Macro

Question 1

Define GDP

Answer 1

The value of total output of an economy in each period

Question 2

Define economic growth

Answer 2

refers to the increase in the capacity of the economy to produce goods and services over time. It is measured by the rate of increase of real GDP

Question 3

Define inflation rate

Answer 3

the percentage increase in the average price of goods and services

Question 4

Gross debt

Answer 4

total liabilities owed to creditors

Question 5

Net debt

Answer 5

total liabilities minus total assets that could be sold to raise money to pay creditors

Question 6

Define Recession

Answer 6

a period of negative growth

Question 7

growth calculation

Answer 7

Question 8

Economic growth in poor countries

Answer 8

If poor countries are to catch up with the living standards of rich countries, they must grow at a faster pace.

Question 9

what is a goal of macro policy

Answer 9

keep the economy as close to the straight line as possible, along the business cycle

Question 10

Inflation calculation

Answer 10

Question 11

Define a household

Answer 11

earn income which they use to purchase goods and services

Question 12

Define a firm

Answer 12

produce goods and services which are sold in the market. Owned by households

Question 13

how do the facotrs of production relate to economic activity

Answer 13

And all factors of production (e.g. labour and land) are owned by households, rented to firms.
- Further assume no savings, no surplus production, and no inter-firm sales.

Question 14

explain the link between firms and households

Answer 14

• Revenue flows into the firm are divided up into wages, rents and profits.
• These wages, rents and profits are then taken back to households as incomes.
• The income is then used as expenditure on the goods that the firm produces.
• These expenditures are the firm’s revenue.

Question 15

The circular flow of income holds:

Answer 15

1. The value of output is equal to household income 𝑅 ≡ 𝑌.
2. The value of output must equal the expenditure used to purchase 𝑌 ≡ 𝐸.
3. Expenditures must equal income 𝐸 ≡ 𝑅.

Question 16

What does y stand for

Answer 16

Output (the value of all production)

Question 17

what does e stand for?

Answer 17

The value of all expenditure on goods and services

Question 18

what does r stand for?

Answer 18

The value of all household income

Question 19

Intermediate goods

Answer 19

goods which fully depreciate in the production process

Question 20

Capital goods

Answer 20

goods purchased by firms from other firms, which do not depreciate in the production process. They are used many times.

Question 21

Capital and intermediate goods in GDP

Answer 21

• Capital goods are final goods – we do want to include this in GDP, but not the intermediate goods.

Question 22

Define value added

Answer 22

the change in the value of a good as it moves through the production process.

Question 23

what does total expenditure equal

Answer 23

C + I

Question 24

What does Household income equal

Answer 24

C + S

Question 25

How is investment for firms funded?

Answer 25

The savings of household

Question 26

How does savings finance investment

Answer 26

1. Loans through the banking system (using the savings of households). 2. Issuing debt (bonds) which are sold to households in the financial market. 3. Issuing equity (shares) which are sold to households in the financial market.

Question 27

How do we account for unsold production?

Answer 27

- Unsold stocks of inventory are counted as part investment by firms, - When these stocks are sold in the next year, they are counted as dis-investment (negative investment) by firms. - Inventory counts towards GDP (as investment) in year 1, but not year 2.

Question 28

two functions of government

Answer 28

- Providing income transfers (benefits, pensions etc) to households - Providing final goods and services (education, police, bridges, etc) to households

Question 29

How does government collect revenue

Answer 29

1. Direct or income tax (wages, capital, rent, profits) 2. Indirect, or expenditure tax

Question 30

Define net taxes

Answer 30

tax minus benefit transfers: NT ≡ Td – B

Question 31

Household disposable income

Answer 31

𝑌 − 𝑁𝑇 ≡ 𝐶 + 𝑆

Question 32

The leakages of the economy

Answer 32

𝑆 + 𝑁𝑇

Question 33

The injections into the economy

Answer 33

𝐼 + 𝐺

Question 34

what happends when 𝐺 − 𝑁𝑇 = 0

Answer 34

balanced budget so S = I

Question 35

what happends when 𝐺 − 𝑁𝑇 > 0

Answer 35

Budget deficit so S > I --> Households finance the deficit

Question 36

what happends when 𝐺 − 𝑁𝑇 < 0

Answer 36

budget surplus so 𝑆 < 𝐼 --> Government pays down the deficit

Question 37

Imports

Answer 37

Goods purchased from foreigner firms by domestic households and firms. - Imports are not part of domestic output. We need to account for them in final expenditure.

Question 38

Exports

Answer 38

Goods sold to foreigners by domestic firms. - Exports are part of domestic output.

Question 39

Net Exports value

Answer 39

NX = X – Z

Question 40

What happens when 𝑁𝑋 > 0

Answer 40

trade surplus

Question 41

What happens when 𝑁𝑋 < 0

Answer 41

trade deficit

Question 42

Nominal GDP

Answer 42

GDP computed at current prices

Question 43

Real GDP

Answer 43

GDP computed at the prices of a base year

Question 44

GDP deflator

Answer 44

Question 45

Gross National Product

Answer 45

the value of all income earned by citizens in a country.

Question 46

example of german who works in london on GDP and GNP

Answer 46

- Contributes to UK, not German, GDP. - Contributes to German, not UK, GNP.

Question 47

Investment from foreign to domestic country

Answer 47

- Contributes to domestic GDP. - Contributes to foreign GNP.

Question 48

Full capacity output

Answer 48

The maximum level of output an economy can achieve at a given period by using all inputs at full capacity.

Question 49

Potential output

Answer 49

The level of output the economy can achieve using all inputs at “normal” capacity.

Question 50

Recession

Answer 50

A period of slow to negative economic growth for which the actual output starts to diverge from the potential output.

Question 51

Boom

Answer 51

A period of rapid economic growth in which the difference between actual output and full capacity output becomes small.

Question 52

Phases of the business cycle

Answer 52

1. The upturn: the economy is below trend output but slowly recovering. 2. The expansion: The economy experiences rapid economic growth. 3. The peaking out: Growth slows down or even ceases. 4. The recession: GDP starts to fall (negative growth).

