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macroeconomics > chapter 12 > Flashcards

chapter 12 Flashcards

1
Q

what are the 2 ways open economies can interact?

A

buying and selling of goods and services in the world product market

buying and selling of capital assets like stocks and bonds in the world financial market

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2
Q

what is net exports (trade balance) (NX)?

A

the value of a nations exports minus the value of a nations imports

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3
Q

what does net exports determine?

A

wither a countries exports or imports exceed the other, this will determine if they are in a trade surplus, trade deficit or trade balance

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4
Q

what is a trade surplus?

A

when net exports is greater than 0, they had more exports than imports

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5
Q

what is a trade deficit?

A

when net exports is less than 0, they had more imports than exports

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6
Q

what is a trade balance?

A

when net exports equals 0, they had the same amount of imports and exports

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7
Q

what is net capital out flows (NCO)?

A

the purchase of foreign assets by domestic residents minus the purchase of domestic assets by foreigners

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8
Q

what are 4 factors that influence the net capital outflow (NCO)?

A

real interest on foreign assets

real interest on domestic assets

perceived economic and political risk of holding a foreign countries assets

government policies that affect foreign ownership of domestic assets

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9
Q

what is an example of the 4 factors that influence net capital outflow impacting investment?

A

a Canadian investor deciding if they are going to purchase Canadian or Mexican government bonds, the real interest rate will decide what bonds he buys

if he was deciding between canadian and greek government bonds, the deciding factor would be the default risk that the greek bonds have

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10
Q

what will net capital outflow always equal?

A

net capital outflows will always equal net exports

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11
Q

why will net capital outflow always equal net exports?

A

this holds true because every transaction that affects one side of the equation will affect the other side

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12
Q

what does it mean when a country’s net exports are less than 0?

A

the country is buying more goods and services from foreigners than they are producing in their own factories

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13
Q

how can countries fill this potential gap between income and expenditure?

A

the country would borrow money to maintain its current consumption levels through selling domestic financial assets

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14
Q

what are some financial assets that a government might sell to fill the gap between income and expenditure?

A

bonds

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15
Q

why would selling domestic financial assets (bonds) help fill the gap between income and expenditure?

A

selling bonds gets the country an upfront sum of money that they will use to keep up with the spending if needed but they will have they pay that money back at a later date

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16
Q

when net capital outflow is negative what does that mean for the country?

A

capital is flowing out of the country, the country is consuming more than they are creating

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17
Q

what does it mean when a countries net exports is greater then 0?

A

the country sells more goods and services to foreigners then it consumes

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18
Q

what is the form of the surplus of trade revenue?

A

foreign denominations

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19
Q

since a countries income must equal their expenditures, what must a country do to to make income= expenditure?

A

they lend out money and make investments through the purchases of foreign financial assets

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20
Q

what is capital outflow closely linked to?

A

the current account

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21
Q

what is current account?

A

the measurement of the size and direction of international lending and borrowing

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22
Q

what does current account equal?

A

net capital outflow

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23
Q

what is the identity for national savings for a closed economy?

A

S=Y-C-G

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24
Q

what is the identity for national savings for an open economy?

A

Y-C-G=I+NX

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25
Q

what is the identity for net capital outflow?

A

NCO=S-I OR NCO= private S + public S - I

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26
Q

what is the difference between net exports (NX), net capital outflow (NCO) and current account (CA)?

A

nothing, they are the same thing and measure the same thing

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27
Q

what is NCO?

A

net capital outflow

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28
Q

what is NX?

A

net exports

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29
Q

what is the identity for net exports?

A

exports minus imports

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30
Q

what does it mean if net capital outflow (NCO) is positive?

A

money is coming in to the economy

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31
Q

what does it mean if net capital outflow (NCO) is negative?

A

money is leaving the country and being invested outside the country

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32
Q

what are the 3 kinds of scenarios that can impact net capital outflow (NCO)?

