Page 42 - FINAL CFA I SLIDES JUNE 2019 DAY 6
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Session Unit 5:
20. Currency Exchange Rates
LOS 20.j: Explain the effects of exchange rates on
countries’ international trade and capital flows.
Absorption Approach, p. 167
The elasticities approach only considers the microeconomic relationship between exchange
rates and trade (X/M) balances , and ignores capital flows. Absorption Approach states:
Y relative E must increase (domestic
absorption must fall) for the BOT to improve in
response to a currency depreciation.
A trade deficit (X – M < 0) must be absorbed by
excess of I over S or excess of G over T
For the BOT to improve, S > I (and I is a component of E).