Question 53

Keynesian cross model - overview

Answer 53

- Aggregate output fluctuations are caused by changes in aggregate demand. - In periods of recession or boom, the government can use policy to move the economy back to potential output.

Question 54

Keynesian cross model - assumptions

Answer 54

- Prices, rents, and wages are all fixed. - Firms always produce what demand requires. - Workers are always available to work at current wage. - Firms always have spare capacity that can profitably be used at current prices. - There are always resources available at current rents. - We start with two agents: households and firms - Government and foreign trade will be added.

Question 55

What does the Keynesian cross model consist of

Answer 55

Investment: Firms desired or planned additions to physical capital and inventories. Consumption: Household demand for goods and services.

Question 56

The Consumption Function

Answer 56

𝐶 = 𝐴 + 𝑐𝑌 - 𝐴 > 0 - 0 < 𝑐 < 1

Question 57

What does the consumption function show

Answer 57

The desired aggregate household consumption at each level of aggregate income.

Question 58

What is A in the consumption function

Answer 58

The part of consumption that does not depend on income, called autonomous consumption. This is the level of consumption at 𝑌 = 0.

Question 59

What is c in the consumption function

Answer 59

The marginal propensity to consume. It is the amount of each additional pound in income that is consumed (rather than saved.)

Question 60

MPC in different households

Answer 60

- A very poor household is likely to immediately spend any extra income they earn. Their MPC is relatively high. - A very wealthy household is likely to spend very little of a small income change. Their MPC is relatively low.

Question 61

Marginal propensity to save

Answer 61

1 - c

Question 62

Relationship between conumption and saving function

Answer 62

The steeper the consumption functions the flatter the saving function.

Question 63

Savings function

Answer 63

𝑆 = 𝑌 − 𝐶 = 𝑌 − 𝐴 − 𝑐𝑌 = −𝐴 + (1 − 𝑐)𝑌

Question 64

what is aggregate demand the sum of

Answer 64

consumption and investment

Question 65

what does the 45degree line correspond to

Answer 65

the circular flow

Question 66

In equilibrium

Answer 66

In equilibrium 𝑌∗ = 𝐶 + 𝐼 We know that 𝑌∗ = 𝐶 + 𝑆 Therefore, in equilibrium it must be the case that 𝑆 = 𝐼

Question 67

autonomous spending and investment calculation

Answer 67

𝑌∗ = 𝐴 + 𝐼/(1 − 𝑐)

Question 68

what is the multiplier

Answer 68

- A change in AD leads to a change in output which leads to a change in household income which leads to a change in AD.

Question 69

multiplier calculation

Answer 69

1/1-c

Question 70

what happens when desired savings fall

Answer 70

- At 𝑌0∗: 𝑆 < 𝐼 (not in equilibrium) - As incomes rise from 𝑌0∗ to 𝑌1∗, households increase their savings. - This happens until 𝑆 = 𝐼. - Notice, there is no change in savings

Question 71

Summarise an increase in A

Answer 71

- Decrease in C - Decrease in Y - No change in S

Question 72

Consumer Confidence

Answer 72

- Shifts in A and I are often due to change in consumer and firm confidence. - we assume that confidence about the future is independent of current income levels. - If households and firms lack confidence in the outlook for the economy, they will increase savings (put off investment). - If households feel less wealthy, they will increase savings (put off investment). - The government will try and deter system-wide increases in savings during times of recession.

Question 73

Fiscal policy

Answer 73

the government’s policy on spending and taxes

Question 74

Stabilisation policy

Answer 74

refers to actions taken by the government to minimize movements in aggregate demand and output (keep it close to potential output).

Question 75

Budget deficit

Answer 75

the excess of government spending over government receipts (taxes) each year.

Question 76

national debt

Answer 76

the stock of outstanding government debt.

Question 77

What are the two ways that government can finance spending?

Answer 77

1. Tax (provide benefits) at a constant rate proportional to income. 2. Collect taxes as a lump-sum (not conditional on income).

Question 78

Tax (provide benefits) at a constant rate proportional to income.

Answer 78

- Let 𝑡 be the net tax rate: the rate of taxation, less rate of benefit transfer. - Tax revenues will be 𝑡𝑌, where 0 < 𝑡 < 1. - Disposable household income will be 𝑌𝑑 = (1 − 𝑡)𝑌

Question 79

Collect taxes as a lump-sum (not conditional on income).

Answer 79

- Let 𝑁𝑇 be the net tax: taxes less benefits transfer. - Tax revenues will be 𝑁𝑇. - Disposable household income will be 𝑌𝑑 = 𝑌 − 𝑁𝑇

Question 80

The consumption function written in terms of disposable income (PT)

Answer 80

C = 𝐴 + 𝑐(1 − 𝑡)𝑌

Question 81

AD written in terms of disposable income (PT)

Answer 81

AD = 𝐴 + 𝑐(1 − 𝑡)𝑌 + 𝐼 + 𝐺

Question 82

What does an increase in G do to the AD curve (PT)

Answer 82

Shift it up

Question 83

what happen to the AD curve when t increases (PT)

Answer 83

AD curve pivots, becoming less steep.

Question 84

Equilibrium output with government spending (PT)

Answer 84

Question 85

impact of tax on the multiplier (PT)

Answer 85

Question 86

Household disposable income (LST)

Answer 86

𝑌𝑑 = 𝑌 − 𝑁𝑇

Question 87

The consumption function written in terms of disposable income (LST)

Answer 87

𝐶 = 𝐴 + 𝑐(𝑌 − 𝑁𝑇)

Question 88

AD written in terms of disposable income (LST)

Answer 88

𝐴 + 𝑐(𝑌 − 𝑁𝑇) + 𝐼 + 𝐺

Question 89

What does an increase in G do to the AD curve?

Answer 89

shift it up

Question 90

What does an increase in NT do to the AD curve?

Answer 90

shift the AD curve down

Question 91

NT and G increasing by the same amount

Answer 91

If 𝑁𝑇 increases by the same amount as 𝐺, the AD curve shifts down, but not all the way back.

Question 92

Equilibrium output for LST

Answer 92

Question 93

Multiplier for LST

Answer 93

1/1-c - However, the shift in government spending is offset by the decrease in household disposable income.

Question 94

What is a balanced budget?