A

trade deficit scenario
trade surplus scenario
trade balance scenario

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33
Q

what does it mean when a country is in a trade deficit?

A

exports are less than imports, NX is less than 0

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34
Q

if an economy is in a trade deficit how will this impact income and expenditures?

A

income will be less than expenditures
Y<C+I+G

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35
Q

if an economy is in a trade deficit how will this impact saving and investments?

A

saving will be less than investment
S<I

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36
Q

how will a trade deficit impact net capital outflows (NCO)?

A

net capital outflows will be less than 0

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37
Q

what is a trade surplus?

A

when exports is more than imports, NX is more than 0

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38
Q

if an economy is in a trade surplus how will this impact income and expenditures?

A

income will be more than expenditure
Y>C+I+G

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39
Q

if an economy is in a trade surplus how will this impact saving and investments?

A

savings will be more than investment
S>I

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40
Q

how will a trade surplus impact net capital outflow (NCO)?

A

NCO will be greater than 0

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41
Q

what is a trade balance?

A

when exports equal imports, NX=0

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42
Q

if an economy has a trade balance how will this impact income and expenditures?

A

income will equal expenditures
Y=C+I+G

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43
Q

if an economy has a trade balance how will that impact saving and investment?

A

saving will equal investment
S=I

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44
Q

how will a trade balance impact net capital outflows (NCO)?

A

NCO=0

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45
Q

are all trade deficits bad?

A

no, there are some notions of “good deficit” and “bad deficit”

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46
Q

what is a “good deficit”?

A

when the deficit is caused by an increase in investment
NCO=private S + public S - I^

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47
Q

what makes a “good deficit” good?

A

when the deficit is caused by an increase in investment, this means that money is used to invest domestically for the future

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48
Q

what is a “bad deficit”?

A

when the deficit is caused by a decrease in either public or private savings
NCO=private S + public S - I

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49
Q

what makes a “bad deficit” bad?

A

when the deficit is caused by savings decreasing for the purpose of consumption

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50
Q

what could decrease savings to cause a “bad deficit”?

A

people taking out loans for consumption purposes

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51
Q

what is the nominal exchange rate?

A

the price of foreign currency in terms of domestic currency

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52
Q

what is direct exchange rate?

A

domestic currency to foreign currency

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53
Q

what is indirect exchange rate?

A

foreign currency to domestic currency

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54
Q

what is an example for direct exchange rate?

A

1.33 CAD to 1 USD

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55
Q

what is an example of indirect exchange rate?

A

0.75 USD to 1 CAD

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56
Q

what is the formula for indirect nominal exchange rate?

A

1 divided by nominal exchange rate (foreign/ domestic)

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57
Q

what is the formula for direct nominal exchange rate?

A

direct nominal exchange rate= domestic divided by foreign

58
Q

what is appreciation?

A

the increase in value of domestic currency interns of foreign currency

59
Q

decrease in nominal exchange CAD/ USD means what?

A

Canadian dollar is appreciating

60
Q

increase in nominal exchange rate USD/CAD means what?

A

US dollar is appreciating

61
Q

what is deprecation?

A

the decrease in value of domestic currency in terms of foreign currency

62
Q

what are the 5 affects of domestic currency depreciation

A

makes domestic residents relatively poorer

makes imports more expensive

makes exports more competitive (cheaper)

domestic inflation increases

demand for goods and services increases both domestic and foreign

63
Q

what are 5 affects of domestic currency appreciation?

A

makes domestic residents relatively richer

makes imports cheaper

makes exports less competitive (expensive)

domestic inflation decreases

demand for goods and services decreases both domestic and foreign

64
Q

what is real exchange rate?

A

the rate at which a person can trade a good or service of one country for the other good or service of another country

65
Q

what is the formula for real direct exchange rate DOM/FOR?

