Why is the supply curve in the foreign-currency exchange market vertical?

External question — Economics Stack Exchange Author: Jocka G Original post: https://economics.stackexchange.com/questions/41933 License: CC BY-SA 4.0 — https://creativecommons.org/licenses/by-sa/4.0/ Adaptation: HTML converted to plain text; contact email addresses removed. In the book 'Economics' by Mankiw and Taylor the demand and supply curves on the foreign-currency exchange market are shown as follows: The supply equals the Net Capital Outflow (NCO). I would have assumed that the exchange rate influences NCO in the same way it influences imports and exports, for example a higher exchange rate makes it more profitable to invest abroad than domestically, leading to an increased NCO. However, the supply isn't influenced at all by the exchange rate according to Mankiw and Taylor and that's what I don't understand.

External answer — Economics Stack Exchange Author: csilvia Original post: https://economics.stackexchange.com/a/41935 License: CC BY-SA 4.0 — https://creativecommons.org/licenses/by-sa/4.0/ Adaptation: HTML converted to plain text; contact email addresses removed. Because the supply of pounds in the model is controlled and fixed by the central bank. The central bank does not have to change (increase) the supply of pounds when the exchange rate changes. So the supply of pounds will be just a flat vertical line because no matter what the exchange rate is the supply of pounds will not respond to exchange rate as it is given by the central bank's monetary policy.

External answer — Economics Stack Exchange Author: Daniel Original post: https://economics.stackexchange.com/a/42428 License: CC BY-SA 4.0 — https://creativecommons.org/licenses/by-sa/4.0/ Adaptation: HTML converted to plain text; contact email addresses removed. The authors assume that the capital outflow is exogenous, i.e. not affected by the current exchange rate. Here's why (from a U.S. point of view): If I want to invest money in Mexico, then I want to know how much money I get back after one year. That is determined by: the rate of return in Mexico (in pesos); and how much the peso/$ rate changes. Regarding the latter, it doesn't matter what the current exchange rate is; what matters is how much it will change in the coming year. Of course, no one can predict exchange rate changes (similarly a rate of return usually can't be predicted, except for safe bonds). But those aren't relevant, because your chart simply shows that capital flows are not a function of the current exchange rate.

External answer — Economics Stack Exchange Author: Charlie Babe Original post: https://economics.stackexchange.com/a/56215 License: CC BY-SA 4.0 — https://creativecommons.org/licenses/by-sa/4.0/ Adaptation: HTML converted to plain text; contact email addresses removed. Let's assume an example of U.S. dollar in exchange for yen. I assume your rationale is that higher exchange rate would make people in the U.S. invest more in Japan because 1$ turned into more yen and thus more shares of Japanese stock. But you need to think that when you sell the Japanese stocks, you need to convert back to dollars. SO what really matter to net foreign investment is real interest rate differentials rather than real exchange rate. So Mankiw is right on this.