Answer 94

A balanced budget means that the government will set taxes such that government spending is always covered.

Question 95

How has taxation been adjested in a balanced budget?

Answer 95

so that NT = G

Question 96

What happens when the government runs a balanced budget

Answer 96

government spending offset by a tax increase will always increase in output.

Question 97

why is using a balanced budget multiplier as a fiscal tool indefinetely not feasible

Answer 97

- It involves raising taxes for greater expenditures. - It involves replacing some private spending (in the form of household consumption) with public spending. - Once we include interest rates in the model, we will also see that government spending “crowds out” capital investment from firms.

Question 98

Savings in equilibrium

Answer 98

𝑆 = 𝐼 + 𝐺 − 𝑁𝑇

Question 99

How does household savings finance investment by firms

Answer 99

- Through the banking system - Shares - Bonds - Government bonds.

Question 100

Budget deficit

Answer 100

when total government spending is greater than total tax revenue 𝐺 > 𝑁𝑇.

Question 101

Budget surplus

Answer 101

when total government spending is less than total tax revenue 𝐺 < 𝑁𝑇.

Question 102

automatic stabilisers

Answer 102

used to dampen the response of the economy to shocks.

Question 103

automated taxes and transfers

Answer 103

they work by offsetting the economy’s response to contraction and expansion.

Question 104

equlibrium when we have a proportional net tax

Answer 104

Question 105

multiplier when we have a proportional net tax

Answer 105

Question 106

a positve demand shock on output

Answer 106

A positive demand shock will cause output to increase above its potential level

Question 107

a negative demand shock on output

Answer 107

A negative demand shock will cause output to decrease below its potential level

Question 108

what is the policy objectives for shocks to AD

Answer 108

Our policy objective is to make the deviations from 𝑌bar as small as possible.

Question 109

Investment shock without tax

Answer 109

Question 110

Investment shock with a proportional tax

Answer 110

Question 111

Discretionaty fiscal policy

Answer 111

decisions that are made, on a case-by-case basis, to change spending/tax rates to stabilize aggregate demand.

Question 112

fiscal stimulus

Answer 112

A discretionary increase in spending, or cut to taxes, is referred to as fiscal stimulus. An example of this is the furlough scheme used during the pandemic.

Question 113

what does austerity mean

Answer 113

a reduction in 𝑮 − 𝑵𝑻.

Question 114

Analysis of why a recession is the wrong time for austerity

Answer 114

- Austerity worsens economic output declines. - Stabilization policy uses proportional taxes, deficits in downturns, and surpluses in booms. - Full-capacity economy assumptions alter analysis conclusions. - Full-capacity leads to government spending crowding out private spending.

Question 115

trade deficit

Answer 115

When 𝑋 − 𝑍 < 0

Question 116

trade surplus

Answer 116

When 𝑋 − 𝑍 > 0

Question 117

import demand function

Answer 117

𝑍 = 𝑧𝑌 - little z is MPZ

Question 118

what does a high domestic income mean for trade balance

Answer 118

trade deficit

Question 119

what does a low domestic income mean for trade balance

Answer 119

trade surplus

Question 120

Equilibrium including x and z

Answer 120

Question 121

what does a small value of z do to the AD curve

Answer 121

pivot it up

Question 122

what does a large value of z do to the AD curve

Answer 122

pivot it down

Question 123

if exports are higher than imports

Answer 123

more is sold to foreigners than is purchased from them. This extra income is part of savings (holding all else constant).

Question 124

if imports are higher than exports

Answer 124

more is purchased from foreigners than is sold to them. This suggests a decrease in savings (holding all else constant).

Question 125

what is money

Answer 125

Money is any generally accepted means of payment for delivery of goods or settlement of debt.

Question 126

functions of money

Answer 126

1. Medium of exchange of goods and services 2. Unit of account in which prices are quoted and accounts are kept 3. Store of value. 4. Standard of deferred payment (enables borrowing and lending)

Question 127

what is fiat money

Answer 127

A currency without intrinsic value.

Question 128

what is commodity money

Answer 128

the actual use of a valued commodity as a form of money.

Question 129

what is representative money?

Answer 129

is money that represents a claim on a commodity.

Question 130

what are commerical banks

Answer 130

Commercial banks are a financial intermediary, coordinating activities between savers and borrowers.

Question 131

bank reserves

Answer 131

the money that a bank has available to meet possible withdrawals from depositors.

Question 132

reserve ratio

Answer 132

the percent of all deposits that banks keep on hand to meet withdrawals.

Question 133

money supply

Answer 133

the value of the stock of all money in circulation.

Question 134

monetary base

Answer 134

the value of currency either in circulation or held in reserves.

Question 135

monetary base function

Answer 135

𝑐𝑝𝐷 + 𝑐𝑏𝐷

Question 136

money supply function

Answer 136

𝑐𝑝𝐷 + 𝐷

Question 137

money multiplier

Answer 137

Question 138

financial asset

Answer 138

a piece of paper entitling the owner to a stream of payments over a specified period.

Question 139

liquidity

Answer 139

the speed at which an asset can be turned into money.

Question 140

solvency crisis

Answer 140

when an institution’s assets have become less than its liabilities.

Question 141

liquidity crisis

Answer 141

when an institution is temporarily unable to meet immediate payment requests.

Question 142

bills

Answer 142

- Short term asset with a known date of repurchase at the known price. - High liquidity.

Question 143

bonds

Answer 143

- Longer-term - Medium liquidity

Question 144

perpetuities

Answer 144

- A type of a bond which is never repurchased by the issuer. Interest payments made forever. - Medium liquidity

Question 145

equities

Answer 145

- Company shares, entitling the owner to receive corporate dividends. - Low liquidity.

Question 146

role of the central bank

Answer 146

1. Issue bank notes (££££). 2. Lender of last resort 3. Banker to the government 4. It may also be the job of the Central Bank to police the financial system. 5. Monitoring and controlling the money supply, interest rates & inflation.

Question 147

How can the central bank influence the money supply

Answer 147

1. Reserve requirements 2. Setting the bank rate 3. Open market operations

Question 148

The yield calculation

Answer 148

Question 149

relationship between price and interest rate

Answer 149

inverse

Question 150

real money supply

Answer 150

M/P

Question 151

why do we hold money

Answer 151

1. Transaction - we do not buy and sell things at the same time. 2. Precautionary - we hold money for unexpected costs that may arise. 3. Asset - money has very low risk, but also very low return.

