Federal Reserve

Federal Reserve

Topic 1

A

To explain how an exchange rate changes over time, we have to understand the factors

that shift the expected-return schedules for domestic (dollar) deposits and foreign

(euro) deposits.

As we have seen, the expected return on foreign (euro) deposits depends on the foreign interest rate iF minus the expected appreciation of the dollar . Because a change in the current exchange rate Et results in a movement along the expected-return schedule for euro deposits, factors that shift this schedule must work through the foreign interest rate iF and the expected future exchange rate . We examine the effect of changes ...