Economics Exam #2 Notes_2008

Back which decreased the currency and therefore

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back, which decreased the currency and, therefore, increased interest rates, hurting its housing market and other areas. MORAL: Fixing currency can allow issues in the international government to become internalized. Thailand: overvalued the baht (Thai currency) (GRAPH 4) (price ceiling) Q S >Q D of FX, surplus of baht on world market, natural action would be for the rate to decrease, which cannot happen Thailand, BP<0, deficit (trading partners, BP>0, surplus) Thai central bank buys the surplus baht by selling foreign currency reserves (currency in circulation decreases, so does holdings of foreign currency on assets/liabilities sheet) Thai money supply decreases, the interest rate increases, discourages saving and causes a recession This situation ends when Thailand runs out of foreign currency reserves, so they need to devalue their dollar to stay with the fix, but this is not done because you still need foreign currency to support the devaluation Move to a float and let currency devalue Fix unsustainable in LR Sovereign Wealth Funds- Investment fund of the government that accumulates foreign assets and currency. Used to reinvest globally and sometimes domestically.
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Economics Lecture #16 07:12 Holy Trinity of monetary policy- A country can only have two of three:
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Economics Lecture #16 07:12 Fix exchange rate Capital mobility Monetary autonomy Mexican Peso Crisis Peso is valued too high/dollar is too cheap (government instability, lowers value of the peso) The fixed rate becomes a price floor, meaning its above the equilibrium point Q S P >Q D P , so Mexican BP<0, US BP>0 Excess supply of peso; the peso should depreciate/devaluate Mexican central bank must buy pesos to avoid this from happening, so it sells dollars (buys pesos), decreasing its assets of foreign currency and decreases its liabilities of its own currency, money supply decreases, interest rates rise, so the domestic market shrinks, this can only happen temporary because you eventually run out of foreign currency reserves, in which case Mexico must devalue or move to float (generally move to float, because with a new fix reserves still don’t exist so any issues they need to re-devalue) Floating: Market sets price, so price changes when demand/supply changes BP=CA (current account, X-M, goods/services)+KA(capital account, A dom -FA, money flow) DMD FC- generated by domestic country because country wants to buy foreign goods and assets D FX =f(M,FA) Supply FC- generated by foreigners because they want domestic country’s good and assets S FX =f(X,A dom ) Purchasing Power Parity (PPP)- Ties exchange rate movements to changes in goods and service flow (linked to CA (X-M) in BP) P dom =P foreign(*) e (P=price) P dom <P*e, people buy domestically, the price increases, while people don’t buy abroad, so price decreases, until equilibrium is eventually reached P dom /P*=e
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Economics Lecture #16 07:12 Log(P)-log(P*)=log(e) Rate of change P dom -rate of change P*=Rate of change ER Anything that changes relative prices will cause the ER to move. How does this change happen?
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