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Global Economics (Chapter 3 (Real Exchange Rate (The relative price of…
Global Economics
Chapter 3
Intro
Monetary Approach to Exchange Rates: A long run theory that combines the theory of price level determination and purchasing power theory of exchange rate determination
Law of One Price
LOOP -> without trade frictions, free competition, and price flexibility, goods sold in different places sell for the same price, just expressed in that area's home currency
Purchasing Power Parity
PPP -> macroeconomic equivalent to the microeconomic LOOP. It relates exchange rates to the comparative prices of a basket of goods
Absolute PPP: price levels across boarders are the same when expressed in their respective currencies
Real Exchange Rate
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Real Depreciation: more home goods are need in exchange for foreign goods -> real exchange rate increase
Real Appreciation: less home goods are needed in exchange for foreign goods -> exchange rate decrease
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Relative PPP, Inflation, and Exchange Rate Depreciation
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What is Money
Money: 3 key functions -> store of value, unit of account, medium of exchange
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Hyperinflations
Occurs when the inflation rate is more than 50% per month for a sustained amount of time (prices double every 51 days)
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Real Interest Parity
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Real Interest Parity: if PPP and UIP remain constant, r is in equilibrium across boarders
World Real Interest Rate: refers to all countries connected in the global capital market -> they all share a common expected real interest rate
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Chapter 2
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Private Actors
Commercial Banks: trade for themselves for profit and serve clients who import/export goods & services
Interbank Trading: global network that where financial institutions trade currencies among themselves
Corporations in FX Market: use the market if they have large transactions to buy and sell in foreign markets
Nonbank Financial Institutions: invest so much in foreign markets its justifiable to set up their own FX trading operations, ex-> mutual companies or asset managers
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Chapter 7
Consumption
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Marginal Propensity to Consume: the slope of consumption function -> explains how for every $1 of disposable income we get is spent on consumption
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Investment
Expected Real Interest Rate: a firm's borrowing cost -> nominal interest rate - expected rate of inflation
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The Government
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Transfer Programs: excluded from government consumption b/c they don't produce a change in total spending on goods and services, just a change in who gets to interact in the spending
The Trade Balance
Expenditure Switching: a factor in determining the balance of a country's exports and imports -> spending patterns change b/c of real exchange rate change -> foreign purchases turn into domestic
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Supply and Demand
Goods Market Equilibrium Condition: demand has to = supply -> Y = C (T-Y) + I (i) + G + TB(EP / P, Y-T, Y-T)
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Chapter 9
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Central Balance Sheet
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Reserves: foreign currency bought and help by the central bank for the BOP and influence foreign exchange of its currency
Central Bank Balance Sheet: understanding the assets and liabilities helps monetary authorities understand what policies need to be made to promote a healthy economy
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Conclusions
Corners Hypothesis: In a trilema diagram, countries would prefer being in the corners than in the middle
Chapter 4
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Risky Arbitrage
Fundamental Equation of the Asset Approach to Exchange Rates: the equation for UIP -> dollar rate of return on dollar deposits = expected dollar rate of rerun on euro deposits
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The Trilemma
Not all desirable policy goals can be done at the same time, there are trade-offs
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Chapter 6
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Precautionary Saving, Reserves, and Sovereign Wealth Funds
Precautionary Saving: a buffer of external assets that governments use when credit line risk is too high
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Sovereign Wealth Funds: government run asset management companies that invest government savings/central bank reserves internationally
Generalizing
Marginal Product of Capital: (MPK) = change in output per worker (Δq) / change in capital per worker (Δk)
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a Versus k
Divergence: productivity differences don't allow investment to cause poor countries to reach the same level of capital and output per worker as rich countries
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Social Efficiency: a reflects how institutions, public policies, and cultural conditions affect productivity
Foreign Aid: foreign aid doesn't necessarily do better than foreign investment which promotes economic growth
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The Home Bias Puzzle
Home Bias: investors have a higher proportion of their investments devoted to home assets rather than being globally diversified to further hedge their risk
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Chapter 8
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Liability Dollarization, National Wealth, and Contractionary Depreciations
Fear of Floating: fixed rates prevent large changes in external wealth, so emerging economies are afraid to let their rates float
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Chapter 10
Intro
Currency Union: an area where countries or sates use a common currency because it makes economic sense
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Maastricht Treat: Signed in 1992 which started the framework for an economic and monetary union to use the a common currency in Europe
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Sticking to the Rules
Stability and Growth Pact: (SGP) how countries will stay fiscally disciplined along with economic and monetary union
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