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International Economics Final Exam Review
Final Review Notes
39
Economics
Undergraduate 3
05/03/2010

Additional Economics Flashcards

 


 

Cards

Term
List and describe the components of the current account balance.
Definition

Three categories:

 

1. Exports of goods and services and income receipts.

 

2. Imports of goods and services and income payments.

 

3. Net unilateral transfers (international gifts)

Term
How can a country reduce a trade deficit?
Definition

Three options:

 

1.  Increase the level of saving (CA = S - I).

 

2. Lower the level of investment (CA = S - I).

 

3. Reduce the level of government spending (S = Y - C - G).

 

 

Term
What is the U.S. Net Foreign Wealth?
Definition
U.S Net Foreign Wealth = (foreign assets owned by U.S. residents) - (U.S. assets owned by foreign residents)
Term
What does the change in net foreign wealth depend on?
Definition

Three things:

 

1. The current account balance for that year.

 

2. Changes in worldwide asset prices.

 

3. Changes in exchange rates (that are used to convert wealth measured in various currencies into a common currency)

Term
The balance on the current accounts equals:
Definition

The sum of:

 

Exports of goods and services and income receipts (Line 1)

 

Imports of goods and services and income payments (Line 18)

 

Unilateral current transfers, net (Line 35)

Term
The balance on Capital Account equals:
Definition
Capital account transactions, net (Line 39)
Term
The balance on Financial Account equals:
Definition

The sum of:

 

U.S.-owned assets abroad, excluding financial derivatives (Line 40)

 

Foreign-owned assets in the United States, excluding financial derivatives (Line 55)

 

Financial derivatives, net (Line 70)

Term
The official settlements balance or the balance of payments equals:
Definition

The sum of:

 

U.S. official reserve assets (Line 41)

 

Foreign official assets in the United States (Line 56)

 

*with the sign reversed.

 

If negative, it implies that the U.S. is running down its official international reserves or borrowing from foreign central banks for that amount.

Term
What is dollar appreciation?
Definition

Occurs when the dollar will purchase more of a foreign currency.

 

Example: exchange rate changes from 10 euros per dollar to 15 euros per dollar.

 

The dollar price of foreign goods will fall in dollar terms.

Term
What is dollar depreciation?
Definition

When the dollar will purchase less of a foreign currency.

 

Example: the exchange rate changes from 10 euros per dollar to 5 euros per dollar.

 

Depreciation causes the price of foreign goods to rise in dollar prices.

Term
Dollar rate of return on Euro deposits is equal to:
Definition

The sum of:

 

The Euro interest rate (Re)

 

Expected Rate of Dollar Depreciation

Term
Describe the interest parity condition.
Definition

The interest parity condition states that the expected returns on deposits of any two currencies are equal when measured in the same currency.

 

It implies that potential holders of different currency deposits view them as equally desirable assets.

Term
Suppose Argentina's inflation rate is 30% over one year but the inflation rate in Australia is only 5% over the same period.  According to relative PPP, what will happen over the year to the Australian dollar and the Argentine peso?
Definition

Relative PPP predicts that inflation differentials are matched by changes in the exchange rate.

 

Under relative PPP, the Australian dollar/Argentine peso exchange rate would fall by 25%/

 

That is, the Australian dollar is expected to appreciate against the Argentine peso by 25%.

Term
What happens to the nominal and real dollar/euro exchange rate if the U.S. has an increase in productivity relative to that of the E.U.?
Definition

An increase in U.S. productivity relative to that of the E.U. will cause the real dollar/euro exchange rate to depreciate.  

 

The real depreciation combined with a fall in the U.S. price level makes the effect on the nominal exchange rate ambiguous.

Term

"An increase in world relative demand for the U.S. output causes a long-run real depreciation of the dollar against the euro."

 

Do you agree or disagree with this statement?  Explain your answer.

Definition

Disagree.

 

There will be a long-run real appreciation of the dollar.  Absent changes in monetary conditions, there will be long-run nominal appreciation of the dollar as well.

