As we know from earlier posts, economic theory approaches the issue of exchange rates by trying to find a theoretical equilibrium level, against which one can measure over- or undervaluation relative to the actual exchange rate. Such theory relies on a number of important premises with regard to the information that might affect exchange rates:
Exchange [...]
Archive of entries posted on June 2009
(In)Efficient Markets
CURRENCIES ARE DIFFERENT
The first thing to say about the currency market is that it possesses and obeys a different set of dynamics to other financial markets. Unlike in the case of equity or fixed income markets, the vast majority of currency market practitioners are speculators of one sort or another. Global merchandise trade going through the currency [...]
Productivity
Last but not least, we look at how productivity growth can affect the equilibrium real exchange rate. What is productivity? We have a vague concept of this in our work place, but it has a precise definition — output per man hour. Rising productivity growth causes increased supply of a good. Supply/demand dynamics require that [...]
Terms of Trade
Another important aspect of the external balance approach to exchange rate determination is the so-called “terms of trade”, which is the relationship between a country’s export and import prices. A country’s terms of trade can be an important determinant of its long-term equilibrium real exchange rate. We find this particularly the case for countries that [...]