Trade & Open Economy · advanced
What moves on the Interest Rate Parity diagram
A rise in the expected future exchange rateexchange rateThe price of one currency in terms of another. raises expected foreign returns now, moving the spot rate immediately: expected depreciationdepreciationThe wearing out of capital over time, or, for currencies, a fall in value against others. causes actual depreciation.
Expected returns on foreign deposits include the expected change in the exchange rateexchange rateThe price of one currency in terms of another..
A confidence shock: markets start believing the home currency will be weaker next year.
Holding foreign assets now promises a capital gain, so the foreign return curve shifts out.
The currency depreciates TODAY, purely because people expect it to depreciate later. ExpectationsexpectationsBeliefs about the future that shape behavior today, the hinge variable of modern macroeconomics. are self-fulfilling in currency markets.
Examiners ask this as: depreciation expectations, speculative attack, currency crisis fears, expected devaluation, confidence shock.
Other scenarios on Interest Rate Parity