topics 9&10 Flashcards
(24 cards)
What are the three dimensions of an open economy?
- Goods market
- Financial market
- Factor markets
The goods market includes foreign and domestic goods, the financial market includes foreign and domestic assets, and factor markets involve global supply chains and outsourcing of labor and production.
What is the difference between nominal and real exchange rates?
Nominal rates don’t consider inflation; real rates consider currency appreciation and depreciation.
Real exchange rates provide a more accurate measure of currency value by accounting for inflation.
What event caused a sharp depreciation of the pound in 2022?
Increased uncertainty in the UK economy following the mini budget.
Investors shifted from GBP assets to USD assets as USD was perceived as safer.
What is the balance of payments?
Country’s transactions with the rest of the world.
It includes trade balance, current account, and capital account.
What does the current account deal with?
Payments to and from the rest of the world.
What does the capital account deal with?
Financial transactions to and from the rest of the world.
What is the interest parity condition?
A way of thinking about interest rate and exchange rate movements.
What happened to bond yields in Greece after joining the eurozone?
Bond yields remained low and stable for most of the 2000s but diverged following the financial crisis of 2008/09.
What does the equation Z = C + I + G + X - IM represent?
Aggregate demand in an open economy.
Here, X stands for exports and IM stands for imports.
What determines imports in an open economy?
Domestic income or an appreciation in domestic currency.
What happens when exports are above domestic demand (DD)?
Trade surplus.
What happens when exports are below domestic demand (DD)?
Trade deficit.
True or False: Equilibrium in the Keynesian cross always equals trade balance.
False.
What occurs when there is a fall in government spending in the Keynesian cross model?
Fall in output, consumption, and investment.
This also reduces imports, which impacts the multiplier effect.
What happens to output when government spending increases?
Higher output, consumption, and investment.
However, this may also lead to an increase in imports.
What effect does a rise in foreign demand have on the domestic economy?
Shifts net exports upwards and increases output.
The increase in exports typically outpaces the increase in imports.
What is the impact of currency depreciation on net exports?
Increases net exports.
How does a rise in domestic interest rates affect the economy?
Decreases investment, demand for domestic goods, and output.
It typically leads to currency appreciation.
What happens when interest rates fall in an open economy?
Higher investment and potential output.
It also leads to currency depreciation, boosting demand and net exports.
What is the effect of a decrease in government spending?
Fall in consumption, investment, and overall output.
This can also boost net exports due to reduced imports.
What are pegged exchange rates?
Fixed exchange rates against another currency.
What does it mean to devalue a pegged exchange rate?
The pegged rate is lowered, causing the domestic currency to lose value.
What is the condition for domestic interest rates in a fixed exchange rate system?
Domestic interest rate must equal foreign interest rate.
What role does government fiscal policy play in a fixed exchange rate system?
It becomes more important as monetary policy is limited.
