Global Economics
EXCHANGE RATES: price of foreign currency compared to home currency
floating rates: consistent changes in the exchange rate over a wide range of time
fixed rates: minimal variation in exchange rates
exchange rate crisis: unexpected change in floating or fixed rates due to changes in foreign currencies
debts and deficits
current account: difference between gross national disposable income and gross national expenditure
net worth: difference between assets and liabilities; this also applies to foreign (external) worth
external wealth rises when there is a surplus, and falls when there is a deficit
capital gains or losses can effect a country's investments
country risk: "grade value" determining a country's level to pay off bonds - the lower the grade, the greater the risk
**international flow of goods, services, income & capital allow the global macro economy to operate
REGIMES: rules and norms economists follow
advanced countries: ease of integration into the world economy and has a high average level of income per person
emerging markets: gradual emergence into world economy and average level of income per person
developing countries: little to no integration into world economy and low-income level per person
dollarization: countries choose to adopt foreign currencies as their own
law of one price (LOOP): the same good sold in different countries must be the same price
arbitrage: buying low and selling high for profit
money: low rate of return, unit of account (all prices in the economy are quoted), and is very liquid
real exchange rate: equates number of goods needed to purchase a foreign good
when more "home" goods are needed to purchase foreign goods, the real exchange rate rises and the "home" has experienced real depreciation
when less "home" goods are needed to purchase foreign goods, the real exchange rate decreases and the "home" has experienced real appreciation
purchasing power parity (PPP): incorporates exchange rate for same good sold in different countries
inflation: rate of the growth of price levels
absolute PPP: when price levels in two different countries are equal when expressed in the same currency
relative PPP: depreciation rate of nominal exchange rate equals the difference between the inflation of the two countries
M0: includes both currency and reserves of commercial banks
M1: includes currency in circulation and high liquid instruments (checking accounts); does not include bank's reserves
M2: M1 + includes less liquid assets (savings accounts)
THE CENTRAL BANK CONTROLS THE COUNTRY'S MONEY SUPPLY
money demand: rise in nominal income creates a proportional increase in aggregate money demand
**in the long run, assume prices are flexible and will adjust money market into equilibrium
hyperinflation: when the rate of inflation rises by more than 50% per month
hyperinflation helps understand how currencies can become extinct if they start losing functionality and lose value quickly
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The Fisher Effect: a rise in the inflation rate leads to a proportional rise in the nominal interest rate
real interest parity: real interest rates are equal between all countries in the market when PPP & UIP hold
uncovered interest parity (UIP): link between interest rates and exchange rates
nominal anchors: policy constraints to control inflation in the long run
monetary regime: long run nominal anchoring and short run flexibility that policy makers refer to
depreciation: weakened currency value
appreciation: strengthened currency value
effective exchange rates: using "trade weights" to determine multiple levels of exchange rates
floating exchange rate regime: larger changes in a country's exchange rate, and the government does not attempt to fix it
fixed exchange rate regime: little to no movement in a country's exchange rate over a period of time
free float: lots of peaks and troughs in the exchange rate over a few months
band: tiny variations in exchange rates
foreign exchange market (FOREX): a market of corporations that buy and sell exchange rates
spot exchange rate: exchange rate for a transaction made "on the spot"
forward contract: agreement made today between two parties but delivery of currencies in the future
swap contract: spot sale of foreign currency with a repurchase date in the future
futures contract: two parties agree to provide each with their currencies at a future date
option contract: buyer can buy or sell currency for another at a specified exchange rate in a future date
capital control: restriction on cross border financial transactions
arbitrage: trading strategy that exploits profits from price differences
nominal rigidity: assumption of sticky prices
trilemma: three goals of the economy are incompatible; only pairs can be chosen
balance of payment accounts: measuring of cross-border flows in an open economy
gross national expenditure (GNE): total expense of final goods and services by home entities
gross domestic product (GDP): all goods and services produced as output minus the value of all goods and services purchased as input
gross national income (GNI): all income paid to domestic entities in a closed economy
current account (CA): tally of all international transactions of goods and services
capital account (KA): value of capital transfers from the rest of the world minus transfers to the rest of the world
in a closed economy, GNE = GDP = GNI
