Teaching Foreign Exchange Markets: When Quantities Matter

Abstract

In a world dominated by large economies with flexible exchange rates andpredictable market forces, quantities of currencies bought and sold would warrant verylittle attention. Models illustrating and explaining foreign exchange markets would focusalmost exclusively on prices, i.e. exchange rates, and not quantities. In our paper we arguethe world economy described above does not exist and therefore quantities do matter.Furthermore, we argue that the number of countries which have pursued an export-ledgrowth policy since WWII, and the number that might do so in the future, necessitates aforeign exchange model that allows students to focus more easily on the role thatquantities play in understanding fixed exchange rates, sovereign wealth funds,undervalued (overvalued) currencies, etc. In our paper we provide a model whichemphasizes quantities of currencies not just exchange rates. Using our model students canmore easily understand why, for example, an export-led growth policy and a sovereignwealth fund are two sides of the same coin (A22, F31).