting the exchange rate than any of the economic models available at that time.
In addition, economic researchers have shown that the exchange rate tends to be disconnected from
the fundamentals, or the factors that usually affect the exchange rate in economic models. These findings
are known as the Meese-Rogoff puzzle and the exchange rate disconnect puzzle, respectively. In a
2005 paper,Exchange Rates and Fundamentals, Charles Engel and Kenneth West demonstrated that
given the statistical properties of the fundamentals and the discount factor of the individuals (the weight
they place on future consumption relative to todays consumption), it should be expected that exchangerate behavior is similar to a random walk.
In a 2002 paper, Order Flow and Exchange Rate Dynamics, Charles Evans and Richard Lyons took
another approach. They showed that using information on the demand and supply of foreign currency
(the order flows by the banks participating in the foreign exchange market), it is possible to forecastcurrency appreciation and depreciation in the short run better than using the random walk.
Currency appreciation and depreciation affect all the international transactions of a country because they
affect international relative prices. In international trade, currency appreciation makes a countrys exports
more expensive for the residents of other countries if exporters in that country can increase the prices at
which they sell their goods to foreign customers. If the exporters cannot increase their sale prices due to
competition, their profits fall because the cost of production, which is denominated in their domestic
currency, rises relative to their revenues, which are denominated in the foreign currency. If the profits
decline a lot, some firms will stop exporting, so that the volume of exports from a country experiencing
8/8/2019 Currency Appreciation and Depreciation Biblography
http://slidepdf.com/reader/full/currency-appreciation-and-depreciation-biblography 2/2
currency appreciation will decline. The reverse is also true: Currency depreciation will make a countrysexports more competitive, increase exporters profits, and increase the volume of countrys exports.
Similar mechanisms link currency appreciation and depreciation to a countrys imports. If a currency
appreciates, the countrys residents will find imported goods inexpensive relative to goods produced
domestically, and the volume of imports will increase. Likewise, if a currency depreciates, the countrys
residents will find that imported goods are very expensive, and they will prefer to switch to buying goodsproduced domestically, thus lowering the volume of imports. Such changes in trade pattern occur in
response to the long-run changes in the exchange rate, and they develop slowly over time becauseinternational trade contracts are written well in advance.
Currency appreciation and depreciation also affect international asset trade and the value of the holdings
of foreign assets. If a domestic currency depreciates, the value of that countrys residents foreign
currency asset holdings increases (because foreign currencies become relatively more valuable), while
the value of foreigners holdings of that countrys assets declines. These changes can be described as
capital losses and gains due to changes in the exchange rate. In the beginning of the 2000s, the U.S.
dollar experienced substantial depreciation. While the United States continued to borrow abroad, its total
debt to foreigners did not increase, because dollar depreciation meant capital gains for the U.S. residents
and capital losses for the foreigners, which offset new borrowing by U.S. residents. This effect is known in
economic literature as a valuation effect of exchange rate changes. Cªdric Tille, in his 2003 paper TheImpact of Exchange Rate Movements on U.S. Foreign Debt, calculated the exact contribution of thevaluation effect to the international financial position of the United States.
When a country accumulates a large amount of foreign currency debt, a sharp depreciation of its currency
can be very harmful. If firms revenues or assets are denominated in their own currency while their debts
or liabilities are denominated in foreign currency, the currency depreciation will lower the value of
firms assets relative to liabilities, sometimes so much that firms become bankrupt. Such an effect isknown in the economic literature as the balance sheet effect . During the financial crises of the late 1990s,
the negative balance sheet effects of currency depreciations outweighed their positive effects on
exporters profits. This experience exposed the importance of matching the currency composition of assets and liabilities.
SEE ALSO Balance of Payments; Central Banks; Currency Depreciation;Currency Devaluation and Revaluation; Dirty Float ; Exchange Rates; Greenspan, Alan; Hedging ; Macroeconomics; Money ; Mundell-Fleming Model ; Purchasing Power Parity ; Reserves, Foreign; Trade Surplus
BIBLIOGRAPHYEngel, Charles, and Kenneth D. West. 2005. Exchange Rates and Fundamentals. J ournal of Political Economy 113: 485 517.
Evans, Martin D., and Richard K. Lyons. 2002. Order Flow and Exchange Rate Dynamics. J ournal of Political Economy 110 (1): 170 180.
Meese, Richard, and Kenneth Rogoff. 1983. Empirical Exchange Rate Models of the Seventies: Do TheyFit Out of Sample? J ournal of International Economics14: 3 24.
Tille, Cªdric. 2003. The Impact of Exchange Rate Movements on U.S. Foreign Debt. Current Issues inEconomics and Finance 9 (1): 1 7.