International Finance Essay Example | Topics and Well Written Essays - 1500 words - 7

International Finance - Essay Example There are various assumptions that are held regarding this model. The first one is that all prices, wages included are flexible both increasing and decreasing to restore the equilibrium after the observed shocks. The other assumption is that economical agents are rational and that exchange rate is regarded as an asset price, which is seen as a means of holding the wealth (Ghatak & SaÃŒ nchez-Fung 2007). There is also an assumption that there is a perfect sustainability of foreign and domestic goods, PPP holds continuously, capital is perfectly mobile and that money supply is exogenous with an instant clearing. The assumption that PPP holds continuously can be represented as follows: St=Pt-PtFor UIP, given the sustainability of the bonds and the mobility of capital: ∆Set+1=it-it. For the domestic residents wealth constraint: Wt=Mt+ Bt+Bt .Here Wt is nominal wealth, Mt= holding of domestic money, while Bt=holding of the domestic bond. This allows the IUP to hold. Attention is often focused on the money market where bonds have no independent role in the determination of the exchange rate (Evans 2011). This could be indicated by considering the domestic and foreign money demand: Thus, if the national income goes up, there is more demand for an individual to hold money in ones hands as one wants to spend. Moreover, if interests go up there is more incentive to save rather than hold the money (Parvin 2009). This leads into a less to hold making an individual to hold less in the long run. If the prices go up, it costs more to purchase given goods and services making an individual more content in holding money more. This makes an individual to hold more of this money (increase in pt while the mtt also increase). Considering that money supply is in this extent exogenous with instant clearing where money market is always equilibrated: then, mtD =mts≠¡mt, and mtD =Mts≠¡mt..From the equations, mt is the