Question 152

what is the primary benefit to holding money

Answer 152

- Higher consumption means higher money demand. - Money demand is increasing with income (ceteris paribus).

Question 153

the cost of holding money

Answer 153

- All wealth held in money rather than bonds forgoes the interest that bonds earn. - The cost of holding money is greater when the interest on bonds is greater. - Money demand is decreasing with interest rates (ceteris paribus).

Question 154

What happens to the cost of borrowing money following an increase in the return on bonds

Answer 154

increase

Question 155

what happens to the demand for money when the rate of interest decreases

Answer 155

decrease

Question 156

What happens to demand as income increases

Answer 156

- Households need more cash for consumption transactions. - Holding all else constant, the demand for real balances increases.

Question 157

demand equation for real money balances

Answer 157

𝐿𝐿 = 𝛼 + 𝛽𝑌 − 𝛾(𝑟 − 𝑟𝑑)

Question 158

Given the money demand schedule 𝐿𝐿, the Central Bank can either:

Answer 158

- Set the interest rate and let the money supply adjust. - Set the money supply and let the interest rate adjust.

Question 159

Endogenous variables in the money market - moves along the curve

Answer 159

Interest rates, 𝑟

Question 160

Exogenous variables in the money market - shift curves

Answer 160

Income/output, 𝑌 Nominal money balances, 𝑀 Price level, 𝑃

Question 161

how does changing the interest rate effect households?

Answer 161

- higher interest rates imply higher price of bonds ⇒ Households feel wealthier, consumption increases. - Lower interest rates imply lower cost of borrowing, increasing spending on consumer durables (housing, cars, furniture) , consumption increases.

Question 162

how does changing the interest rate effect investment by firms?

Answer 162

Lower interest rates imply lower cost of borrowing, increasing investing by firms.

Question 163

goods market equilibrium

Answer 163

defined by output level 𝑌∗, such that aggregate demand and actual income (output) are equal.

Question 164

money market equilibrium

Answer 164

defined by interest rate 𝑟∗, such that money demand is equal to money supply.

Question 165

IS schedule

Answer 165

combinations of 𝑌 and 𝑟 for which the goods market is in equilibrium.

Question 166

MP schedule

Answer 166

combinations of 𝑌 and 𝑟 for which the money market is in equilibrium.

Question 167

Shifts in the IS curve

Answer 167

- Anything that shifts the AD curve for a given interest rate will shift the IS curve. - Changes in 𝐺. - Exogenous changes in 𝐶 or 𝐼 that are not due to changes in 𝑟.

Question 168

Shifts in the MP curve

Answer 168

- Changes in the money supply (𝐿) for a given income level will shift the MP curve.

Question 169

impact of increase government spending on spending

Answer 169

- Public spending has crowded out private spending – investment spending has decreased.

Question 170

Quantitive easing

Answer 170

refers to action taken by the central bank to increase the money supply.

Question 171

quantitive tightening

Answer 171

refers to action taken by the central bank to decrease the money supply.

Question 172

monetary financing

Answer 172

Monetary financing refers to an arrangement whereby the central bank creates money to finance a government deficit.

Question 173

what effects the slope of the MP curve?

Answer 173

- The slope of the Monetary Policy (MP) curve represents the change in interest rates resulting from changes in output. - This slope is determined by the responsiveness of money demand to output fluctuations.

Question 174

Flat MP curve

Answer 174

- Money demand is not very responsive to changes in output. - Fiscal policy is effective. - Little change in 𝑟, large change in 𝑌. - Minimal crowding out of private spending.

Question 175

Steep MP curve

Answer 175

- Money demand is very responsive to changes in output. - Fiscal policy is largely ineffective. - Large change in 𝑟, little change in 𝑌. - Government spending has a large crowding out effect on private spending – small increase in output is at the expense of a reduction in investment.

Question 176

what effects the slope of the IS curve?

Answer 176

- The IS curve's slope reflects how output changes with interest rate variations. - This depends on how sensitive aggregate demand is to interest rate changes, specifically investment and consumption. - High sensitivity (large AD shifts) leads to a flat IS curve.

Question 177

Flat IS curve

Answer 177

- 𝐼 and 𝐶 are very sensitive to changes in the interest rate. - Monetary policy is effective. - Output is highly responsive to changes in the interest rate.

Question 178

Steep IS curve

Answer 178

- 𝐼 and 𝐶 are not very sensitive to changes in the interest rate. - Monetary policy is relatively ineffective. - Output does not respond to changes in the interest rate.

Question 179

Fiscal Policy - increase in government spending

Answer 179

- Increase in government spending increases AD → IS shifts right - Output increases, which leads to an increase in interest rates, which decreases investment spending. - This adjustment stops when we arrive at the new equilibrium. - Output has increase, interest rates have increased. - Government spending has crowded out some investment spending.

Question 180

Monetary policy increase in money supply

Answer 180

- Central bank increases the money supply → MP curve to the right. - Interest rates decreases, as a result firms want to increase their investment spending. - There is a feedback between the goods market and money market as output and interest rates adjust. - This adjustment stops when we reach the new general equilibrium. - Output has increase, interest rates have decreased. Investment spending has increased.

Question 181

Pros of monetary policy to stimulate the economy

Answer 181

- Works by stimulating private investment andconsumption.

Question 182

Cons of monetary policy to stimulate the economy

Answer 182

- Zero (nominal) lower-bound! - May be slow to work. - Cannot be “targeted”.

Question 183

Pros of fiscal policy to stimulate the economy

Answer 183

- Can work fast (e.g. job retention scheme). - Can be targeted.

Question 184

Cons of fiscal policy to stimulate the economy

Answer 184

- May lead to a crowding out of private consumption. * Lots of disagreement about the size of the multiplier.

Question 185

When should we use fiscal policy versus monetary policy to simulate the economy?

