Foreign exchange - unit 7

Unit 7 

Mechanics of Foreign Exchange

• The buying and selling of currency
• Any transactions that occurs in the Balance of Payments necessitates foreign exchanges
• The exchange rate is determined in the foreign currency market

Changes in Exchange Rates

• Exchange rates (e) are a function of the supply and demand for currency
• An increase in supply of a currency will decrease exchange rate of currency
• A decrease in supply of currency will increase exchange rate of a currency
• An increase in demand for a currency will increase the exchange rate of a currency
• A decrease in demand for a currency will decrease the exchange rate of a currency

Appreciation and Depreciation

• Appreciation of a currency occurs when the exchange rate of that currency increases
• Depreciation of a currency occurs when the exchange rate of that currency decreases

Exchange Rate Determinants

• Consumer Tastes
• Relative Income
• Relative Price Level
• Speculation

Exports & Imports

• Exchange rate is a determinant of both exports and imports
• Appreciation of the dollar causes American goods to be relatively more expensive and foreign goods to be relatively cheaper thus reducing exports and increasing imports
• Depreciation of the dollar causes American goods to be relatively cheaper and foreign goods to be relatively more expensive thus increasing exports and reducing imports

Floating/Flexible Rates

• Based upon supply and demand of that currency vs other currencies
• Very sensitive to business cycle and provides options for investments

Fixed Rate

• Based on a country's willingness to distribute currency and to control the amount 

absolute advantage- Unit 7

Unit 7

• Absolute Advantage:

 -Individual- exists when a person can produce more of a certain good/ service than       someone else in the same amount of time (or can produce a good using the least   amount of resources.)

·         National-exists when a country can produce more o a good/ service than another county can in the same time period.

• Comparative Advantage:

-A person or a nation has a comparative advantage in the production of a product when it can produce the product at a lower domestic opportunity cost than can a trading partner.

                                       

• Specialization and Trade:

-Gains from trade are based on comparative advantage, not absolute advantage.

• Examples of Output Problem:

- per acre 

-miles per gallon

-word per minute

-apple per tree

-television produced per hour

• Examples of Input Problems:

-number of hours to do a job

-number of acres to feed a horse

-number of gallon of paint to paint a house

Balance of payments - unit7

Unit 7 - Balance of Payments

• Balance of Payment
• Measure of money inflows and outflows between the united States and the Rest of the World (ROW).
• Inflows are referred to as CREDITS.
• Outflows are referred to as DEBITS.
• The Balance Payments is divided into 3 accounts
• Current Account
• Capital/Financial Account
• Official Reserves Account
• Current Account
• Balance of Trade or Net Exports
• Exports of Goods/Services - Imports of Goods/Services
• Exports create a credit to the balance of payments
• Imports create a debit to the balance of payments
• Net Foreign Income
• Income earned by U.S. owned foreign assets - Income paid to foreign held U.S. assets
• Ex. Interest Payments on U.S. owned Brazilian bonds - Interest payments on German owned U.S. Treasury bonds
• Net Transfers (tend to be unilateral)
• Foreign Aid ---> a debit to the current account
• Ex. Mexican migrant workers send money to family in Mexico
• Capital/Financial Account
• The balance of capital ownership
• Includes the purchase of both real and financial assets
• Direct investment by U.S. firms/individuals in a foreign country are debits to the capital account
• Purchase of foreign financial assets represents a debit to the capital account
• Purchase of domestic financial assets by foreigners represents a credit to the capital account
• Relationship between Current and Capital Account
• The Current Account and Capital Account should zero each other out
• Only if the Current Account has a negative balance (deficit), then the Capital Account should then have a positive balance (surplus)
• Official Reserves
• The foreign currency holdings of the United States Federal Reserve System
• When there is a balance of payments surplus, the Fed accumulates foreign currency and debits the balance of payments
• When there is a balance of payments deficit the Fed depletes its reserves of foreign currency and credits the balance of payments
• Where there's a balance of payments the Fed depletes
• Active v. Passive Official Reserves
• The United States is passive in its use of official reserves. It does not seek to manipulate the dollar exchange rate

