Session 5&6 Flashcards
1
Q
Transfer payment
A
a payment made to individuals by the federal government through various social benefit programs.
One-way payment of money for which no money, good, or service is received in exchange. Governments use such payments as means of income redistribution by giving out money under social welfare programs such as social security, old age or disability pensions, student grants, unemployment compensation, etc. Subsidies paid to exporters, farmers, manufacturers, however, are not considered transfer payments. Transfer payments are excluded in computing gross national product.
2
Q
Stagnation
A
rokud, kesadi
recession, depression
3
Q
Contraction
A
enghebaz
the general contraction of the industry did further damage to morale
synonyms: shrinking
4
Q
Fractional reserve banking
A
A banking system in which only a fraction of bank deposits are backed by actual cash-on-hand and are available for withdrawal. This is done to expand the economy by freeing up capital that can be loaned out to other parties. Most countries operate under this type of system.
5
Q
Bank reserve
A
Bank reserves are the currency deposits which are not lent out to the bank’s clients. A small fraction of the total deposits is held internally by the bank or deposited with the central bank. Minimum reserve requirements are established by central banks in order to ensure that the financial institutions will be able to provide clients with cash upon request.
The main purpose of holding reserves is to avoid bank runs and generally appear solvent. Central banks place these restrictions on banks, because the banks can earn a much larger return on their capital by lending out money to clients rather than holding cash in their vaults or depositing it with other institutions. Bank reserves decrease during periods of economic expansion and increase during recessions.
6
Q
NAFTA
A
The North American Free Trade Agreement (NAFTA), is an agreement signed by Canada, Mexico, and the United States, creating a trilateral rules-based trade bloc in North America. The agreement came into force on January 1, 1994. It superseded the Canada–United States Free Trade Agreement between the U.S. and Canada.
7
Q
Eurozone
A
The eurozone, officially called the euro area, is a monetary union of 19 of the 28 European Union (EU) member states which have adopted the euro (€) as their common currency and sole legal tender. The other nine members of the European Union continue to use their own national currencies.
The eurozone consists of Austria, Belgium, Cyprus, Estonia, Finland, France, Germany, Greece, Ireland, Italy, Latvia, Lithuania, Luxembourg, Malta, the Netherlands, Portugal, Slovakia, Slovenia, and Spain. Other EU states (except for Denmark and the United Kingdom) are obliged to join once they meet the criteria to do so. No state has left, and there are no provisions to do so or to be expelled. Andorra, Monaco, San Marino, and Vatican City have formal agreements with the EU to use the euro as their official currency and issue their own coins. Kosovo and Montenegro have adopted the euro unilaterally, but these countries do not officially form part of the eurozone and do not have representation in the European Central Bank (ECB) or in the Eurogroup.
8
Q
Free economic zones
A
Free economic zones (FEZ) or free zones (FZ) are a class of special economic zone (SEZ) designated by the trade and commerce administrations of various countries. The term is used to designate areas in which companies are taxed very lightly or not at all in order to encourage economic activity. The taxation rules are determined by each country. The World Trade Organization (WTO) Agreement on Subsidies and Countervailing Measures (SCM) has content on the conditions and benefits of free zones.
9
Q
Free trade zones
A
A free trade zone (FTZ) is a specific class of special economic zone. They are a geographic area where goods may be landed, handled, manufactured or reconfigured, and reexported without the intervention of the customs authorities. Only when the goods are moved to consumers within the country in which the zone is located do they become subject to the prevailing customs duties. Free-trade zones are organized around major seaports, international airports, and national frontiers—areas with many geographic advantages for trade. It is a region where a group of countries has agreed to reduce or eliminate trade barriers. Free trade zones can also be defined as labor-intensive manufacturing centers that involve the import of raw materials or components and the export of factory products.
10
Q
Sovereign wealth fund
A
sandoghe zakhire arzi
Pools of money derived from a country’s reserves, which are set aside for investment purposes that will benefit the country’s economy and citizens. The funding for a sovereign wealth fund (SWF) comes from central bank reserves that accumulate as a result of budget and trade surpluses, and even from revenue generated from the exports of natural resources. The types of acceptable investments included in each SWF vary from country to country; countries with liquidity concerns limit investments to only very liquid public debt instruments.
Some countries have created SWFs to diversify their revenue streams. For example, the United Arab Emirates (UAE) relies on oil exports for its wealth. Therefore, it devotes a portion of its reserves to an SWF that invests in other types of assets that can act as a shield against oil-related risk.
11
Q
Sovereign
A
possessing supreme or ultimate power.
in modern democracies the people’s will is in theory sovereign
synonyms: supreme,
12
Q
Crawling peg exchange rate
A
A system of exchange rate adjustment in which a currency with a fixed exchange rate is allowed to fluctuate within a band of rates. The par value of the stated currency is also adjusted frequently due to market factors such as inflation. This gradual shift of the currency’s par value is done as an alternative to a sudden and significant devaluation of the currency.