Answer 185

The answer depends on the shape of these curves! - If the MP curve is steep (households and firms are sensitive to interest rate changes) use monetary policy - The fiscal spending multiplier will be low, lots of crowding out. - If the MP curve is flat (households and firms are not sensitive to interest rate changes) use fiscal policy - The fiscal spending multiplier will be high.

Question 186

Small open economy

Answer 186

- Small means that the countries decisions will not affect world prices (world prices are exogenous). - An open economy has trade and financial links to other countries (foreign economies) which will impact the domestic economy.

Question 187

foreign exchange market

Answer 187

This is where the currency of one country is exchanged for the currency of a different country.

Question 188

exchange rate

Answer 188

The price (in units of domestic currency) at which a foreign can be purchased

Question 189

exchange rate calculation

Answer 189

Question 190

appreciation

Answer 190

Appreciation of domestic currency refers to an increase in the exchange rate

Question 191

Depreciation

Answer 191

Depreciation of domestic currency refers to a decrease in the exchange rate

Question 192

market for foreign exchange

Answer 192

- A higher exchange rate (USD/GBP) means pounds are more expensive for foreigners. - This makes domestic goods and services pricier. - Consequently, the foreign demand for pounds decreases.

Question 193

Impact on foreign demand as ER decreases

Answer 193

Foreign demand increases - demand for pounds is decreasing with exchange.

Question 194

UK demand for foreign goods, when ER decreases

Answer 194

UK demand for iPhones foreign goods when the exchange rate decreases ⟹ supply of pounds is increasing with exchange.

Question 195

Where can the supply of the pound in the foreigne exchange market come from?

Answer 195

1. Firms, households and government purchases of foreign goods and services. 2. Central monetary authority for the purpose of influencing the exchange rate.

Question 196

If the central bank wishes to decreases the exchange rate what should they do

Answer 196

shift the supply curve right

Question 197

If the central bank wishes to increases the exchange rate what should they do

Answer 197

shift the supply curve left

Question 198

exchange rate regime

Answer 198

refers to the government’s policy with respect to how exchange rates are determined.

Question 199

fixed exchange rate

Answer 199

actions are taken by the central bank to fix exchange rates at a pre-determined level.

Question 200

floating exchange rate

Answer 200

the exchange rate is determined by the market for foreign exchange equilibrium.

Question 201

benefits of a fixed regime

Answer 201

- A fixed exchange rate regime provides stability. - This is attractive to foreign and domestic investors. - Can be used to avoid inflation (i.e. gives the central bank a money-supply target)

Question 202

cost of a fixed regime

Answer 202

- Central bank must always keep a large stock of foreign reserve. - If capital is perfectly mobility in and out of country, country will lose control of its interest rate.

Question 203

Nominal exchange rtae vs purchasing power

Answer 203

Nominal exchange rates reflect the exchange rate between different currencies, but they do not tell us about the purchasing power of different currencies.

Question 204

the real exchange rate

Answer 204

reflects the relative price of actual goods and services when measured in different currencies.

Question 205

real exchange rate calculation

Answer 205

Question 206

Purchasing power parity

Answer 206

the hypothetical nominal exchange rate that makes the same “basket of goods” in two countries cost the same.

Question 207

balance of payments

Answer 207

a record of all transactions between the residents of one country and the rest of the world.

Question 208

current account

Answer 208

measures the real value of trade balances (Exports-Imports). This was previously denoted by 𝑁𝑋 = 𝑋 − 𝑍 ≈ 𝐶𝐴.

Question 209

increasing and decreasing of the capital account

Answer 209

The current account is increasing in foreign income, decreasing in domestic income, and decreasing with the exchange rate.

Question 210

capital account

Answer 210

the difference between the value of domestic assets purchased by foreign investors and the value of foreign assets purchased by domestic investors.

Question 211

what does the capital account depend on

Answer 211

The capital account depends positively on the difference between the domestic interest rate and the foreign interest rate.

Question 212

Balance of payments equation

Answer 212

𝐵𝑃 = 𝐶𝐴 + 𝑘𝐴

Question 213

If 𝐶𝐴 > 0

Answer 213

then the country is in a current account surplus, income from foreign spending exceeds spending on foreign goods.

Question 214

If 𝐶𝐴 < 0

Answer 214

then the country is in a current account deficit, income from foreign spending is less than spending on foreign goods.

Question 215

In equilibrium the balance of payments must sum to

Answer 215

0

Question 216

what happends to the current account when domestic income increases

Answer 216

CA decrease

Question 217

what happends to the current account when foreign income increases

Answer 217

CA increases

Question 218

what happends to the current account when exchange rate increases

Answer 218

CA decreases

Question 219

what happens when the domestic interest rate is greater than the foreign interest rate

Answer 219

capital flows into the domestic economy and the capital account increases

Question 220

what happens when the domestic interest rate is less than the foreign interest rate

Answer 220

capital flows out of the domestic economy and the capital account decreases

Question 221

capital mobility

Answer 221

how easily can an investor move funds (financial capital) in and out of a country.

Question 222

perfect capital mobility means ..

Answer 222

that there are no impediments to funds flowing from one currency to another.

Question 223

An increase in domestic income will increase import demand, leading to a ...

Answer 223

current account deficit

Question 224

To solve the CA deficit and return to equilibrium what must happen

Answer 224

- Interest rates must rise. - Foreign investment flows in, increasing the capital account.

Question 225

Slope of the BP curve reflects the mobility of capital:

Answer 225

- Perfect capital mobility is reflected by a horizontal BP curve. - Perfectly immobile capital is reflected by a vertical BP curve.

Question 226

What happens when domestic interest rates are higher than foreign interest rates

Answer 226

demand for domestic currency increase, which leads to currency appreciation

Question 227

What happens when domestic interest rates are lower than foreign interest rates

Answer 227

demand for domestic currency decrease, which leads to currency depreciation.

Question 228

what happens to goods when the curency depreciaties e.g. ER decreases

Answer 228

domestic goods become relatively inexpensive

Question 229

what happens to goods when the curency appreciates e.g. ER increases

Answer 229

domestic goods become relatively expensive

Question 230

what happens to NX when the curency depreciaties

Answer 230

NX increases, AD shifts up

Question 231

what happens to NX when the curency depreciaties

Answer 231

NX decreases, AD shifts down

Question 232

When the domestic currency depreciates (e decreasing) - imports and exports

Answer 232

- Imports are becoming expensive relative to domestic goods - Foreigners find exports relatively cheap. - The IS curve shifts right. WIDEC

Question 233

When the domestic currency appreciates (e increasing) - imports and exports

Answer 233

- Imports are becoming cheap relative to domestic goods - Foreigners find exports relatively expensive. - The IS curve shifts left.