A

nominal real exchange rate =DOM/FOR exchange rate times (foreign price divided by domestic price)

66
Q

what is an example for real direct exchange rate?
-bushel of Canadian wheat= 200 CAD
-bushel of Argentinian wheat = 1600 ARS
-nominal direct exchange rate CAD/ARS= 0.25 CAD for 1 AR

A

real direct exchange rate= nominal real ER X (price ARS divided by price CAD)

0.25 X (1600/200)= 2

real direct exchange rate= 2

67
Q

if the real direct exchange rate is 2, how many Canadian bushels of wheat can you exchange for Argentinian bushel of wheat?

A

when the real direct exchange rate is 2, that means for 2 bushels of Canadian wheat you can get 1 bushel of Argentinian bushel of wheat

68
Q

what is an example of real indirect exchange rate?
-bushel of Canadian wheat= 200 CAD
-bushel of Argentinian wheat = 1600 ARS
-nominal direct exchange rate ARS/CAD= 4 ARS for 1 CAD

A

real indirect exchange rate= nominal real ER X (price CAD decided by ARS)

4 X (200/ 1600)= 0.5

real indirect exchange rate= 0.5

69
Q

if the real indirect exchange rate is 0.5, how many Argentinian bushels of wheat can you exchange for Canadian bushel of wheat?

A

when the real direct exchange rate is 0.5, that means for 0.5 bushels of Argentinian wheat you can get 1 bushel of Canadian bushel of wheat

70
Q

what is the first theory of exchange rate determination?

A

purchasing-power parity (PPP)

71
Q

what is the purchasing-power parity (PPP)?

A

a theory of exchange rates, where buying a unit of any given currency should be able to purchase the same quantity of goods in all countries

72
Q

what is the purchasing-power parity (PPP) theory based on?

A

the principle called the law of one price (LOOP)

73
Q

what is the law of one price (LOOP)?

A

the idea that a goods must sell for the same price in all countries

74
Q

under purchasing-power parity, what must a currency have?

A

the same purchasing power in all countries

75
Q

suppose a price of a good sold as different in 2 locations
Vancouver sells 1 kilo of coffee for $4
Winnipeg sells 1 kilo of coffee for $5

what would happen?

A

people would take advantage of this price discrepancy and would buy coffee in Vancouver to sell it in Winnipeg

76
Q

what is arbitrage?

A

when people take advantage of price discrepancies

77
Q

if Vancouver sells 1 kilo of coffee for $4 and Winnipeg sells 1 kilo of coffee for $5 and people buy coffee and Vancouver and sell it in Winnipeg, what is this called?

A

an arbitrage opportunity

78
Q

Vancouver sells 1 kilo of coffee for $4
Winnipeg sells 1 kilo of coffee for $5

if people take advantage of this arbitrage opportunity, how will this impact Vancouver and Winnipeg supply and demand for coffee and the price per kilo?

A

this would result in an increase in demand for coffee in Vancouver, prices would increase in Vancouver due to higher demand. in Winnipeg supply would increase but price would decrease due to supply increase

79
Q

what happens in the long run in both Vancouver and Winnipeg if people take advantage of the coffee arbitrage?

A

eventually prices will be the same in both markets

80
Q

what are the implications of purchasing-power parity if the prices of the two goods that are different are in 2 different countries and currencies?

A

prices must be valued the same

81
Q

why must prices be valued at the same, under the purchasing-power parity, when the prices of 2 different goods are in different countries?

A

if the prices are not valued the same then there will be an arbitrage opportunity, this will result in the prices changing until they become equivalent in each country

82
Q

how do you find nominal exchange rate under purchasing-power parity?

A

under purchasing-power parity, nominal exchange rates will be determined by the prices levels of equivalent goods for 2 currencies

83
Q

if user purchasing-power parity,
1 kilo of coffee in Canada is $5
1 kilo of coffee in Japan is 500 yen

what is the nominal direct exchange rate

A

nominal exchange rate= price in CAD divided by price in JPY

5/500= 0.01

nominal direct exchange rate= 0.01 CAD for 1 yen

84
Q

the nominal direct exchange rate between 2 currencies should equal what?