 Formulas

• Balance of Trade: (Goods Exports + Goods Imports)
• Balance on goods and services: (Goods Exports + Service Exports + Goods Imports + Service Imports)
• Current Account: (Balance on goods and services + Net Investment + Net Transfers)
• Capital Account: (Foreign Purchases + Domestic Purchases)

Economic Growth and Productivity - Unit 6

Economic Growth and Productivity

• Economic Growth Defined
• Sustained increase in Real GDP over time.
• Sustained increase in Real GDP per Capita over time.
• Why Grow?
• Growth leads to greater prosperity for society.
• Lessens the burden of scarcity.
• Increases the general level of well-being.
• Conditions for Growth
• Rule of Law
• Sound Legal and Economic Institutions
• Economic Freedom
• Respect for Private Property
• Political & Economic Stability
• Low Inflationary Expectations
• Willingness to sacrifice current consumption in order to grow
• Saving
• Trade
• Physical Capital
• Tools, machinery, factories, infrastructure
• Physical Capital is the product of investment
• Investment is sensitive to interest rates and expected rates of return.
• It takes capital to make capital.
• Capital must be maintained.
• Technology & Productivity
• Research and development, innovation and invention yield increases in available technology.
• More technology in the hands of workers increases productivity.
• Productivity is output per worker.
• More Productivity = Economic Growth
• Human Capital
• People are a country's most important resource. Therefore human capital must be developed.
• Education
• Economic Freedom
• The right to acquire private property
• Incentives
• Clean Water
• Stable Food Supply
• Access to technology
• Hindrances to Growth
• Economic and Political Instability
• High inflationary expectations
• Absence of the rule of law
• Diminished Private Property Rights
• Negative Incentives
• The welfare state
• Lack of Savings
• Excess current consumption
• Failure to maintain existing capital
• Crowding Out of Investment
• Government deficits and debt increasing long term interest rates
• Increased income inequality ---> Populist policies
• Restriction on Free International Trade

unit 5 Supply-side economics

Supplyside Economics

• change in AS, not in AD, which determines the level of inflation, unemployment rate and economic growth
• supplyside economists support policies that promote GDP growth by arguing that higher marginal tax rates along with the current system of transfer payments such as unemployment compensation or welfare programs, provide disincentives to work, invest, innovate, and undertake entrepreneurial ventures
• lower marginal tax rates induce more work and AS increases; they also make leisure more expensive and work more attractive

Incentives to Save & Invest

1. High marginal tax rates reduce rewards for savings and investment
2. Consumption might increase, but investments depend on savings
3. Lower marginal tax rates encourage saving and investment

Laffer Curve

• Depicts the relationship between tax rates and government revenues
• As tax rates increase from 0, government revenue increases from 0 to some max level, and then decline
• 3 Criticisms of Laffer Curve

1. Research suggests that the impact of tax rates on incentives to work, save, and to invest are small.
2. Tax cuts increase demand which can fuel inflation and demand may exceed supply.
3. Where the economy is actually located on the curve is difficult to determine.

Lrpc Unot 5

Long Run Phillips Curve

• Because the LRPC exists at the natural rate of unemployment (Un), structural changes in the economy that affect Un also cause LRPC to shift
• Increases in Un will shift LRPC --->
• Decreases in Un will shifts LRPC <---

• No tradeoff between inflation and unemployment
• Always vertical at natural rate of unemployment
• Will only shift if LRAS shifts
• Major LRPC assumption is that more worker benefits create higher natural rates, and fewer benefits creates lower natural rates

Short Run Phillips Run

• Short-Run AS SHIFTERS
• Supply Shocks are rapid and significant increases in resource cost, cause SRAS curve to shift
• Outcome: SRAS will decrease <---, SRPC will increase --->
• Misery Index: combination of inflation and unemployment in any given year
• *single digit misery is good*

Inflation: rise in price level

Deflation: general decline in price level

Disinflation: decrease in rate of inflation over time

Stagflation: where inflation and unemployment increase at same time

Extending -Unit 5

Unit 5 

Short Run Aggregate Supply

• Period in which wages (and other input prices) remain fixed as price level increases or decreases.