13
Q
Residual
A
baghimande
the withdrawal of residual occupying forces.
synonyms: remaining, leftover,
14
Q
Reconcile
A
solh dadan, TATBIGH DADAN
restore friendly relations between.
she wanted to be reconciled with her father
15
Q
Contingency (accounting)
A
a liability dependent on a future event. (like legal proceedings)
16
Q
Proxy statement
A
A document containing the information that a company is required by the SEC to provide to shareholders so they can make informed decisions about matters that will be brought up at an annual stockholder meeting.
17
Q
Provision (accounting)
A
an estimated liability.
Prudence–> we should provide for expenses as soon as they are foreseeable–> they’re expenses in income statement and liabilities in balance sheet (like restructuring provision or tax expense in income statement)
18
Q
Federal funds rate
A
The federal funds rate is an important benchmark in financial markets. The interest rate that the borrowing bank pays to the lending bank to borrow the funds is negotiated between the two banks, and the weighted average of this rate across all such transactions is the federal funds effective rate.
19
Q
Non borrowed reserves
A
‘Non-Borrowed Reserves’ A measure of the reserves in the banking system. Non-borrowed reserves represent the numerical difference between total reserves minus funds that have been borrowed from the Fed discount window.
20
Q
Bank reserves
A
Bank reserves or central bank reserves are banks’ holdings of deposits in accounts with their central bank (for instance the European Central Bank or the Federal Reserve, in the latter case including federal funds), plus currency that is physically held in the bank’s vault (“vault cash”).
21
Q
Lender of last resort
A
An institution, usually a country’s central bank, that offers loans to banks or other eligible institutions that are experiencing financial difficulty or are considered highly risky or near collapse.
22
Q
Bailout
A
A situation in which a business, individual or government offers money to a failing business in order to prevent the consequences that arise from a business’s downfall. Bailouts can take the form of loans, bonds, stocks or cash.
23
Q
Fractional reserve banking
A
Fractional-reserve banking is the practice whereby a bank accepts deposits, and holds reserves that are a fraction of the amount of its deposit liabilities. Reserves are held at the bank as currency, or as deposits in the bank’s accounts at the central bank. Fractional-reserve banking is the current form of banking practiced in most countries worldwide.
24
Q
Full reserve banking
A
Full-reserve banking (also known as 100% reserve banking) is an alternative to fractional reserve banking in which banks are required to keep the full amount of each depositor’s funds in cash, ready for immediate withdrawal on demand. Funds deposited by customers in demand deposit accounts (such as checking accounts) would not be loaned out by the bank because it would be legally required to retain the full deposit to satisfy potential demand for payments. Proposals for full reserve banking systems generally do not place such restrictions on deposits that are not payable on demand, for example time deposits.
25
Natural monopoly
Average cost of production is falling over the relevant range of consumer demand. So having more than one producer would result in a significantly higher cost
26
Network effect
=synergies
A source of market power. Makes it very difficult to compete with a company once it has reached a critical level of marker penetration
27
Economic rent
economic rent is used to describe a payment to a factor of production above it's value in it's next highest valued use (it's opportunity cost).
Economic rent is the positive difference between the actual payment made for a factor of production (such as land, labor or capital) to its owner and the payment level expected by the owner, due to its exclusivity or scarcity.
fek konam mosavie supplier surplus beshe.
28
Rent seeking
When a company, organization or individual uses their resources to obtain an economic gain from others without reciprocating any benefits back to society through wealth creation.
An example of rent-seeking is when a company lobbies the government for loan subsidies, grants or tariff protection. These activities don't create any benefit for society, they just redistribute resources from the taxpayers to the special-interest group.
29
Common value auction
| Private value auction
1. common value: value of the auctioned item is the same to all of the bidders, but they don't know that value at the time of the auction. (e.g., oil lease, IPO, jar of quarters!)
* the bidder who most overestimates wins= winner's curse
2. private value: usually of art and collectibles, bidders bid the value of the item to them and no more
30
Ascending price auction
=english
bidders can bid an amount greater than the previous high bid and the bidder that first offers the highest bid of the auction wins and pays the bid.
31
Sealed bid auction
each bidder provides one bid, which is unknown to other bidders. the bidder submitting the highest bid wins and pays the bid.
* reservation price: the highest price that a bider is willing to pay
* optimal bid for the bidder with highest reservation price: slightly above that of the second high value bidder. --->> bids are not always necessarily equal to bidders' reservation price
32
Second price sealed bid auction
= vickery
the bidder submitting the highest bid wins the item but pays the amount bid by the second highest bidder.
