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macroeconomic 2partial Flashcards

1
Q

What is the Expected Present Discounted Value (PDV)?

A

The value today of an expected sequence of future payments.

[cite: 699]

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2
Q

How does the PDV relate to future payments and interest rates?

A

PDV depends positively on expected future payments and negatively on current and expected future interest rates.

[cite: 710, 711]

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3
Q

Formula for PDV with uncertain future payments and interest rates?

A

$EV_{t}=Ez_{t}+rac{1}{(1+i_{t})}Ez_{t+1}^{e}+rac{1}{(1+i_{t})(1+i_{t+1}^{e})}Ez_{t+2}^{e}+…$

[cite: 709]

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4
Q

Formula for PDV with constant interest rates (i) and constant payments (z) forever, starting next year?

A

$EV_{t}=rac{Ez}{i}$

[cite: 715]

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5
Q

What is the PDV of a sequence of payments if interest rates are zero?

A

The sum of the expected payments.

[cite: 717]

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6
Q

Define Discount Bonds vs. Coupon Bonds.

A

Discount bonds promise a single payment at maturity (face value). Coupon bonds promise multiple payments before maturity and one payment at maturity.

[cite: 727, 728]

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7
Q

What are the two main dimensions bonds differ in?

A

Risk (default risk, price risk) and Maturity.

[cite: 731, 732, 733]

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8
Q

What is the Yield Curve (or Term Structure of Interest Rates)?

A

The relation between bond yields and maturity.

[cite: 738]

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9
Q

What is the approximate relationship between the 2-year interest rate ($i_{2t}$) and 1-year rates ($i_{1t}$, $i_{1,t+1}^{e}$)?

A

$i_{2t}\approx\frac{1}{2}(i_{1,t}+i_{1,t+1}^{e})$.

[cite: 762]

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10
Q

What does an upward-sloping yield curve suggest about market expectations?

A

Financial markets expect short-term interest rates to be higher in the future.

[cite: 765]

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11
Q

What is the fundamental value of a stock ($Q_t$)?

A

The PDV of expected future dividends ($D^e$), discounted by the interest rate ($i$) plus an equity premium (x).

[cite: 789]

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12
Q

What are Rational Speculative Bubbles vs. Fads in asset pricing?

A

Bubbles: prices increase because investors expect them to increase. Fads: prices increase for no reason other than past increases, possibly due to irrational agents.

[cite: 812, 814, 815]

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13
Q

What two types of wealth determine consumption according to modern theory?

A

Human wealth (PDV of expected future after-tax labor income) and Non-human wealth (financial and housing assets).

[cite: 830, 836]

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14
Q

What is the core idea of the Permanent Income / Life Cycle theories of consumption?

A

Consumers look beyond current income and plan consumption over their entire lifetime to smooth it.

[cite: 832, 833, 853]

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15
Q

What does the Intertemporal Budget Constraint (IBC) show?

A

The available choices between present and future consumption given present and expected future income and the real interest rate.

[cite: 842]

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16
Q

How does consumption realistically depend on income and wealth?

A

$C_{t}=C(Total Wealth_{t}, Y_{t} - T_{t})$. It depends on both total wealth and current disposable income, especially with liquidity constraints.

[cite: 850, 860]

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17
Q

In what two ways do expectations affect consumption?

A
  1. Directly via human wealth (expected income/taxes/interest rates). 2. Indirectly via non-human wealth (asset prices like stocks, bonds, houses).

[cite: 861, 862]

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18
Q

What is ‘consumption smoothing’?

A

The tendency for consumers to want to maintain a relatively stable path of consumption over time, responding less than one-for-one to temporary changes in current or future income.

[cite: 853, 868]

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19
Q

What is the basic condition for a firm to undertake an investment?

A

The PDV of expected future profits from the investment must exceed its cost.

[cite: 880, 881]

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20
Q

What is the formula for the PDV of expected profits ($V(\Pi^e_t)$) from a machine, considering depreciation ($\delta$)?

A

$V(\Pi^{e}{t})=\frac{{\Pi^{e}}{t+1}}{1+r_{t}}+(1-\delta)\frac{{{\Pi^{e}}{t+2}}{(1+r{t})(1+{r^{e}}_{t+1})}+…$

[cite: 880]

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21
Q

What is the ‘rental cost’ (or user cost) of capital?