financial account (FA): records transactions of financial assets between residents and foreigners
BOP credit: positive CA, KA and FA values
BOP debit: negative CA, KA and FA values
external wealth (W): a country's net worth; home assets owned by the rest of the world minus the rest of the world's assets owned by the home
long-run budget constraint (LRBC): places a limit on a country's budget to see how a country can live within their means in the long tun
small open economy: a country that trades goods and services with the rest of the world but only by issuing bonds
perpetual loan: a sequence of loans for only which the principal is refinanced every year
LRBC says that in the long run expenditures (GNE) must equal its production (GDP) plus any initial wealth, and an economy must live within its means in the long run
in an open economy, LRBC is satisfied (= 0), consumption is smooth, no gains from financial globalization because only consume what it produces, thus no need to borrow or lend to achieve preferred consumption path
a closed economy can't smooth consumption
diversification: countries own the income steam from their own capital stock and from capital stocks in other countries
consumers consume more when their disposable income increases, aka the consumption function
marginal propensity to consume (MPC): slope of teh consumption function that tells us how much of every $1 of disposable income received by households is spent on consumption
basic model of economic activity: in the short run, collects taxes (T) from private households and spends amount G on government consumption of goods and services
transfer programs: social security, medical care, etc. are not included in the aggregate because they don't generate change to total expenditure of goods - they just change who gets to engage in act of spending
expenditure switching: spending patterns change in response to changes in real exchange rate
keynesian cross: depicts the goods market equilibrium, where demand equals supply
LM curve: a set of combos of output and interest rates that ensure equilibrium in the money market
stabilization policy: possibility that authorities can use changes in policies to keep the economy near its full employment level of output
the exchange rate mechanism created a fixed rate system throughout Europe and the Deutsche mark (DM) was used as the base currency for the ERM -- they were able to create their own money suuply and nominal interest rates
economic integration: growth of market linkages in goods, capital and labor markets among countries
asymmetric shock: fixed exchange rate that can lead to costs that are not shared by the other countries
fixed exchange rate systems: more commonly used in the real world that involve multiple countries to peg to a foreign base country
reserve currency system: "n" number of countries participate and the center country provides the reserve currency which is the base for all other pegged countries
cooperative arrangements: mutual agreements and compromises between center and non-center countries when establishing interest rates and fixed exchange rates
revaluation: country 1 has a higher exchange rate than country 2
devaluation: country 2 has a higher exchange rate than country 1
these terms should only be used in terms of adjusting pegs
depreciation and appreciation should only be used when describing exchange rates that float up or down
banking crisis: in a private sector, if banks and other financial institutions face adverse shocks causing them to close or declare bankruptcy
default crisis: in the public sector, if the government faces adverse shocks, it may default and be unable to pay the principal or interest on debts
twin crises crisis in pairs, or triple crisis crisis in threes, magnify the costs of any one type of crisis
domestic credit: money loaned to domestic economy used for the central bank's purchases
reserves = foreign assets
central bank balance sheet: constructed list of the bank's assets
backing ratio (R/M): indicates fraction of the money supply that is backed by reserves on the central bank balance sheet
fiscal dominance: monetary authorities have no independence - the treasury hands over bonds to the central bank, receives the same amount in cash returns and uses the cash to fund the gov't deficit
speculative attack: when investors sell all their holdings of a particular currency; when this attach occurs, the economy must IMMEDIATELY switch to the floating regime, since it has zero reserves, the money supply will always equal domestic credit which will grow at a constant rate
contingent commitment: if things are bad, the gov't will let the exchange rate float rather than put the economy through turmoil
optimum currency area (OCA): monetary union between multiple countries
as market integration rises, efficiency benefits of a common currency increase
as symmetry rises, stability costs of a common currency decrease
inflation bias: inability to resist political pressure to use expansionary monetary policy for short term gains
Marshall Plan: Americans provided monetary support to aid war-torn regions of Western Europe to rebuild economic infrastrcture u
Treaty of Rome: signed by France, West Germany, Italy, Belgium and Luxembourg to create the European Economic Community (EEC) with plans for cooperation and integration
exchange rate mechanism (ERM): fixed exchange rate regime based on bands