*in this type, there is no reason for a bidder to bid less than his reservation price.
33
Descending price auction
= dutch
begins with a price greater than what any bidder will pay and this offer price is reduced until a bidder agrees to pay it. (if there are several items, the winner can take for example 3 of 10 and then the auction continues.
*Modified version: winning bidders all pay the same price, which is the reservation price of the bidder whose bid wins the last units offered.
34
Network effect
Agar sherkat az haddi bozorgtar she va sahme bishtari peyda kone dge maziatayi dare ke reghabato hahash kheyli sakht mikone
35
Quotas
government imposed production limits.
36
Giffen good
is an inferior good for which the negative income effect outweighs the positive substitution effect when price falls. (theoretically supported by rules of consumer choice)
*is theoretical and have an upward sloping demand curve
37
Veblen good
a higher price makes the good more desirable
*vs giffen: not inferior, not theoretically supported
38
Accounting profit
total revenue - total accounting (explicit) costs
39
Economic profit
accounting profit - implicit opportunity costs
40
Normal profit
the accounting profit that makes economic profit zero. (long term equilibrium)
41
Supply function under each market structure
1. perfect competition: (short run) what we talked about from the beginning, a defined function between P and Q, it's the firm's MC function above AVC and market's short run supply function is sum of the quantities supplied under at each price. for long run supply function can change by a change in firm's capacity and scale
2. other markets: there is no well defined supply function because they all face downward sloping demand curves and the quantity supplied is determined by the intersection of marginal cost and revenue and the price is determined by the demand curve the firm is facing.
* *dar vague supply be MR va MC va gheymat vibists ke ina khodeshun be Q va nemudarashun bastegi daran, tuye reghabate kamel chon MR=P va sabet bud mishod supply ro be surate faghat tabeE az P nevesht amma tu baghieye bazara intor nist va nemishe inkaro kard.
42
Identifying market structures
examining pricing power of firms. measuring elasticity of demand directly is very difficult, so we use concentration measures:
1. N-firm concentration ratio: percentage of market sales accounted for by the N largest firms in the industry.
* it does not directly measure market power or elasticity of demand
* limitation: not sensitive to mergers
2. Herfindahl Hirschman index (HHI): sum of the squares of the market shares of the largest firms in the market
* a problem of both methods: not considering barriers to entry, if barriers to entry is low and there is potential competition even firms with high market share face high elasticity demands and cannot increase their prices.
43
Pricing strategy under each market
1. perfect competition: price taker
2. monopoly: MR=MC
3. monopolistic competition: like monopoly
4. oligopoly:
* kinked d curve: kink price
* collusion: like monopoly
* dominant firm model: dominant firm price (MC=MR)
* game theory: don know!
44
GDP calculation concepts
* MARKET value of FINISHED goods/services.
* PRODUCED (not sold) in this year
* new (not sold before)
* goods and services provided by the government are included even though not priced in market (police, jurisdiction, ...)
* transfer payments not included
* rent and value of owner occupied housing is included.
* value of labor not sold (like housewives) not included.
* two different approaches (each method would fall under one of these) for calculation: expenditure approach (amount spent on goods/services) and income approach (amount earned by producing)- two approaches must give equal answers but due to measurement issues there are differences.
45
Value of final output method
an exp app for GDP.
| summing the values of all goods and services produced.
46
Sum of value added method
an exp app for GDP.
| summing the additions to value created at each stage of production and DISTRIBUTION
47
Nominal vs real GDP
by looking at GDP from exp app, nominal GDP is the total value of all goods and services produced by an economy, valued at current market prices.
real GDP: valued at prices from a base year.
48
GDP deflator
a price index that can be used to convert nominal GDP to real.
GDP deflator: nominal/real *100
49
Expenditure approach method (macro view)
| Income approach method (macro view)
Exp: GDP = C+I+G+(X-M)
* C= consumption spending
* I= business investment (capital equipment, inventories)
* G= government spending
* X= exports
* M= imports
Income: GDP = national income+capital consumption allowance+statistical discrepancy
* capital consumption allowance (CCA): measures the depreciation of physical capital in a period.
* statistical discrepancy: an adjustment for the difference between exp and inc
50
GDP method, income expenditure
GDP = income = C+S+T
* C= consumption spending
* S= household and business savings
* T= net taxes (tax paid minus transfer payment received)
51
National income
sum of income received by all factors of production.
=compensation of employees
+corporate and government enterprise profits before taxes.