A

the ratio of aggregate price levels between the 2 countries

85
Q

what is the formula for direct nominal exchange rate?

A

direct nominal exchange rate= domestic price / foreign price

86
Q

what is the formula for indirect nominal exchange rate?

A

indirect nominal exchange rate= foreign price / domestic price

87
Q

what is the key of purchasing-power parity theory?

A

that nominal exchange rates change when price levels change

88
Q

under monetary policy, what happens when price levels go up (money supply, inflation, nominal exchange rate)?

A

money supply increases
inflation increases due to price increase
the nominal exchange rate does not change

89
Q

under purchase-power parity, what happens if price levels increase?

A

the money supply stays the same
inflation increases due to both domestic and foreign prices increase
nominal exchange rate increases

90
Q

what are the 3 limitations of purchasing-power parity?

A

non-tradable goods and services
product quality and preferences of tradable goods
trade barriers and capital control

91
Q

why is non-tradeable goods a limitation of purchasing-power parity?

A

houses and real estate are not tradable in the global market so purchasing-power parity may not affect them

92
Q

why is product quality and preferences of tradable goods a limitation of purchasing-power parity?

A

because even through under PPP any given currency should be able to purchase the same quantity of goods in all countries, the quality and preferences of those goods in other countries may not be the same all around the world

93
Q

why is trade barriers and capital controls a limitation of purchasing-power parity?

A

even tradable goods that are priced the same in 2 countries, can be impacted by import fees creating a difference in prices for individuals in either country

94
Q

what are the 3 paritys in the theory of exchange rate determination?

A

purchasing power parity (PPP)
uncovered interest rate parity (UIP)
covered interest rate parity (CIP)

95
Q

what is the uncovered interest rate parity?

A

a theory of exchange rates, whereby changes in the real interest rates on comparable financial assets across different countries influence those different countries exchange rates

96
Q

what does “e” denote?

A

exchange rate

97
Q

consider a 1 year investment opportunity with 1 CAD, what are the 2 things you can do?

A

buy a domestic bond
buy a foreign bond

98
Q

what is the formula for return on a 100CAD investment in to domestic bond?

A

100 CAD X (1 + interest rate)

99
Q

what is the formula for return on a 1 CAD investment in to a foreign bond?

A

1 CAD/ current e X (1+ interest rate*) X future e

100
Q

what does “interest rate*” mean?

A

the foreign interest rate

101
Q

what is the formula for exchange rate domestic to foreign?

A

domestic price devided by foreign price*

102
Q

what is the formula for exchange rate foreign to domestic?

A

1 divided by (domestic to foreign exchange rate)

103
Q

under LOOP, if the foreign and domestic bond returns differ what will happen?

A

if these these differ in any way that will cause an arbitrage opportunity, due to this arbitrage opportunity eventually these 2 bond returns will become the same

104
Q

what does “et+1” mean?

A

this is the future nominal exchange rate

105
Q

what does “E” mean?

A

this is the future exchange rate, both E and et+1 are the same thing

106
Q

what is a key implication of exchange rates?

A

changes in exchange rates are due expected changes in interest rate differentials

107
Q

what is the expected monetary policy decision in response to inflation change?

A

it will change exchange rates

108
Q

what is covered rate parity (CIP)?

A

when the future exchange rate on a foreign bond is predetermined

109
Q

what does “Ft+1” stand for?

A

it is the fixed future exchange rate of a foreign bond

110
Q

what does the purchase power parity (PPP) theory focus on?

A

purchase power parity focus on the relationship between the exchange rates and price levels (inflation)

111
Q

what does the uncovered interest rate parity theory focus on?

A

uncovered interest rate parity theory focus on the relationship between exchange rate and interest rate differentials

112
Q

what do both purchase power parity theory and uncovered interest rate parity provide inside in to?

A

exchange rate determination

113
Q

what theory focuses on the long run dynamics of exchange rate determination?

A

the purchase power parity theory focuses on the long run dynamics of exchange rate determination

114
Q

what is an example of a long run dynamic that impacts exchange rate determination?