Question 234

Fiscal policy with a fixed ER

Answer 234

Consider an increase in government spending: - The domestic economy moves to point B. - At B, 𝑟 > 𝑟𝑓. - Demand for domestic currency leads to currency appreciation (𝑒 ↑). - To stop the appreciation, the Bank increases the supply of domestic currency. - The MP curve shifts to new equilibrium C. - Fiscal policy is effective in increasing output

Question 235

Monetary policy with a fixed ER

Answer 235

- Does not work.

Question 236

expansionary fiscal policy on a floating exchange rate

Answer 236

- The government increases spending, which shifts the IS curve right. - At domestic equilibrium B, 𝑟 > 𝑟𝑓. - This increase in domestic interest rates leads to an appreciation in the domestic currency. - Currency appreciation shifts the IS curve left (as net exports fall). - The economy shifts back to equilibrium A. - Fiscal policy is completely ineffective (crowds out exports).

Question 237

expansionary monetary policy on a floating exchange rate

Answer 237

- The money supply increases shifting the MP curve right. - At domestic equilibrium B, 𝑟 < 𝑟𝑓. - Reduction in the demand for domestic currency (for investment) ⇒ devaluation of currency. - The currency devaluation means that net exports increase ⇒ IS curve shifts right. - This happens until the new equilibrium at C is reached. - Monetary policy is effective.

Question 238

A decrease in foreign exchange rate (fixed)

Answer 238

- 𝑟𝑓 decreases, (holding 𝑒 and 𝑌𝑓 constant) - Domestic currency starts to appreciate (currency demand increase in foreign exchange). - Central bank responds by increasing the funds in foreign exchange market. - Domestic interest rate falls to foreign interest rate. - Investment and household spending increases in response to the lower interest. - Output increases

Question 239

A decrease in foreign exchange rate (floating)

Answer 239

- 𝑟𝑓 decreases, (holding 𝑒 and 𝑌𝑓 constant) - Domestic currency starts to appreciate (currency demand increase in foreign exchange). - Domestic goods are becoming expensive relative to foreign goods. - Net exports fall. - Money demand decreases, until domestic and foreign interest rates are equal. - Output falls overall.

Question 240

An increase to foreign exchange rate

Answer 240

- increase 𝑟𝑓, holding 𝑒 and 𝑌𝑓 constant. - At interest rate 𝑟1we are in a BP deficit. - Capital begins to leave the UK seeking the higher foreign interest rate, 𝑟1𝑓. - Domestic currency depreciates. - Currency depreciation leads to an increase in the demand for domestic goods and services, as well as an increase in the domestic interest rate.

Question 241

The quantity theory of money

Answer 241

The quantity theory of money states that the price level is directly proportional to the nominal money supply.

Question 242

what does the quantity theory of money suggest about nominal money supply and price level

Answer 242

A % change in nominal money supply → same % change in the price level.

Question 243

what is velocity

Answer 243

The speed at which the stock of money passes around the economy.

Question 244

what is the equation of exchange

Answer 244

𝑀𝑉 = 𝑃𝑌

Question 245

how do we calculate velocity

Answer 245

where PY is the nominal value of transactions and M is the money supply

Question 246

Why is inflation bad

Answer 246

- Shoe leather costs: The negative effects of inflation can be avoided by holding less money. This means that people will make more frequent trips to the bank to change their savings into cash. - Menu costs: It is costly for firms to change their prices. - Misallocation costs: If some businesses find it easier to change their prices than others, then inflation distorts the role of prices in reflecting the relative value of different goods and services.

Question 247

winners and losers from inflation

Answer 247

- Consider a mortgage. I borrow money from my bank and agree to pay back the nominal amount + interest in the future. - I use that money to purchase a house. - If there is unanticipated inflation the nominal value of the money, I pay back remains unchanged, however the real amount decreases. - My house maintains its real value (its nominal value increases). - Inflation benefits borrowers but hurts lenders.

Question 248

what happens if inflation is bad

Answer 248

a) The lending system can break down entirely, as lenders become unwilling to agree to nominal contracts. b) People want to change their nominal holdings into real holdings. This leads to more inflation.

Question 249

fisher equation

Answer 249

Question 250

What does the AD curve reflect

Answer 250

The AD curve reflects the quality of output demanded by the economy at any given price level.

Question 251

How does the price level effect aggregate demand - Consumption

Answer 251

Wealth effect. - Simple economy in which the only goods are food and clothing. - Individuals have a fixed nominal wealth. - Inflation increases the price of food and clothing by the same amount, but does not affect nominal wealth.

Question 252

How does the price level effect aggregate demand - Investment

Answer 252

Real interest rates

Question 253

How does the price level effect aggregate demand - Net exports

Answer 253

Exchange rate effect. - Foreign demand is increasing when the real value of domestic goods and services decreases.

Question 254

AS curve

Answer 254

The AS curve shows the total supply of goods and services in the economy at each price level (inflation).

Question 255

Where does supply come from?

Answer 255

- Firms making production decisions. - Individuals supplying labour. - Resources and production technologies available in the economy.

Question 256

On the AS curve, at low levels of output, below potential output:

Answer 256

- Capital is underutilized at current rents, - Labour is underutilized at current wages, - Firms and workers are always willing to provide more output with no effect on inflation.

Question 257

How does supply change with changes in the general price levels?

Answer 257

- If a firm that experiences a doubling in the cost of production and a doubling in the price of its goods will not change production. - Workers that experience a doubling of wages and a doubling of all prices will not change labour supply.

Question 258

Fiscal policy, Classical model - increase in government spending

Answer 258

1. The increase in 𝐺 causes aggregate demand to shift right. 2. Now 𝐴𝐷 > 𝐴𝑆, therefore the general price level starts to increases. 3. The increase in the general price level means households reduce their spending (negative wealth effect), net exports decreases. 4. At the new equilibrium, the general price level has increased, and government spending has lead to full crowding out of private spending (no change in 𝑌).