+interest income
+business owners income
+rent
+indirect business taxes - subsidies
52
Personal income
```
=national income
+transfer payments to households
-indirect business taxes
-corporate income taxes
-undistributed corporate profits
```
53
Personal disposable income (PDI)
=personal income - personal taxes
54
Savings relationship
C+I+G+(X-M) = C+S+T
-->
S= I+(G-T)+(X-M)
G-T = fiscal balance
(positive: budget deficit, negative: budget surplus)
X-M = net exports or trade balance
(positive: trade surplus, negative: trade deficit)
55
Fiscal balance
G-T = (S-I)-(X-M)
a government deficit must be financed by a combination of trade deficit (which is itself financed by foreign investment) and an excess of private savings over private investment (domestic capital)
56
IS (income-davings) curve
*equilibrium in the goods market (income = expenditure)
(S-I) = (G-T) + (X-M)
1. increase in income increases savings more than investments--> increase in S-I as income increases.
2. increase in income decreases fiscal balance because it increases tax incomes and decreases trade balance because it increases imports
57
LM (liquidity-money) curve
*equilibrium in the money market
58
MPC/MPS
marginal propensity to consume/save
MPS +MPC = 100%
parts of disposable income: save- invest
59
Macroeconomics flow
```
GDP
IS-LM--> aggregate demand
aggregate supply
equilibrium and disequilibrium analysis
economic growth
----
business cycles
unemployment
inflation
----
monetary policy
fiscal policy
```
60
Inventory/sales ratio (status in cycles)
* early in contraction--> sales slow--> increase in inventory levels--> increase in ratio
* early in expansion: decrease
61
Labor and capital utilization (status in cycles)
* contraction: fall in sales--> L and K less used
* expansion: opposite
faaz?!!--> mikhad bege stickyness dare, estefade az K o L kam mishe vali tul mikeshe ta masalan sherkat niru ensanisho kam kone
62
Trade sector and relation to business cycles
* Imports: depend on domestic business cycle
* Export: depend on foreign business cycle
* both are affected by currency depreciation or appreciation
63
Business cycle theories
school of thought/ cause of cycles/ *recommended policy*:
1. Neoclassics/different rates of technology changes over time/ allow wages and prices to adjust to settle over and under employment GDPs and come to equilibrium (self correcting)
2. Keynesian/ AD dhifts with changes in business expectations, contractions persist due to downward sticky wages (cannot simply self correct)/ use fiscal and monetary policies to restore full employment
3. New keynesian/ same as keynesians but believe other input prices are also downward sticky/ same as keynesians
4. Monetarists/ inappropriate changes in money supply growth rate (affects AD)/ steady, predictable growth rate of money supply
5. Austrians/ government intervention in economy/ don't force interest rates to artificially low levels
6. new classical (real business cycle theory)/ rational responses to external shocks, technology changes/ don't intervene to counteract business cycles
64
growth rate of money supply
monetarists believe money supply should grow as the same rate as the economy, if the economy has grown 3%, money supply should also grow at 3% to support that
65
Types of unemployment
1. frictional: results from time it takes employers and employees to find each other.
2. structural: results from long term changes in the economy that requires workers to gain new skills to fill new jobs.
3. cyclical: results from changes in economic growth, equals 0 at full employment (does't mean that unemployment is zero, just the cyclical)- cyclical unemployment can be negative in over employment cycles.
66
Unemployment definition
| Unemployment rate
* to be counted as unemployed, a person should be available for work and actively looking for work.
* unemployment rate= number of unemployed/ labor force
* labor force: employed + unemployed!!
67
Participation ratio
labor force/ working age population (>16)
68
Discouraged workers
those who are available for work but not employed or seeking employment, so not in labor force and not counted as unemployed.
69
Inflation
Disinflation
Deflation
Hyperinflation
1. persistent increase in price levels
2. decrease in positive inflation rate over time
3. persistent decrease in price level over time, negative inflation rate
4. out of control high inflation
70
Inflation indexes
price indexes
a price index is a weighted average of goods and services prices compared to a base period.
1. CPI: measures the cost of a fixed basket of goods and services compared to the cost in base year.
2. price index for personal consumption expenditures: surveys businesses instead of consumers
3. GDP deflator
4. producer price index: on crude materials, intermediate goods, finished goods prices, should show inflation before it hits consumers
71
Headline and core inflation
* headline: price indexes that include all goods and services.
* core: prices of all goods excluding food and energy, because they are subject to large short term fluctuations that can magnify or mask the true inflation rate.
72
Adjustments for CPI biases
* CPI = laspeyers: uses basket weights from base period.
* Paasche index: uses basket weights from current period and compares cost to base period.
* chained price index: reduces bias from substitution, e.g., fisher index: geometric mean of lapsers and paste indexes.
73
NAIRU
non accelerating inflation rate of unemployment.
the lowest unemployment rate that will not induce wage push inflation, also called natural rate of unemployment
*likely varies over time and across countries
74
Leading indicators
a group of economic indicators.