A

The sum of the real interest rate (r) and the depreciation rate ($\delta$), representing the implicit cost of using capital for a period.

[cite: 887]

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22
Q

How does aggregate investment ($I_t$) relate to the PDV of expected profits per unit of capital ($V(\Pi^e_t)$)?

A

Investment increases with the PDV of expected future profits: $I_{t}=I(V(\Pi^{e}_{t}))$ (+).

[cite: 885]

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23
Q

Why might current profits ($\Pi_t$) strongly influence current investment, beyond their effect on expected future profits?

A

Firms may face borrowing (liquidity) constraints; banks prefer lending to firms with high current profits.

[cite: 890, 891]

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24
Q

How does the volatility of investment compare to consumption?

A

Investment is much more volatile than consumption, though both tend to move together with output.

[cite: 901, 903]

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25
How is the IS relation modified to include expectations?
$Y=A(Y,T,r,Y^{\prime e},T^{\prime e},r^{\prime e})+G$. Aggregate private spending (A) now depends on expected future output ($Y^{\prime e}$), taxes ($T^{\prime e}$), and interest rates ($r^{\prime e}$). ## Footnote [cite: 911]
26
How do expectations of future Y, T, and r affect current private spending (A)?
Higher $Y^{\prime e}$ increases A (+). Higher $T^{\prime e}$ or $r^{\prime e}$ decreases A (-, -). ## Footnote [cite: 913, 914, 915, 916, 917]
27
Which variables shift the expectations-augmented IS curve LEFT?
Increases in current taxes (T), expected future taxes ($T^{\prime e}$), or expected future interest rates ($r^{\prime e}$). ## Footnote [cite: 918]
28
Which variables shift the expectations-augmented IS curve RIGHT?
Increases in government spending (G) or expected future output ($Y^{\prime e}$). ## Footnote [cite: 919]
29
Why is the expectations-augmented IS curve typically steeper than the standard IS curve?
A change in the current interest rate (r) has a smaller effect on spending if expected future rates ($r^{\prime e}$) don't change. ## Footnote [cite: 921, 922]
30
What determines the effectiveness of monetary policy (changing current 'r') in the expectations model?
Its effect on expectations ($Y^{\prime e}, r^{\prime e}$). If lowering 'r' also lowers $r^{\prime e}$ and raises $Y^{\prime e}$, the IS curve shifts right, amplifying the output effect. ## Footnote [cite: 924, 933]
31
In the standard model, what is the short-run effect of deficit reduction (lower G or higher T)?
It shifts the IS curve left, reducing output (Y). ## Footnote [cite: 940]
32
How can expectations potentially cause deficit reduction to *increase* short-run output?
If the plan is credible and leads to expectations of lower future interest rates ($r^{\prime e}$) and higher future output ($Y^{\prime e}$), this 'expectations effect' can shift the IS curve to the right, potentially offsetting the direct negative effect. ## Footnote [cite: 957, 959, 960]
33
What factors influence whether deficit reduction is expansionary in the short run?
Credibility, timing (backloading vs. frontloading), composition, initial debt levels, and accompanying monetary policy.
34
What is meant by 'backloading' a deficit reduction plan?
Concentrating the spending cuts or tax increases in the future rather than the present. ## Footnote [cite: 961]
35
What is the risk of backloading a deficit reduction plan?
It may lack credibility; markets might doubt the government will follow through on future cuts/increases. ## Footnote [cite: 962]
36
What are fiscal multipliers?
They measure the change in output (Y) resulting from a change in government spending (G) or taxes (T), considering both direct and expectation effects. ## Footnote [cite: 975]
37
What are the three dimensions of economic openness?
Openness in goods markets (trade), financial markets (capital flows), and factor markets (labor/firm mobility). ## Footnote [cite: 981]
38
Define Nominal Exchange Rate (E).
The price of the domestic currency in terms of foreign currency (e.g., $/€). E increases = appreciation; E decreases = depreciation. ## Footnote [cite: 1000, 1003]
39
Define Real Exchange Rate ($\epsilon$).
The price of domestic goods in terms of foreign goods. $\epsilon = EP/P^*$. ## Footnote [cite: 1011]
40
