Which is true about the asset market approach?

Question

BlackTom AI · Accepted Answer

The asset market approach treats the exchange rate as the relative price of domestic versus foreign financial assets, so exchange-rate movements reflect shifts in supply and demand for those assets driven by expected returns, interest-rate differentials, risk, and capital flows.

1) Relevant knowledge points and concepts
- Exchange rates are determined in asset markets by investors choosing between domestic and foreign assets.  
- Key determinants: expected future exchange rates, domestic and foreign nominal/real interest rates, risk premia, and capital mobility.  
- Uncovered interest parity (UIP) and models like Dornbusch’s overshooting result from this view: asset prices adjust quickly, goods prices adjust slowly.

2) Step-by-step reasoning
- If domestic interest rates rise relative to foreign rates, domestic assets offer higher expected returns.  
- Investors increase demand for domestic assets, which requires buying domestic currency, causing immediate currency appreciation.  
- Conversely, a fall in expected domestic returns or rise in perceived risk leads to capital outflows and depreciation.  
- Because asset prices and capital flows adjust rapidly, these mechanisms produce prompt appreciations or depreciations (short-run movements). Over time, goods-market fundamentals and price adjustments can move the exchange rate toward a different long-run equilibrium.

3) Calculations / intermediate steps
- No arithmetic needed; conceptually: if r_dom > r_for and UIP holds, expected depreciation adjusts so that (1 + r_dom) ≈ (1 + r_for) × expected exchange-rate change. A sudden increase in r_dom raises demand for domestic assets → immediate appreciation until expectations or rates change.

4) Why the correct answer is correct
- The approach explicitly models quick asset reallocation and expectation-driven price changes, so it naturally explains short-run appreciations and depreciations.

5) Why other possible statements would be incorrect
- Claims that it primarily explains long-run PPP-driven rates are incorrect: PPP is a goods-market long-run concept, not the asset-market short-run mechanism. Saying it ignores expectations or capital flows is also wrong, since those are central to the approach.

Conclusion: Therefore, the asset market approach explains appreciations and depreciations in the short run, matching the provided correct answer.

Which is true about the asset market approach?单项选择题

类似问题