*the indicator peaks before the economy peaks.
*weekly hours for manufacturing workers
*stock prices
*yield curve
*manufacturers' new orders
*unemployment insurance claims
...
75
Coincidence indicators
a group of economic indicators.
*the indicator peaks with the economy.
* employees on nonfarm payrolls
* Industrial production
* personal income less transfer payments
* manufacturing and trade sales
76
Lagging indicators
a group of economic indicators.
*the indicator peaks after the economy.
*unemployment rate
*duration of unemployment
*inventory/sales ratio
...
77
Monetary policy
management of supply of money and credit (or rate of growth of supply)
* expansionary: increase the money supply, will cause a decrease in interest rates and therefore increases aggregate demand.
* contractionary: decrease the money supply, increase interest rates, slow economic growth and inflation.
78
Fiscal policy
government decisions on taxing and spending
* expansionary: increase spending and/or decrease taxes, will cause an increase in budget deficit and therefore will increase aggregate demand.
* contractionary: decrease spending and/or increase taxes, decrease the budget deficit, reduce aggregate demand
79
Functions of money
1. medium of exchange
2. unit of account
3. store of value
80
Narrow money
| Broad money
1. no interest payment: currency in circulation-- checkable deposits-- travelers checks
2. narrow money + savings deposits-- time deposits
81
How banks create money
in fractional reserve banking:
saves a fraction, loans the rest!
theoretically, the rest can be deposited and loan out again, so:
1000 in --> 800+640+512+ ... out
*Potential increase in money supply: Sum= 1000/1-0.8= 5000
*Maximum deposit expansion multiplier= 1/1-0.8
(1-0.8 = required reserve ratio)
82
Demand for money
1. transaction demand: increases with GDP
2. precautionary demand: held for unforeseen future, increases with GDP
3. speculative demand: held to take advantage of future investment opportunities, smaller when current returns are high, greater when risk in perceived to be high
83
Supply of money
The entire stock of currency and other liquid instruments in a country's economy as of a particular time. The money supply can include cash, coins and balances held in checking and savings accounts.
*is set by the monetary authority, central bank
84
Fisher effect
riskless nominal interest rate=
real risk rate + expected inflation
modification: uncertainty about future cash inflation rates and other economic variables adds a risk premium to above equation
85
Objectives of central bank
**all of them have price stability (low inflation) as an objective, many have explicit target rates usually 2% to 3%
* maintain full employment (may push in different direction than inflation reduction)
* promote economic growth
* keep exchange rates stable
* keep long term interest rates moderate
86
Expected inflation
if inflation is equal to what we expected:
1. increases cost of holding money (always, not particular to this situation).
2. adds the cost of frequently changing prices.
87
Unexpected inflation
if inflation is more than what we expected:
1. shifts wealth from lenders to borrowers.
2. less reliable supply/demand information in price changes. (firms might think of an increase in price as real and take incorrect supply decisions while it's just inflation)
3. number 2 also contributes to less stable business cycles.
88
Monetary policy tools
1. Policy rate: interest rate central bank charges banks for borrowed reserves. (raising--> less bank lending, decreasing--> more bank lending, so finally affects market interest rates)
2. Open market operations: most used, changing money supply- managing fed fund rates through changing money supply-
central banks buy government securities for cash so money supply increases and reserves increase. they also decrease money supply by selling securities.
3. Required reserve ratio: seldom changed, if decreased, increases the money supply
89
Characteristics of central banks
to be effective, central banks should be:
1. independent: operational independence (free to set policy rate) and target independence (sets inflation target, measures it, determines horizon to meet the target)
2. credible: follows through on stated intentions and policies.
3. transparent: discloses inflation reports, indicators they use and how they use them
90
Monetary policy transmission
1. buys government bonds from banks
2. bank reserves increase
3. interbank lending rates decrease
4. short term and long term lending rates decrease
5. businesses increase investment
6. consumers increase house, auto, and durable goods purchases.
7. domestic currency depreciates, exports increase
*overall, aggregate demand increases, increasing real GDP, employment and inflation.
91
Central bank targets
1. interest rate targeting: increase money supply when above target and vice versa
2. inflation targeting: usually a target band is used (typically 1% to 3%)
* increase money supply growth when below target band and vice versa.
3. exchange rate targeting: having a target band for currency exchange rate with developed country.
* sell domestic currency when above target and vice versa (limited by availability of foreign reserves)
92
Neutral interest rate
trend growth rate of real GDP + target inflation rate
if growth rate of GDP and money supply be equal, the inflation rate would be zero. but if we have targeted an inflation rate, money supply rate should be equal to neutral interest rate.