How do nominal (E) and real ($\epsilon$) exchange rates typically move relative to each other?
They tend to move largely together, as relative price levels (P/P*) change slowly. ## Footnote [cite: 1017, 1016]
41
What does openness in financial markets allow?
Investor diversification, speculation, and financing of trade imbalances (surpluses/deficits). ## Footnote [cite: 1024, 1025]
42
What is the Balance of Payments?
A record of a country's transactions with the rest of the world, divided into the Current Account and the Capital Account. ## Footnote [cite: 1030]
43
What does the Current Account (CA) balance represent?
Net exports (trade balance) + net income from abroad + net transfers received. ## Footnote [cite: 1028]
44
What does the Capital Account (KA) balance represent?
The change in foreign holdings of domestic assets minus the change in domestic holdings of foreign assets (net capital flows). ## Footnote [cite: 1045]
45
What is the theoretical relationship between the Current Account and Capital Account balances?
CA balance + KA balance = 0 (ignoring statistical discrepancy). A CA deficit implies a KA surplus, and vice versa. ## Footnote [cite: 1032, 1050]
46
Define GDP vs. GNP.
GDP: Value added domestically. GNP: Value added by domestically owned factors (GNP = GDP + net factor income from abroad). ## Footnote [cite: 1062, 1063, 1064]
47
What is the (Uncovered) Interest Parity Condition (UIP)?
The condition that expected returns on domestic and foreign bonds must be equal (arbitrage). $i_{t}\approx{i_{t}}^{*}-\frac{{E^{e}}_{t+1}-E_{t}}{E_{t}}$. ## Footnote [cite: 1076]
48
According to UIP, if the domestic interest rate ($i_t$) is higher than the foreign rate ($i_t^*$), what must financial markets expect about the exchange rate?
They must expect the domestic currency to depreciate. ## Footnote [cite: 1079]
49
What is the equation for the demand for domestic goods (Z) in an open economy?
$Z=C+I+G+X-IM/\epsilon$, where X is exports, IM is imports, and $\epsilon$ is the real exchange rate. ## Footnote [cite: 1096]
50
What determines Imports (IM)?
Positively on domestic income (Y) and positively on the real exchange rate ($\epsilon$). $IM = IM(Y, \epsilon)$ (++) ## Footnote [cite: 1100]
51
What determines Exports (X)?
Positively on foreign income (Y*) and negatively on the real exchange rate ($\epsilon$). $X = X(Y^*, \epsilon)$ (+-) ## Footnote [cite: 1102]
52
Define Net Exports (NX).
$NX = X - IM/\epsilon$. Assuming P, P* constant, $NX = NX(Y, Y^*, E)$ (-, +, -). ## Footnote [cite: 1108]
53
What determines Exports (X)?
Positively on foreign income (Y*) and negatively on the real exchange rate (ε). X = X(Y*, ε) ## Footnote [cite: 1102]
54
Define Net Exports (NX).
NX = X - IM/ε. Assuming P, P* constant, NX = NX(Y, Y*, E) ## Footnote [cite: 1108, 1109]
55
What is the IS relation in an open economy?
Y = C(Y-T) + I(Y,i) + G + NX(Y,Y*,E) ## Footnote [cite: 1109]
56
What is the effect of an increase in government spending (G) on output (Y) and net exports (NX) in an open economy?
Y increases (but by less than in a closed economy) and NX decreases (trade deficit) ## Footnote [cite: 1112, 1114]
57
What is the effect of an increase in foreign income (Y*) on domestic output (Y) and net exports (NX)?
Y increases and NX increases (trade surplus) ## Footnote [cite: 1119, 1122]
58
What condition ensures that a real depreciation (lower ε or E) increases Net Exports (NX)?
The Marshall-Lerner condition ## Footnote [cite: 1133]
59
Assuming Marshall-Lerner holds, what is the effect of a depreciation (lower E) on output (Y) and net exports (NX)?
Y increases and NX increases (trade balance improves) ## Footnote [cite: 1134]
60
If a country has output at potential (Yn) but a large trade deficit (NX<0), what policy mix can address both issues?
A depreciation (to increase NX) combined with fiscal contraction (lower G, to reduce Y back to Yn) ## Footnote [cite: 1139]
61
What is the J-Curve effect?
Following a depreciation, the trade balance (NX) often worsens initially before improving over time (6-12 months) as export/import quantities adjust ## Footnote [cite: 1156, 1155]
62
What is the relationship between total saving (S), investment (I), and net exports (NX) in an open economy?
S = I + NX. A trade surplus (NX > 0) means S > I (lending abroad); a trade deficit (NX < 0) means I > S (borrowing abroad) ## Footnote [cite: 1160, 1161, 1162]
63
