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1、21CHAPTER4:PARITYCONDITIONSININTERNATIONALFINANCE/CURRENCYFORECASTINGCHAPTER4PARITYCONDITIONSININTERNATIONALFINANCEANDCURRENCYFORECASTINGThischapteremphasizesthatcurrencypricesaredeterminedinthesamewaythatotherassetpricesare,bytheinteractionofsupplyanddemandcurves.Thekeyconcepthere
2、istherelationshipbetweeninflationandexchangeratechangestheinternaldevaluationofacurrency(inflation)eventuallyleadstoitsexternaldevaluation.KeyPoints1.Inflationisthelogicaloutcomeofanexpansionofthemoneysupplyinexcessofrealoutputgrowth.Asthesupplyofonecommodityincreasesrelativetosu
3、ppliesofallothercommodities,thepriceofthefirstcommoditymustdeclinerelativetothepricesofothercommodities.Inotherwords,itsvalueinexchangeorexchangeratemustdecline.Similarly,asthesupplyofmoneyincreasesrelativetothesupplyofgoodsandservices,thepriceofmoneyintermsofgoodsandservicesmustde
4、cline,i.e.,theexchangeratebetweenmoneyandgoodsdeclines.2.Theinternationalparalleltoinflationisdomesticcurrencydepreciationrelativetoforeigncurrencies.Inordertomaintainthesameexchangeratebetweenmoneyandgoodsbothdomesticallyandabroad,theforeignexchangeratemustdeclineby(approximately)
5、thedifferencebetweenthedomesticandforeignratesofinflation.Thisispurchasingpowerparity,whichisitselfbasedonthelawofoneprice.3.Althoughthenominaloractualmoneyexchangeratemayfluctuateallovertheplace,wewouldnormallyexpecttherealorinflation-adjustedexchangeratetoremainrelativelyconstant
6、overtime.Thesameistruefornominalversusrealratesofinterest.However,althoughthepredictionthatrealinterestandexchangerateswillremainconstantovertimeisareasonableoneexante,expostwefindthattheserealrateswanderallovertheplace.AswewillseeinChapter11,achangingrealexchangerateisthemostimpor
7、tantsourceofexchangeriskforcompanies.4.Fouradditionalequilibriumeconomicrelationshipstendtoholdininternationalfinancialmarkets:purchasingpowerparity,theFishereffect,internationalFishereffect,interestrateparity,andtheforwardrateasanunbiasedestimateofthefuturespotrate.5.Theseequilibr
8、iumrelationshipsareatthehe