* Policy rate > neutral rate --> contractionary
* Policy rate expansionary
93
liquidity trap
a monetary policy limitation:
if demand for money is very elastic, people will hold currency even as money supply increases.
94
Quantitative easing
recently central banks also buy longer dated government securities, mortgage securities and risky bonds to reduce long term rates to stimulate the economy
95
Fiscal policy
expansionary:
*increase government spending, decrease taxes --> increasing aggregate demand and the budget deficit
contractionary:
*vice versa
96
Automatic stabilizers
taxes and transfer payments.
tend to increase deficits during recessions and decrease deficits during expansions. e.g., in a recession there is more unemployment so the government should pay more for unemployment insurance, G goes up automatically.
97
Fiscal policy objectives
1. influence aggregate demand and economic growth
2. redistribute wealth (transfer payments)
3. affect the allocation of resources to different sectors of the economy (like subsidizing ethanol to use in vehicles, or taxing cigarettes)
98
Fiscal policy tools
Spending side:
1. transfer payments
2. current spending: purchases of goods and services (for operations of the government, like military)
3. capital spending: to increase future productivity, on infrastructure, or to support research and development of new technologies.
Revenue side:
1. direct taxes: levied on income or wealth- take time to implement
2. indirect taxes: levied on goods and services- quick to implement
99
Fiscal multiplier (government purchases multiplier)
initial government spending (like a new army base) has a multiplied effect (like Maximum deposit expansion multiplier) as it creates more spending.
= 1/ [1-MPC(1-t)]
* MPC= marginal propensity to consume (the percentage of a dollar that gets spent by people)
* an increase in savings and take reduce
100
Tax multiplier
how much would an increase in taxes reduce consumption:
= MPC* fiscal multiplier (?)
with a 100 billion increase in taxes, consumption is reduced by 80, because if not taxed, people would have spent only 0.8 of that money.
by adding the effect of fiscal multiplier, over time, it leads to a decrease in consumption spending of 2.27*80 = 182
*so a 100 increase in spending and a 100 increase in taxes will lead to an increase in consumption by 227-182 = 45
101
Balanced budget multiplier
=fiscal multiplier - tax multiplier
102
Ricardian equivalence
if a tax decrease causes tax payers to increase savings in anticipation of higher future taxes, the resulting decrease in spending will reduce the expansionary impact of a tax cut.
*if the increase in savings just offsets the tax decrease, it os termed Ricardian equivalence
103
Government debt
The total amount of money that government owes to creditors. government's creditors include all individuals, businesses, governments and other organizations that own government debt securities.
Debt ratio = government debt/ GDP
70-80 --> sustainable
*if the interest rate on government debt is less than the real rate of growth, debt ratio will decrease and vice versa.
104
Reasons to be concerned about budget deficits
1. may lead to higher future tax rates that will reduce GDP
2. government borrowing can drive up interest rates and reduce private investment
3. at some point, debt can become risky, interest rate rises, country may default or expand money supply and cause inflation.
105
Reasons not to be concerned about budget deficits
1. if deficit is to finance capital investment, future GDP will be higher. (it's like our lives, if you borrow to invest, it's ok, but it's wrong to borrow to consume)
2. deficits don't matter if Ricardian equivalence holds
3. if the economy is operating below capacity (LRAS), government borrowing will not displace capital investment. (less concerns with reducing private investments)
106
Fiscal policy lags
Keynesians say government should shift the AD curve to counter cycle and smooth the business cycles but there are problems in the way of doing, like these lags:
1. recognition lag: to identify the need for fiscal policy change
2. action lag: to enact legislation
3. impact lag: for the policy change to have the intended effect
-->lags can cause fiscal policy changes to be destabilizing rather than stabilizing.
107
Fiscal policy limitations
1. if economy is at full employment, fiscal stimulus will result in higher inflation
2. if economy is bellow full employment but we have supply shortages, fiscal stimulus will lead to inflation rather than GDP growth
3. if the economy has high unemployment and high inflation (stagflation) fiscal policy cannot address both.
108
Analysis of fiscal policy
wether fiscal policy is expansionary or contractionary depends on the business cycle stage, we cannot just look at the deficit and say wether it's expansionary or contractionary because we're gonna run higher deficits in recession and lower deficits when reaching a peak. so we use an adjusted or full employment deficit amount, we project what would our deficit be if we were at full employment to adjust for business cycles.
109
Monetary vs fiscal
monetary--> affecting private sector (monetary policy sets interest rates)
fiscal--> affecting public sector
*the monetary policy doesn't transmit through the economy as fast as fiscal policy (increase in government spending). so if monetary is contractionary and fiscal is expansionary aggregate demand would be likely higher.
110
Benefits/costs of international trade
Benefits:
1. lower cost to consumers of imports.
