In response to Bill's question about international finance, I wrote: >>I think the problem here is there's a confusion of the supplies of money and loanable funds, which help to determine the interest rate, and the supply of currency, which helps to determine the exchange rate. << Bill writes: >What is the difference between the supplies (?) of money and loanable funds? Are there supplies of money which are not loanable? Aside from cash under the mattress, what money is not loanable? If an importer uses her bank account (presumably, pace Post Keynesians, debt, not currency) for the transaction, there is no currency involved.< Loanable funds these days include _more_ than money. Nowadays, treasury bills and the like are also lent. To deal with this, redefine "money" as including such liquid assets. But that misses the point of my comment: it's important to separate the supply and demand for _money_ and the supply and demand for _foreign exchange_. The immediate impact of the former is the determination of the interest rate, while the immediate impact of the latter is determination of the exchange rate. In Keynesian liquidity preference theory (which I see as not contradicting an approprately interpreted loanable-funds theory), people and nonfinancial corporations want to hold a certain amount of money. This amount might be a mix of cash, different kinds of bank-account money, T-bills, etc. An increase the amount of "liquidity preference" (say, due to a fall in confidence in the future or a rise in fear that interest rates will rise, causing capital losses on T-bills) would imply a partial shift away from less-liquid money (like T-bills) to more-liquid money (cash). This encourages higher interest rates. The money holdings that people and nonfinancial corporations want might also involve a mix of U.S. dollars, Yen, British Pounds, etc. (or dollar-denominated bonds, Yen-denominated bonds, etc.) As people and nonfinancial corporations shift their portfolios between different kinds of currency or bonds, it affects exchange rates. >>But I would restate the story as follows: >>* the Bank of Japan reduces the supply of money (perhaps via an open-market >>purchase of Japanese treasury bonds, though I don't know how they do >>monetary policy), driving up the interest rate on Yen-denominated assets. > >Why would they do this? What if they did not? I don't know why they would do this. I just was trying to restate your scenario in a way that made sense to me. >What I really would like to know is, How do Japanese importers >actually pay for their imports? If they import a ship full of wool >sweaters from England, do they essentially write a check? That is, do >they go to their bank and say "We need a cashier's check for 1 million >Pounds", at which point the bank pulls out from the importer's account >and exchanges the necessary amount of Yen in the forex market for this >amount of Pounds, then handing over this (check, cash?) to the >importer. If the forex market is "linked", along with the importer's >bank account, into the money market, then there would be no net change >in the amount of Yen in Japan (the debit in the importer's bank >account would be matched by an equivalent credit in the account(s) of >the person(s) who gave up Pounds in the Forex market). What happens is that Japanese pay Y to buy Pounds, using cash or check. The British get some Yen (or claims on Yen). The Pounds are then paid to British sweater manufacturers. The Japanese lose Yen (or now suffer from greater foreign claims on their Yen) but gain sweaters. If the amount of Yen doesn't not change (a vertical supply curve), and the demand for Yen falls (shift in demand), the exchange rate falls. (The number of Pounds needed to buy a Y falls.) Jim Devine [EMAIL PROTECTED] & http://clawww.lmu.edu/Departments/ECON/jdevine.html