Question 259

monetary policy in the classical model - when inflation is greater than the bank's target

Answer 259

- If 𝜋0 > 𝜋∗ then the central bank can tighten its monetary policy (shift 𝑖𝑖 up). - This increases the real interest rate at all levels of inflation. - This will lead to a leftward shift in the AD curve.

Question 260

What is the output gap

Answer 260

Output gap reflects the deviation of output from its long-run trend (potential).

Question 261

Sticky wages

Answer 261

The classical model assumes that inflation reflects a uniform change across all prices and wages in the economy. - No relative price changes. - It must be that all prices are changing by the same amount at the same time.

Question 262

Reasons to question the assumption that wages adjust instantly:

Answer 262

Employees find it costly to leave their employer, even for higher wages elsewhere. Work contracts restrict the ability of firms to adjust employee hours and wages when market conditions change

Question 263

In the short-run, output is only affected by inflation when

Answer 263

𝑎𝑐𝑡𝑢𝑎𝑙𝑙𝑦 𝑖𝑛𝑓𝑙𝑎𝑡𝑖𝑜𝑛 ≠ 𝑒𝑥𝑝𝑒𝑐𝑡𝑒𝑑 𝑖𝑛𝑓𝑙𝑎𝑡𝑖𝑜𝑛

Question 264

𝑎𝑐𝑡𝑢𝑎𝑙 𝑖𝑛𝑓𝑙𝑎𝑡𝑖𝑜𝑛 > 𝑒𝑥𝑝𝑒𝑐𝑡𝑒𝑑 𝑖𝑛𝑓𝑙𝑎𝑡𝑖𝑜𝑛

Answer 264

output prices grow faster than wages. Firms increase output ⟹ positive output gap.

Question 265

a𝑐𝑡𝑢𝑎𝑙 𝑖𝑛𝑓𝑙𝑎𝑡𝑖𝑜𝑛 < 𝑒𝑥𝑝𝑒𝑐𝑡𝑒𝑑 𝑖𝑛𝑓𝑙𝑎𝑡𝑖𝑜𝑛

Answer 265

output prices grow slower than wages. Firms decrease output ⟹ negative output gap.

Question 266

what happens to wages in the long-run

Answer 266

In the long-run wages adjust to new inflation expectations and output returns to the potential output.

Question 267

aggregate labour market’s ability to clear depends on the time frame - SR

Answer 267

- Fluctuations in labour supply come largely from hours (as opposed to employment). - Employees can be asked to work more or fewer hours. - Wages are unlikely to change.

Question 268

aggregate labour market’s ability to clear depends on the time frame - MR

Answer 268

- Firms begin to adjust their permanent work force. - Employment contracts come up for renegotiation. - This puts pressure on wages.

Question 269

aggregate labour market’s ability to clear depends on the time frame - LR

Answer 269

- All contacts are renegotiated. - Wages fully adjust to new labour demand.

Question 270

The SAS curve can shfit fro two reasons

Answer 270

1. A change in the inflation expectations, 𝜋𝑒. 2. A supply shock.

Question 271

What does the SAS curve show

Answer 271

The relationship between the output gap and inflation.

Question 272

When output deviates from potential output, we see

Answer 272

a movement along the SAS curve.

Question 273

The slope of the SAS curve, 𝜃, reflects

Answer 273

how responsive prices/wages are to changes in inflation.

Question 274

When 𝜃 is close to 0

Answer 274

wage stickiness is high.

Question 275

A larger value of 𝜃 suggests

Answer 275

that wages are less sticky (close to the classical model).

Question 276

What happens following a negative demand shock

Answer 276

- AD falls and firms respond by lowering prices (but not wages) and output. - As time passes, inflation expectations change; firms and workers begin to renegotiate wage contracts. - After enough time, all wage contracts are renegotiated in line with new lower inflation expectations. Short run: Output falls (and employment) and then gradually increases, prices and wages gradually fall. Long-run: No change to output, lower prices and wages.

Question 277

What happens following a positive demand shock

Answer 277

- AD increases and firms respond by increasing prices (but not wages) and output. - As time passes, inflation expectations change; firms and workers begin to renegotiate wage contracts. - After enough time, all wage contracts are renegotiated in line with new higher inflation expectations. Short run: Output increases (and employment) and then gradually decreases, prices and wages gradually increase. Long-run: No change to output, higher prices and wages.

Question 278

A temporary shock to supply

Answer 278

Shift in short-run supply, but not long-run supply. - SAS shifts right, inflation falls below target at the current level of output. - Excess demand at lower prices drives up prices. Positive output gap (C). - Eventually, short-run supply shifts back to its original position (A).

Question 279

permanent shocks to supply

Answer 279

- Technology increase leads to higher productivity. - Both AS and SAS curves shifts right. - Inflation and output move to short-run equilibrium, B. - In the short run there is a negative output gap. - Firms and workers adjust their inflation expectations downwards, shifting the SAS curve right. - Inflation and output move to C.

Question 280

what are the banks 3 choices following a temporary shock in supply

Answer 280

1. Stabilize inflation. 2. Stabilize output. 3. Something in-between.

Question 281

what is the taylor rule

Answer 281

A Taylor rule describes this more complicated monetary policy - how responsive are nominal interest rates (𝑟) to deviations in inflation versus output.

Question 282

taylor rule in terms of nominal interest rates

Answer 282

𝑟 − 𝑟∗ = (1 + 𝑎)( 𝜋 − 𝜋∗) + 𝑏(𝑌 − 𝑌∗)

Question 283

What happens following an increase in government spending.

Answer 283

- AD increases - this leads to a positive output gap and increases inflation. - However, prices for output are increasing faster than wages. - Over time, inflation expectations change, and workers and firms renegotiate wages. - The output gap shrinks. - Eventually, all wages are renegotiated, so wage growth is back in line with inflation.

Question 284

The adjustment process when the central bank wishes to lower its target rate of inflation.