2. higher employment, wages, and profits in export industries.
Costs:
displacement of workers and lost profits in industries competing with imported goods.
*economists: benefits outweigh costs
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Absolute vs comparative advantage
* absolute: refers to lower cost in terms of resources used
* comparative: refers to the lowest opportunity cost to produce a product
*because of comparative advantage, trade makes all countries better off.
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Models of trade
1. ricardian model: labor is the only factor of production-- comparative advantage depends on relative labor productivity for different goods.
2. heckscher-ohlin model: two factors of production (K,L)-- comparative advantage depends on relative amount of each factor possessed by a country.
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Heckscher-Ohlin model wealth redistribution
under this model, there's a redistribution of wealth between the two factors of production due to international trade, the price of more abundant resource will increase.
Because the Heckscher–Ohlin model has two factors of production, labor and capital, (unlike the Ricardian model that has only labor), it allows for the possibility of income redistribution through trade. The demand for an input is referred to as a derived demand because it is derived from the demand for the product it is used to produce. As a country opens up to trade, it has a favorable impact on the abundant factor, and a negative impact on the scarce factor. This result is because trade causes output prices to change; more specifically, the price of the export good increases and the price of the import good declines. These price changes affect the demand for factors used to produce the import and export goods, and hence affect the incomes received by each factor of production.
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Trade restrictions
1. tariff: a tax imposed on imported goods.
2. quota: a limitation on the quantity of goods imported.
3. export subsidies: payments by government to domestic exporters.
4. minimum domestic content: required proportion of product content to be sourced domestically.
5. voluntary export restraints (VERs): agreements by exporting countries to limit the quantity of goods they will export to an importing country (a way to avoid quotas, tariffs or other new rules in the importing country)
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Reasons for trade restrictions
main reasons:
1. protecting domestic jobs
2. protecting domestic producers
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Capital restrictions and it's effects
* Restrictions on flow of financial capital:
1. outright prohibition
2. punitive taxation
3. restrictions on repatriation (capital can flow into the country but not out)
* Effects:
1. decrease economic welfare
2. short term benefit for developing countries: reducing volatile capital inflows and outflows.
3. long term costs of isolation from global capital markets.
* Objectives: (book)
1. reduce the volatility of domestic asset prices. (inflow and outflow of funds)
2. maintain fixed exchange rates (restrictions make it easier)
3. keep domestic interest rates low (restricting outflow makes it easier)
4. protect strategic industries (restrict investing in these businesses)
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Trading bloc gains
*Economic welfare is improved by reducing trade restrictions. but this gains for countries of a trading bloc can be offset by losses if bloc increases restrictions on non member countries.
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Trading bloc (regional trading agreement-RTA) types
1. Free trade areas: all barriers to import and export are removed between members. (like NAFTA)
2. Custom union: 1 + all countries adopt a set of trade restrictions with non members.
3. Common market: 2 + all barriers to the movement of labor and capital goods among member countries are removed.
4. Economic union: 3 + member countries establish common institutions and economic policy for the union. (like european union)
5. Monetary union: 4 + member countries adopt a single currency. (like euro zone)
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Balance of payments (BOP)
A statement that summarizes an economy’s transactions with the rest of the world for a specified time period. The balance of payments, also known as balance of international payments, encompasses all transactions between a country’s residents and its nonresidents involving goods, services and income; financial claims on and liabilities to the rest of the world; and transfers such as gifts.
* includes current account, capital account and financial account
* means the amount of foreign currency that residents buy should balance the amount of domestic currency that foreigners buy, with adjustments for changes in foreign debt to the domestic country and domestic debt to foreign countries. (it's like reconciliation process)
* the balance of payment refers to the fact that increases in country's assets and decreases in it's liabilities must equal (balance with) decreases in its assets and increases in its liabilities.
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Current account
measures the flows of goods and services.
sub accounts:
1. merchandise ands servises: merchandise consists of all raw materials and manufactured goods bought, sold or given away. services include tourism and transportation and business and engineering services, as well as fees from patents.
2. income receipts: include foreign income from dividends on stock holdings and interest on debt securities.
3.unilateral transfers: one way transfers of assets, such as money received from those working abroad and direct foreign aid. in the case of foreign aid and gifts, the capital account of the donor nation is debited.
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Capital account
consists of the capital transfers and the acquisition and disposal of non produced, non financial assets.
1. capital transfers: include debt forgiveness and goods and financial assets that migrants bring when they come to a country or take with them when they leave. also include the transfer of title to fixed assets and of funds linked to the purchase or sale of fixed assets, gift and inheritance taxes, death duties and uninsured damage to fixed assets.
2. sale and purchases of non financial assets that are not produced- like natural resources and intangibles.