How does openness affect the size of the fiscal multiplier (ΔY / ΔG)?
The fiscal multiplier is lower in an open economy than in a closed one, because some increased demand 'leaks' into imports. It's smaller in countries with higher import propensities ## Footnote [cite: 1170, 1171]
64
What model combines the IS-LM framework with open economy considerations (goods and financial markets)?
The Mundell-Fleming model ## Footnote [cite: 1180]
65
In the Mundell-Fleming model, what is the open economy IS relation?
Y = C(Y-T) + I(Y,i) + G + NX(Y,Y*,E) ## Footnote [cite: 1181]
66
What is the LM relation in the modern interpretation used here?
The central bank sets the interest rate: i = ī (horizontal LM curve) ## Footnote [cite: 1195]
67
What equation links the interest rate (i) and the exchange rate (E) in financial markets?
The Interest Parity Condition: E = (1+i)/(1+i*)Ēe (assuming expected future exchange rate Ēe is given) ## Footnote [cite: 1182]
68
According to interest parity, how does the current exchange rate (E) react to an increase in the domestic interest rate (i)?
E increases (domestic currency appreciates) ## Footnote [cite: 1182]
69
According to interest parity, how does the current exchange rate (E) react to an increase in the foreign interest rate (i*)?
E decreases (domestic currency depreciates) ## Footnote [cite: 1183]
70
In the Mundell-Fleming model, why is the IS curve downward sloping?
An increase in the interest rate (i) reduces output (Y) both directly (lower investment I) and indirectly via exchange rate appreciation (lower net exports NX) ## Footnote [cite: 1196]
71
What are the effects of a monetary contraction (increase in i) in the Mundell-Fleming model?
Output (Y) decreases, and the exchange rate (E) increases (appreciation) ## Footnote [cite: 1198]
72
What are the effects of a fiscal expansion (increase in G) if the central bank keeps the interest rate (i) constant?
Output (Y) increases, and the exchange rate (E) remains unchanged ## Footnote [cite: 1199, 1200]
73
What does 'Fixed Exchange Rates' mean?
A country pegs its currency's nominal exchange rate to another currency or a basket of currencies, often within certain bands ## Footnote [cite: 1207, 1209]
74
Under perfect capital mobility and fixed exchange rates, what must be true about the domestic interest rate (i)?
It must equal the foreign interest rate (i*): i = i* ## Footnote [cite: 1211]
75
What policy tool does a central bank give up under fixed exchange rates and perfect capital mobility?
Independent monetary policy (the ability to set its own interest rate) ## Footnote [cite: 1212]
76
What is the 'impossible trinity' in international macroeconomics?
It's impossible for a country to simultaneously have: 1. Fixed exchange rates, 2. Perfect capital mobility, and 3. Independent monetary policy ## Footnote [cite: 1226]
77
What is the real exchange rate formula?
ε = EP/P* ## Footnote [cite: 1244]
78
In the medium run, how can the real exchange rate (ε) adjust even if the nominal rate (E) is fixed?
Through changes in the relative price levels (P/P*). If a country is in recession (Y < Yn), its inflation (π) tends to be lower, causing P to rise slower than P*, leading to a real depreciation (lower ε) over time ## Footnote [cite: 1245, 1251, 1252, 1255]
79
Is medium-run adjustment via relative price changes fast or slow under fixed exchange rates?
It can be long and painful, potentially requiring output to be below potential for a long time ## Footnote [cite: 1256]
80
What is a faster way to achieve real depreciation under a fixed regime?
A one-time devaluation (a discrete decrease in the fixed nominal rate E) ## Footnote [cite: 1257]
81
What can trigger an exchange rate crisis under fixed exchange rates?
Expectations that a devaluation is coming ## Footnote [cite: 1261]
82
If markets expect a devaluation (expect Et+1^e to be lower than Et), what does the UIP condition imply is needed to maintain the peg?
The domestic interest rate (it) must increase significantly ## Footnote [cite: 1260]
83
What are the government's options when facing expectations of devaluation?
1. Give in and devalue. 2. Fight to maintain the peg by raising interest rates (risking recession) and selling foreign reserves ## Footnote [cite: 1262, 1263]
84
Under flexible exchange rates, what does the interest parity condition imply about E?
