m




   
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Depreciation/ Appreciation
Devaluation/Revaluation
Supply Demand model to analyze
exchange rate changes



Suppose direct quote in Indonesia:

Rp9.000/$ ->
Which one is foreign currency?
If we buy one dollar, we pay Rp9,000.
If we sell one dollar, we receive
Where do demand and supply for dollar
come from?




Suppose we have two countries: US and
Indonesia
Demand for $ derived from demand for US
goods and US securities denominated in $
Supply for $ derived from demand for
Indonesian goods and Indonesian securities
denominated in Rp
The $ brought to convert into Rp (to buy
Indonesian goods) becomes supply for $
 m
m !"#m!$m
Rp/$

9.000

$ Quantitiy
Suppose prices in Indonesia
increase at faster rate than
that in US, what will happen
to Demand and Supply
curves?
% m   
Demand for $ will increase, because more
Indonesian people want to buy relatively
cheaper US goods. Demand curve shifts to
the right
Suppy for $ will decreae, because fewer US
people want to buy Indonesian goods. $ to
convert into Rp is getting less. Supply curve
shifts to the left
New equlibrium rate: Rp10,000/$
 "&m   
Rp/$ S¶
S
10,000

9,000

D¶

$ Quantity
 &
'(

 '
 )
Dollar appreciation/dep against Rp
= (S1 ± S0) / S0
= Rp/US$ new ± Rp/US$ old
Rp/US$ old
= (10,000 ± 9,000)/9,000 = +11.11 %

Since the sign is positive, we say:

$ appreciates against Rp by 11.11%
 &

 %

 % % ()

Appreciation/Dep Rp against $
$/Rp new - $/Rp old
$/Rp old
Or:
= 1/S1 ± 1/S0
1/S0
Work it out, we have
= S0 ± S1
S1
 &

 %

 % % ()

The formula: (S0 ± S1)/ S1

(9,000 ± 10,000) / 10,000 = -0.1 or
-10%
Since the sign is negative
(depreciation), we can say:
Rp depreciates against $ by 10%

 m

 %
Suppose US$ appreciates against Rp
by 20%, how much Rp appreciates or
depreciates against $?
Suppose euro depreciates against yen
by 15%, how much yen appreciates or
depreciates against euro?
 * % 
 m

 %
]ariables Impact
Inflation Negative
Economic Growth Positive
Real interest rate Positive
Nominal interest rate Negative
Central Bank Independence Positive
Country¶s competitiveness Positive
Loose monetary Policy Negative
Expectation Positive/
Negative
We really say the effect of one variable
on exchange rate, 6
 
In reality, all variables work
simultaneously to impact exchange rate
Difficult to disentangle the effect of one
variable on the exchange rate
  + 


Central Bank functions:

1. Maintain price stability
2. Maintain fair or low interest rate
3. Maintain exchange rate in the ideal zone

Monetary policy versus government

popular policy
"$m*m"$,"-m"$!!".
Suppose initial exchange rate is Rp8,000/$. Exchange
rate moves quickly to Rp9,000/$. Central bank wants to
move back to Rp8,000/$. How they intervene?

Rp/$
S$

9,000

8,000
D$

$ Quantitiy
"$m*m"$,"-m"$!!".
Suppose initial exchange rate is Rp9,000/$. Exchange
rate moves quickly to Rp10,000/$. Central bank wants
to move back to Rp9,000/$. How they intervene?

Rp/$
S$
10,000

9,000

D$

$ Quantity
  +  / 

=he impact tends to be short term

Long term impcat could be achieved
by changes in macro economic
fundamentals