A

price equivalent between different countries

115
Q

what theory focuses on the short run dynamics of exchange rate determination?

A

the uncovered interest rate theory focuses on the short run dynamics of exchange rate determination

116
Q

what is an example of a short run dynamic that impacts exchange rate determination?

A

market expectations

117
Q

what are capital controls?

A

a tax or hinderance on international financial transactions

118
Q

what is a factor that can impact interrest rate determination?

A

perfect capital mobility

119
Q

what are 2 examples of capital controls?

A

tariffs
tedious paperwork

120
Q

what is perfect capital mobility?

A

a theoretical economic condition where financial capital moves freely across boarders without impediments such as capital controls

121
Q

what does “r” mean?

A

the real interest rate on any investment opportunity

122
Q

what does “w” mean?

A

the world interest rate

123
Q

what does r to the power of w (r^w) mean?

A

the world interest rate on any global investment opportunity

124
Q

when a domestic country is lending to the rest of the world, how does that impact the economy?

A

net capital outflow (NCO)= NX >0
net exports are positive
economy will be in trade surplus
savings will be greater than investment

125
Q

why would a domestic country want to lend money to the rest of the world?

A

they money is being lent from a domestic country to get a return on their investment

126
Q

if a domestic country is borrowing from the rest of the world, how will this impact their economy?

A

investment will be greater than savings
net capital outflow (NCO)= NX<0
net exports are negative
economy will be in a trade deficit

127
Q

when a country Is in a trade deficit from borrowing money from the rest of the world to invest in their domestic country, is it good?

A

yes, this kind of trade deficit is a good trade deficit

128
Q

if a domestic country is a borrower of fund from the rest of the world, what is the cost that they pay?

A

they would pay the “world interest rate” plus the government tax per capital imported (cost= r^w + tax per capital imported)

129
Q

what do domestic governments do to slow down lending out of the country?

A

domestic countries governments impose a tax per capital imported

130
Q

what is the cost of borrowing money from your domestic country?

A

r, just the standard interest rate on any investment opportunity

131
Q

when borrowing money from domestic country and from rest of the world is in equilibrium, what will be the cost of borrowing funds?

A

the cost of borrowing money from a domestic country will be the same as the cost of borrowing money from the rest of the world (r=r^w+tax)

132
Q

when a domestic country lends money to the rest of the world, what is the revenue that the domestic country will receive?

A

they will get the world interest rate minus taxes (revenue= r^w- taxes)

133
Q

why did the government impose tax on revenue from lending capital out of the country?

A

so they encourage domestic capital lending, this creates more domestic investment

134
Q

what is the revenue from lending within the domestic country?

A

the standard interest rate on any investment opportunity

135
Q

what are the 4 scenarios when there will be an arbitrage opportunity in the domestic and world lending and borrowing market?

A

if r< r^w+t
if r>r^w+t
if r<r^w-t
if r>r^w-t

136
Q

why will there be an arbitrage opportunity if “r< r^w+t”?

A

this means that the domestic cost for borrowing is less than world cost for borrowing, this will lead to everyone will borrow domestically

137
Q

why will there be an arbitrage opportunity if “r> r^w+t”?

A

this means that the domestic cost for borrowing is more than the world cost for borrowing, this will lead to everyone will borrow from the rest of the world

138
Q

why will there be an arbitrage opportunity if “r< r^w-t”?

A

this means that the domestic revenue for lending is less than the world revenue for lending, this will lead to everyone lending to the rest of the world

139
Q

why will there be an arbitrage opportunity if “r> r^w-t”?

A

this means that the domestic revenue for lending is more than the world revenue for lending, this will lead to everyone lending to their domestic country

140
Q

what will companies do to mitigate the capital outflow?

A

they will impose capital controls to make sure the countries savings are funding new domestic investments

141
Q

what has caused capital controls to decline overtime?

A

financial globalization

macroeconomics (13 decks)

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