Economics Flashcards
(48 cards)
Absolute Convergence
Poorer countries will eventually catch up to richer ones (same steady state).
Neoclassical model assumes all countries have access to the same technology, so there should be convergence in growth rates, but not convergence in output per capita (absolute convergence)
Absolute PPP
Assumes all goods and services are tradable.
Exchange rate is just price_level_foreign / price_level_domestic
Assumes all goods arbitrage with equalise prices, but doesn’t take into account cost of trading good/service or non-tradability (e.g. day care or cement)
Capital accumulation neoclassical
Capital accumulation impacts level but not growth rate of output
Regardless of initial capital to labour ratio or initial labour productivity, growth will move towards a steady state
In steady state output equals growth in labour force plus TFP scaled for labour’s share of output
Capital deepening neoclassical
Rapid growth initially above steady state when deepening occurs
Diminishing marginal returns if capital grows more quickly than labour productivity marginal growth is lower
Need improvements in TFP and technology to sustain growth rates
Carry trade
Return =
Interest earned
(-) Funding cost
(+) Appreciation in currency A vs B
Club Convergence
Convergence occurs within groups (“clubs”) of countries with similar institutional features.
Conditional Convergence
Countries converge to their own steady states, which depend on factors like savings rate, population growth.
Contrast Classical, Neoclassical, and Endogenous Growth Theories.
Classical: Growth limited by population outpacing resources; income reverts to subsistence.
Neoclassical: Growth driven by capital deepening, labor growth, and exogenous technology; convergence expected. Endogenous: Technological progress is endogenous, driven by investment in human capital/R&D; growth can be permanent.
Contrast the Mundell-Fleming, Portfolio Balance, and Monetary approaches.
Mundell-Fleming: Short-term, ignores inflation (assumes enough slack in economy to increase supply in response to increase in aggregate demand, without increasing inflation).
Portfolio Balance: Long-term impact of fiscal policy; deficits lead to depreciation eventually.
Monetary: Focuses on inflation (PPP); Monetary expansion leads to inflation and depreciation. Dornbusch overshooting considers sticky prices, leading to initial over-depreciation.
Convergence neoclassical
Given relative scarcity and thus higher productivity of capital, developing countries should grow more quickly than developed countries
Should be convergence of per capita income over time
Covered interest rate parity
Spot x (1+r_price x days/360) /(1+r_base x days/360)
Debt sustainability mechanism
If people think the debt is unsustainable will increase selling of debt / currency leading to a devaluation
Dominant factors in FX during short term
Financing / Investing decisions because:
Prices of real goods and services adjust much more slowly than FX and other asset prices
Production of real goods and services takes time and demand decisions are subject to inertia
Current spending reflects only purchases of goods/service currently produced, whereas financing/investment decisions represent current and future expenditures
Expected exchange rate movements can result in substantial moves in actual exchange rates.
Endogenous Growth Model
No diminishing marginal returns to capital, so savings and investment can permanently increase the growth rate.
R&D / knowledge capital benefits not contained in a specific firm, so there are positive externalities here
Separating private and social benefits, helps to explain why all industries are not monopolies, constant returns to scale are most applicable to social factors, e.g. think about deepseek benefitting from R&D from OpenAI, which benefitted from R&D from Google
Explain the Mundell-Fleming model’s predictions High Capital Mobility
Capital flows dominate
Monetary Expansion -> Lower IR -> Outflows -> Depreciation.
Fiscal Expansion -> Higher IR -> Inflows -> Appreciation.
Explain the Mundell-Fleming model’s predictions Low Capital Mobility
Trade flows dominate
Monetary Expansion -> Higher Imports -> Trade Deficit -> Depreciation.
Fiscal Expansion -> Higher Imports -> Trade Deficit -> Depreciation.
Factors impacting change in FX rates under Flow supply/demand mechanism
1) Initial current account deficit
2) Response of import and export prices to change in FX rate
3) Response of import and export demand to changes in import and export prices
Empirical studies found limited pass through of FX rate changes to prices. A 1% decline in currencies value leads to 0.5% increase in prices to compensate. Companies tolerate lower margins to preserve market shares
Response of import/export demand to changes in prices is also relatively sluggish
Factors that impact output per worker
Depreciation rate, savings rate, and growth rate of labour force change the LEVEL of output per worker
Permanent change in the GROWTH of output per worker is only impacted by TFP
Flow supply demand mechanism
Foreign exporters paid in domestic currency, they sell the domestic currency to buy the foreign currency, the selling pressure causes the domestic country to depreciate.
Forward FX Calculation
Find matching cash inflow of original position, determine forward needed to offset this
(FP_t x FP0) x size
Discount back to PV
Steady state growth in the neoclassical model
θ/(1 − α) for per capita
θ/(1 − α) + n
where θ = TFP
n = labour growth rate
How do current account deficits affect exchange rates (long term)?
Can lead to depreciation via:
1) Flow Supply/Demand (selling domestic currency received for exports),
2) Portfolio Balance (reducing concentration risk of holding domestic assets)
3) Debt Sustainability (selling assets if debt deemed unsustainable).
How do you calculate the bid-offer spread?
Offer Rate - Bid Rate.
How do you calculate the forward premium/discount?
(Forward Rate / Spot Rate) - 1. Annualized = Premium/Discount x (360 / Forward Period).