Today's exchange rate (E) depends on the *entire* expected future path of domestic and foreign interest rates and the long-run expected exchange rate ## Footnote [cite: 1268]
85
Why are flexible exchange rates often volatile?
Because they react to any news that changes expectations about future interest rates or the future exchange rate ## Footnote [cite: 1271]
86
What are the two main arguments/exceptions for choosing fixed exchange rates over flexible ones?
1. If countries form an optimal currency area (experience similar shocks or have high factor mobility). 2. If the central bank lacks credibility for responsible monetary policy (fixed rates 'tie its hands') ## Footnote [cite: 1274, 1275]
87
What is an Optimal Currency Area (OCA)?
A group of countries for which adopting a common currency (or permanently fixed rates) is beneficial. Conditions include similar shocks or high factor mobility ## Footnote [cite: 1277, 1278]
88
What is Dollarization?
Replacing the domestic currency entirely with a foreign currency (like the US dollar) ## Footnote [cite: 1290]
89
What is a Currency Board?
An arrangement where the central bank commits to exchange foreign currency for domestic currency at a fixed rate on demand, severely limiting its monetary policy independence ## Footnote [cite: 1290]
90
What is the government budget constraint relating debt change (Bt - Bt-1) to the deficit?
Bt - Bt-1 = rBt-1 + Gt - Tt, where rBt-1 are real interest payments and Gt - Tt is the primary deficit ## Footnote [cite: 1307]
91
Define Primary Deficit and Primary Surplus.
Primary Deficit = Gt - Tt (Gov spending minus taxes, excluding interest). Primary Surplus = Tt - Gt ## Footnote [cite: 1309]
92
If a government cuts taxes by 1 today (B0=1) and wants to fully repay the debt in year t, running zero primary balances until then, what must the primary surplus be in year t?
Tt - Gt = (1+r)^t ## Footnote [cite: 1314, 1315]
93
If a government has debt Bt-1 and wants to stabilize the debt (Bt = Bt-1), what must its primary balance (Tt - Gt) be?
It must run a primary surplus equal to the real interest payments on the debt: Tt - Gt = rBt-1 ## Footnote [cite: 1317, 1321]
94
Write the government budget constraint in terms of the debt-to-GDP ratio (b = B/Y).
b_t - b_{t-1} = (r-g)b_{t-1} + (Gt - Tt)/Yt, where g is the output growth rate ## Footnote [cite: 1325]
95
What determines the change in the debt-to-GDP ratio?
It increases with the real interest rate (r), the initial debt ratio (b_{t-1}), and the primary deficit ratio. It decreases with the output growth rate (g) ## Footnote [cite: 1325]
96
Under what condition can the debt-to-GDP ratio stabilize even with primary deficits?
If the output growth rate (g) is greater than the real interest rate (r) ## Footnote [cite: 1338, 1340]
97
Under what condition will the debt-to-GDP ratio explode if the government runs persistent primary deficits?
If the real interest rate (r) is greater than the output growth rate (g) ## Footnote [cite: 1329, 1331]
98
What is the Ricardian Equivalence (or Ricardo-Barro) proposition?
The idea that financing government spending through debt or taxes is equivalent; forward-looking consumers anticipate future taxes required to repay debt and increase saving now, neutralizing the effect of the deficit on demand ## Footnote [cite: 1347, 1348, 1349]
99
Is Ricardian Equivalence generally considered to hold perfectly in reality?
No, budget deficits likely still affect the economy, perhaps because consumers are not fully forward-looking or face borrowing constraints, but the effect might be smaller than simple models suggest ## Footnote [cite: 1351, 1352]
100
What is a Cyclically Adjusted (or Structural / Full-Employment) Deficit?
An estimate of what the budget deficit would be if the economy were operating at its potential output level (Yn). It adjusts the actual deficit for the effects of the business cycle ## Footnote [cite: 1356]
101
Why might governments finance wars largely through deficits?
To smooth taxes over time (avoiding very high, distorting taxes during the war) and pass some cost burden to future generations ## Footnote [cite: 1362, 1365]
102
What is Seignorage?
The revenue, in real terms, that the government generates by creating money (ΔH / P) ## Footnote [cite: 1378]
103
What can financing large deficits through Seignorage lead to?
High inflation (hyperinflation) ## Footnote [cite: 1380]
104

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