Answer 284

- Output falls as does inflation. Now growth in wages is greater than growth in output prices. - Overtime, workers and employers revise their inflation expectations and renegotiate wage contracts. - Eventually, when all wages are renegotiated, we return to the long run equilibrium, with a new lower inflation rate. - The adjustment to the new inflation rate necessitates a decline in output.

Question 285

What happens following a decrease in interest rate policy.

Answer 285

- Business investment and household consumption increase, shifting aggregate demand. - In the short-run, output and inflation both increases. - Over time, output begins to fall, but inflation continues to increase. - Eventually, output returns to its potential level, but inflation is much higher. - Cutting interest rates will exacerbate inflation!

Question 286

Two stabilization policy goals.

Answer 286

1. Minimize the size of the size of the output gap. 2. Keep inflation near target.

Question 287

What will happen if the supply and demand shift are both temporary?

Answer 287

With fiscal stimulus: - In the short run some output is recovered, but this may be at the expense of some excess inflation. - As the economy recovers, aggregate demand continues to shift right. - Workers and firms in the economy expect a higher level of inflation, so the short-run supply curve does not fully shift back.

Question 288

What is the natural rate of unemployment

Answer 288

The natural rate of unemployment is the unemployment observed when the economy is at its potential output. - In most economies this is thought to be a number around 5–6%.

Question 289

What does the Phillip curve describe

Answer 289

The Phillips curve describes a negative short-run relationship between inflation and unemployment.

Question 290

Maths of the Phillips Curve

Answer 290

Question 291

The short-run impact of a decrease in inflation

Answer 291

- Wage contracts are based on 𝜋0 = 𝜋𝑒. - Unexpectedly low inflation, 𝜋 < 𝜋0, means that wages are increasing faster than prices (output costs are relatively expensive). - In the short-run firms decrease output by cutting back on labour. - Unemployment increases.

Question 292

The short-run impact of an increase in inflation

Answer 292

- Wage contracts are based on 𝜋0 = 𝜋𝑒. - Unexpectedly high inflation, 𝜋 > 𝜋0, means that wages are increasing slower than prices (output costs are relatively cheap). - In the short-run firms increase output by hiring more labour. - Unemployment decreases.

Question 293

The short-run Phillips curve can shift for two reasons.

Answer 293

1. Inflation expectations change. 2. A change in firms’ desired demand for workers at the current level of wage growth (e.g. due to a change in production technology).

Question 294

The long-run natural rate of unemployment curve shifts for two reason.

Answer 294

- A permanent change in firms’ desired demand for workers at the current level of wage growth (e.g. due to a change in production technology). - Structural changes in the economy that reduce the natural rate of unemployment.

Question 295

What role do inflation expectations play in the macroeconomy?

Answer 295

Inflation expectations influence actual inflation. Deviations between natural unemployment and actual unemployment are related to the difference between actual and expected inflation.

Question 296

Consider an economy in which the elected government sets monetary policy

Answer 296

- The government announces a “tough on inflation” policy, changing the target from 𝜋0∗ to 𝜋1∗. - Increases interest rates, shifting the AD curve and increase short-run unemployment. - If the policy is credible, inflation expectations change, shifting SAS and PC.

Question 297

What if the policy announcement is not credible?

Answer 297

- No shift in SAS/PC, and only a modest decrease in inflation. - The government will be forced to abandon its tight monetary policy.

Question 298

The unemployment rate

Answer 298

The unemployment rate is the number of people who are without a job, but actively looking for work, (the unemployed) by the number of people in the labour force

Question 299

The labour force

Answer 299

The labour force is comprised of all people who are employed or are actively looking for work at the current wage rate. It does not include people who are out of the labour force.

Question 300

unemployment rate calculation

Answer 300

Question 301

Frictional (search) unemployment

Answer 301

Unemployment that arises from employees and employers taking time to find the right match. - Workers with specific skills need to find employers with a need for those skills. - Workers may have handicaps that make finding an employer match difficult.

Question 302

Structural unemployment

Answer 302

Unemployment that arises from workers needing to adjust to a change in the types of jobs available. - Redundant workers needing to upgrade or change their skill set

Question 303

Demand-deficient unemployment

Answer 303

unemployment that arises from a fall in aggregate demand (jobs generally become unavailable). This will only correct when aggregate demand returns to its long-run level.

Question 304

Classical unemployment

Answer 304

unemployment that is created when the wage is deliberately maintained above its equilibrium level. - For example: minimum wage laws or unions. - This can be thought of as a type of structural unemployment.

Question 305

Voluntary unemployment

Answer 305

Workers choose not to accept a job at the market wage rate. - This includes frictional and structural unemployment.

Question 306

Involuntary unemployment

Answer 306

Workers are willing to accept a job at the going wage rate, but cannot get a job offer. - This includes demand-deficient and classical unemployment.

Question 307

Natural rate of unemployment maths

Answer 307

Question 308

Voluntary and involuntary employment on a graph

Answer 308

- Unemployment is 𝑁4 − 𝑁2. - Voluntary unemployment is 𝑁4 − 𝑁3 - Involuntary unemployment is 𝑁3 − 𝑁2

Question 309

Supply-side economics requires the use of microeconomic incentives to alter

Answer 309

- The level of full employment. - The level of potential output. - The natural rate of unemployment

Question 310

Long-run supply side polices

Answer 310

In the long-run, the performance of the economy can only be changed by affecting the level of full employment and the corresponding level of potential output

Question 311

how can be the natural rate of unemplotment be altered by structural change

Answer 311

-Labour force mobility (between jobs and geographic). - Income support programmes. - Market competition (i.e. anticompetitive laws).

Question 312

other ways the natural rate of unemployment can be changed

Answer 312

- Changes in the age distribution. - Cultural factors (e.g. female labour force participation)

Question 313

Supply side policies that may change the natural rate of unemployment

Answer 313

- Restricting and reducing the power of unions. - Restrictions on income support programmes. - Reducing income taxes and taxes on firm profits. - Minimum/living wages. - Antitrust/competition laws. - Worker training programmes and requirements.

Question 314

impact of a decrease in unemployment benefits

Answer 314

Decreasing benefits changes the opportunity cost of remaining unemployed. This will result in a shift to the right of the AJ curve. - An increase in the number of people willing to accept employment at a given wage.