Effects over Short-Run

• In short run, price level changes allow for companies to exceed normal outputs and hire more workers because profits are increasing while wages remain constant.
   
• In the long run, wages will adjust to price level and previous output levels will adjust accordingly.

Equilibrium in Extended Model 

• Long AS curve is vertical at FULL EMPLOYMENT

Demand Pull Inflation in AS Model

• Demand Pull: prices increase based on increase in aggregate demand. AD --->
• In the short run, demand pull will drive up prices, and increase production.
• In the long run, increases in AD return to previous levels.

Cost Push

• Cost push arises from factors that increases per unit costs such as increase in price of a key resource
• Short run shifts left 

Dilemma for the Government

• In an effort to fight cost push, the government can react in two different ways
• Actions such as spending by the government could begin an inflationary spiral
• No action however could lead to recession by keeping production and employment levels declining

Monetary Policy

Monetary Policy

3 Tools of Monetary Policy

1. Reserve Requirement 

•     - Only small % of deposit is in the safe. The rest is loaned out. Fractional Reserve Banking
•     - RR is % deposits that must not be loaned out
•     - If fed increases money supply it increases money held in bank deposits 
• - During recession, fed decreases RR to increase money supply, decrease interest, increasing AD
• - During inflation, fed increases RR, decreasing money supply, increasing interest, and decreasing AD
• . Discount Rate
• - interest rate Fed charges commercial banks
• - To increase money supply, decrease discount rate (easy money)
• - To decrease money supply, fed increases discount rate (tight money)
• . Open Market Operations (OMO)
• - Fed buys and sells bonds
• - Most widely used monetary policy
• - To increase money supply, Fed buys securities (bonds)
• - To decrease money supply, Fed sells bonds

Expansionary (recession) v. Contractionary (inflation) Policy

Expansionary 

- Buy Bonds (omo)

- Decrease Discount Rate

- Decrease RR

- MS Increase

- AD increase

- GDP increase

- interest decrease

- Loans increase

Contractionary

- Sell bonds

- Increase discount rate

- RR increase

- MS decreases 

- AD decrease

- GDP decrease

- Interest increase

- Loans decrease

Federal Fund Rate - FDIC member banks make overnight loans to other 

banks

Prime Rate - interest rate banks charge to most credit worthy customers

FED

FED

The Fed

1. control money supply
2. issue paper currency
3. set reserve requirements and hold reserves of banks
4. lend money to banks & charge them interests
5. acts as personal bank for government
6. supervises member banks

Reserve Requirement
- The FED requires banks to always have some money readily available to meet consumers' demand for cash
- The amount set by the FED is required reserve ratio
- The RRR is the % of demand deposits (checking account balances) that must not be loaned out
- typical RRR = 10%

 Types of Multiple Deposit Expansion Question

1. Type 1 - Calculate initial change in excess reserves, aka amount a single bank can loan from initial deposit
2. Type 2 - Calculate change in loans in banking system
3. Type 3 - Calculate change in money supply

Type 2 & 3 may have same results ( no FED involvement)

Bank Liabilities

• Demand Deposits (DD) are cash deposits from the public
• Owner's Equity or Stock Shares are values of bank stocks as held by the public

Bank Assets

• Required Reserve (RR), the percentage of DD required to be stored in the Vault
• Excess Reserves (ER), the remaining % of DD after RR, that is used for loans
• Property, or bank property value statement

Fed Bonds can move in two ways:

1. The Fed sells them to banks and increases amount
2. The Fed buys them from banks and decreases amount