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Financial account
records investment flow.
1. government owned assets abroad: include gold, foreign currencies, foreign securities, ...
2. foreign owned assets in the country.
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Current account deficit
=trade deficit
for a country that has imports valued more than it's exports, in this case deficits should be offset by surplus in capital and financial account. so the excess imports over exports should be offset by sales of assets and debt incurred to foreign entities. a current account surplus is similarly offset by purchases of foreign physical or financial assets.
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International organizations that facilitate trade
1. International monetary fund (IMF): The International Monetary Fund (IMF) is an international organization created for the purpose of standardizing global financial relations and exchange rates. The IMF generally monitors the global economy, and its core goal is to economically strengthen its member countries.
2. World bank: An international organization dedicated to providing financing, advice and research to developing nations to aid their economic advancement.
3. World trade organization (WTO): An international organization dealing with the global rules of trade between nations. Its main function is to ensure that trade flows as smoothly, predictably, and freely as possible.
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Foreign exchange quotation
0.5440 GBP/USD: price on 1 dollar in pounds (GBP: price currency, USD: base currency)
* Nominal exchange rate: quoted rate at any point in time.
* Real exchange rate: nominal exchange rate adjusted for in inflation in each country compared to a base period (it's actually the exchange rate between goods in one country and goods in other country)
**real exchange rate (d/f) = nominal (d/f) * (CPIf/CPId)
**if a currency depreciates comparing to another, part of it is because of inflation in that country, and part of it is because of a higher product exchange rate for the other country.
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Currency market participants
1. sell side: market makers: large multinational banks.
2. buy side: corporations, governments, investment accounts, sovereign wealth funds, pension plans, and also retail market (households)
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Cross exchange rates
CHF/GBP= CHF/USD * USD/GBP
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Forward quotes
ways of quoting a forward rate, relative to the spot rate
*points basis: forward quote is points above or below the spot price and point is the last digit of the spot rate quote (0.0001)
spot: 1.4320 USD/EUR
forward quote: +22.1
--> forward= 1.43421 USD/EUR
*percentage basis:
Spot: 1.6135 USD/GBP
90 day forward quote: -0.29%
--> forward= 1.6135(1-0.0029) = 1.6088 USD/GBP (**US dollar is trading at a forward premium relative to the British pound).
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No arbitrage forward exchange rate
Forward(A/B) = Spot(A/B)*[(1+Ra)/(1+Rb)]
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Exchange rate regimes
1. countries without sovereign currency: these countries cannot have their own monetary policies.
* formal dollarization: uses other country's currency
* monetary union: several countries use a common currency
2. countries with sovereign currency:
* currency board: commits to a fixed rate of exchange of domestic for a foreign currency.
* conventional fixed peg: maintain at pegged rate (+-1%) via direct intervention in FX markets or indirectly via monetary policy changes. (related to a foreign currency)
* target zone: gives flexibility to maintain the exchange rate within a wider range (+-2%)
* crawling peg: the exchange rate is adjusted periodically, typically to adjust for higher inflation versus the currency used in the peg (passive crawling), in active crawling adjustments are announced and then implemented.
* managed floating: no target, government influences exchange rate through direct intervention or monetary policy.
* independently floating: market determined.
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Relation between balance of trade and exchange rates
what to do when we have trade deficit?!
1. elasticities approach: focuses on impact of exchange rate changes on the total value of imports and on the total value of exports
2. absorption approach: because a trade deficit (surplus) must be offset by a surplus (deficit) in the capital account, we can also view the effects of a change in exchange rates on capital flows rather than on goods flows.
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Exchange rate, trade and capital
X-M = (S-I) + (T-G)
X-M>0, trade surplus when private savings + government surplus exceeds domestic investment.
X-M
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Elasticities approach
we have trade deficit, so we want to decrease import and increase exports, so we want to depreciate our currency relative to foreign currency.
but under what circumstances would a depreciation of currency, improve your balance of trade?
--> Generalized marshal lerner condition:
if WxEx + Wm(Em-1) > 0
Wm= imports/(imports + exports)
Wx= exports/(imports + exports)
Ex and Em are demand elasticities of exports and imports.
(** if Ex+Em>1 holds, it's sufficient)
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J curve effect
in the short run, due to existing contracts, export and import demand are relatively inelastic, so currency depreciation initially leads to a larger trade deficit, but in the long run elasticities increase and currency depreciation leads to a reduction in the trade deficit.
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Absorption approach
*focused on capital flows, as well as trade flows
states:
X-M= national income - expenditures
(again not a model, this has to hold)
* for depreciation to improve the balance of trade:
1. national income must increase relative to expenditures
2. national saving (private + government) must increase relative to domestic investment in physical capital (an expenditure component)
