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review_econ116 - Macro 116(b) Final Review Capital account...

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Unformatted text preview: Macro 116(b) Final Review Capital account + current account = 0 - can't have capital account surplus without current deficit - includes exports (-), imports (+), transfer from US abroad (-), abroad in (+) - (-) current account says net wealth going down capital account: foreign citizen buys in US (+), US buys abroad (-).. stock, bond, currency cancel out because foreign country buys the US money to pay real current account = EX IM nominal current account = PX EX PM IM capital account = - (EX + IM) *just capital account, US buys Russian securities, own more foreign assets (-) US capital but had to give bank money for that currency so (+) in US capital account IM = mY m = marginal propensity to import.. this only holds in simple world in complex depends on same as C *add imports causes multiplier to go down.. not as high as when it was closed economy.. some money that would add to multiplier spent on imports - imports depend on relative prices.. foreign relatively higher then import less, if ours are relatively higher then we substitute away from domestic and buy foreign Price/Trade Feedback Trade FBE: EX(us) = IM(f) EX(us) up, Y(us) up, IM(us) up, EX(f) up, Y(f) up, IM(f) up, EX(us) up multiplier lower than before, BUT higher than when EX are totally exogenous to model closed economy > trade fbe > exports exogenous Price FBE: fixed exchange rates, inflation is exportable inflation in one results in inflation in other P(f) up, PEX(f) up, PIM(us) up, {shift back AS curve}, P(us) up, PEX(us) up, PIM(f) up P(f) up again... step of P(us) up is where inflation is exportable Supply/Demand in Foreign Exchange Markets *Demand slopes down b/c when e drops, $ depreciates, US goods cheaper for rest of world, people want to buy US goods, demand for US dollars to buy US goods, as exchange rate down, demand out *supply curve up b/c when e appreciates, $ stronger, goods foreign cheaper, take $ to foreign markets to get goods, supply $ to market our supply $ is = demand foreign if look from foreigner's perspective then the curves are shifted.. demand $, supply pound Flexible Exchange Rates Purchasing power parity: P* = eP (* = foreign) Relative price of basket of goods btw two countries should be the same, e adjusts -if basket does not adjust then there is arbitrage opportunity -inflation in foreign country causes their currency to depreciate -if P is fixed, P* up, then e must change, foreign gets weaker = depreciates relative interest rates: r* < r(US) then the $ appreciates, e up -if our interest rates are high compared to abroad, people want to invest in US -must go to foreign exchange market and demand more $ (D goes up), appreciate *depreciation is inflationary and expansionary expansionary (Y goes up): e(us) down, EX(us) up, Y(us) up IM(us) down/C(dom) up, Y(us) up inflationary (P goes up): AD curve shifts out e(us) down, PIM(us) up {AS back}, assume AD shift > AS J curve: explains current account Nominal current account = PX EX PM IM Can we get rid of current account deficit w/ exchange rates when e down, PIM up, BUT at first can't cut back so current account deficit gets worse at first, eventually IM will go down PM up and IM down will cancel out, EX up b/c exchange rate went down PX EX (+) and PM IM (0), takes so long to happen--not worth it (8 quarters) Monetary/Fiscal Policy in floating exchange rate regime, monetary is VERY effective, fiscal is not (changing Y) monetary policy involves change interest rate o expansionary, r down so r(us) , r(f), people don't want to invest in US, so demand fewer $, e down, currency depreciates (expansionary) o also, if r down, then I and C will increase, both also Y up downside is that P will go up, alright in recession if not worried about P if inflation is problem, can do contractionary policy, I/C down fiscal not effective b/c leakages o G up, Y up, M(d) up, r up, then have opposite of before, I/C down, e appreciate, and Y will go down (crowding out effect) in fixed exchange rate regime, exact OPPOSITE, monetary not effective, fiscal is r(us) = r(f), must be same.. if not there will be pressure to appreciate/depreciate o gov't must get involved thru open market operations.. Fed can play golf o with fixed exchange rate regime, can set an exchange rate (sometimes artificially high), people demand less than supply = excess $, gov't must buy $ out of market by digging into their reserves.. draw down on reserves to maintain e rate - - Exports/Imports depend on Y Y: EX and IM Y up, IM up = mY Y up, EX down (not always, but could be) G up, Y up {AD curve out}, P up, PEX up (relatively more expensive) P/P*.. prices in rest of world high, then imports down (buy domestic), price(us) directly related to imports but negatively related to exports Twin Deficits budget deficit and current account deficit (have now).. worry about it in long term do large budget deficits cause current account deficits and vice versa? NO o however, can be caused by the same things CA = EX - IM G up, Y up, IM up, CA up D=GT G up, D up increase in government spending can cause larger deficit and current account deficit Does current account deficit cause currency to depreciate? Unknown, may put on pressure but doesn't mean it will definitely depreciate. (S/D graph) - IM > EX, have to supply $ to market to get currency.. supply curve shifted down which causes depreciation pressure - Current account deficit means capital account surplus & Macho Effect mean people will want to invest in the US o To invest in the US, need $ so the demand curve for $ shifts out..offsets Forward Markets make contract today to buy/sell currency at a fixed exchange rate 3 months from now big importer, worried exchange rates may change so want to fix rate o F = forward rate: F / e = (1 + r*) / (1 + r) r* = 10%, r = 5%, e = 1, F = 1, then huge arbitrage opportunity, so F cannot be equal to 1 so there is not an arbitrage opportunity Monetarism: VM = PY (or nominal GDP) - assume velocity of money constant, any change in M will affect nominal GDP, not real GDP - any change in the M directly affects prices.. purely inflationary Neo-Classicists: Keynesian assumptions are too simple.. people don't act backwards thinking - people act under rational expectations, know true model and usually correct in predicting o only unpredictable, random events keep out of equilibrium - anticipated change in monetary policy has no affect on output, people worked into expected - Y = Y + f(P Pe) .. expected prices same as real prices.. output = long run output Supply-Side: people focus on AD too much, should focus on AS - should decrease taxes, people work more, total tax revenue will not go down Economic Growth: - can happen in two ways o more resources, learn how to use them more efficiently better technology, better management Y = A f(K,L) Solow Growth Model: - higher savings rate does NOT lead to a higher growth rate in the long run - higher savings could lead to higher output but not growth o only capital can affect the growth rate, economy reaches equilibrium where the growth rate and capital = 0 o save more, have more capital, BUT doesn't mean growth rate of capital went up society should maximize consumption per worker.. to do this: o chose savings rate so that savings function crosses depreciation curve where slope of output function is = slope depreciation function o maximum distance is where slopes are = (golden rule) Reduced Form Equation: Exogenous variable G = Go Endogenous C = bY Bond Prices: = I / (1 + r) .. if r goes up then price bond goes down Stock Prices: = dividend / (1 + r) .. dividend and interest rate can affect stock prices Discount Rate: = 1 / (1 + r) power is year(s) Future interest rates depend on.. 1 / (1 + R) = (1 + r)(1 + re2)(1 + re3) long term interest rate = sum of short term interest rates long term interest rate depends on today's interest rate & expected interest rate ...
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This note was uploaded on 12/02/2007 for the course ECON 116 taught by Professor Rayfair during the Spring '07 term at Yale.

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