Term
Define GNP.
Definition

The value of all final goods and services produced by a nation's factors of production in a given time period.

 

It does not specify that those factors must work within the borders of a country that owns them.

Term
Define GDP.
Definition

GDP measures the final value of all goods and services that are produced within a country.

 

GNP = GDP + (payments from foreign countries for factors of production - payments to foreign countries for factors of production)

 

Term
National income identity for an open economy:
Definition
Y = C + I + G + EX - IM
Term
National savings identity:
Definition

S = Y - C - G

 

In the closed economy, S = I.

 

A closed economy can increase its savings only by accumulating capital.

 

In the open economy, S = I + CA.

 

An open economy can save either by building up its capital stock or by acquiring foreign wealth.

Term
Define Official Reserve Transaction.
Definition
The purchase or sale of official reserve assets by central banks.
Term
Define official reserve assets.
Definition

Foreign assets held by central banks to cushion against financial instability.

 

Includes government bonds, currency, gold, etc.

Term
What influences aggregate money demand?
Definition

Three things:

 

1. Interest rate/expected rates of return: A rise in the interest rate causes aggregate money demand to fall.

 

2. Prices: the prices of goods and services bough in transactions will influence the willingness to hold money to pay those transactions.

* A higher level of average prices means a greater need for liquidity.

 

3. Real national income (GNP): A higher real national income means more goods and services are being sold in the economy, increasing the need for liquidity.

Term
The aggregate demand for money, Md, can be expressed as:
Definition

Md = P x L(R,Y)

 

P is the price level

Y is real national income

R is the interest rate

Term
What is the long-run effect of a change in the money supply?
Definition

In the long run, a change in the supply of money has no effect on the long-run values of real output, interest rates, and the aggregate real money demand, L(R,Y) since all factors are fully employed.

 

All else equal, an increase in a country's money supply causes a proportional increase in its price level in the long-run.

 

The equilibrium condition Ms/P = L(R,Y) shows that P is predicted too adjust proportionally when Ms adjusts because L(R,Y) does not change.

Term
Define the Law of One Price.
Definition
The law of one price simply states that the same good in different competitive markets must sell for the same price, when transportation costs and barriers between those markets are not important.
Term
Define Purchasing Power Parity.
Definition
PPP is the application of the law of one price across countries for all goods and services.
Term
What does PPP imply?
Definition

PPP implies that:

 

E$/e = Pus/Pe

 

The exchange rate between two currencies equals the ration of the countries' price levels.

Term
What is the monetary approach to the exchange rate?
Definition

The monetary approach to the exchange rate uses monetary factors to predict how exchange rates adjust in the long run.

 

It uses the absolute version of PPP.

 

It predicts that levels of average prices adjust so that the quantity of real money supply will equal the quantity of real money demand.

Term
What is the effect of a change in the growth rate of the money supply?
Definition

A change in the money supply results in a change in the level of average prices.

 

A change in the growth rate of the money supply results in a change in the growth rate of prices (inflation).

 

A constant growth rate in the money supply results in a persistent growth rate in prices (ongoing inflation) at the same constant rate, when other factors are constant.

Term
What is the Fisher effect?
Definition

The Fisher effect describes the long-run relationship between nominal interest rates and the inflation rate.

 

It is expressed as:

R$ - Re = PIus - PIeu

 

This formula implies that the international interest rate difference equals the international expected inflation difference.

 

The Fisher effect predicts that a rise in the domestic inflation rate causes an equal rise in the interest rate on deposits of domestic currency in the long run, when other factors remain constant.

Term
What is the real exchange rate?
Definition

The real exchange rate is the rate of exchange for goods and services across countries. The real exchange rate is defined as:

 

Qus/eu = (E$/e x Peu)/Pus

Term
An increase in the relative demand for U.S. goods causes:
Definition

An increase in relative demand for U.S. goods causes the price of U.S. goods relative to the price of foreign goods to rise.  

 

This results in a long-run real appreciation of the dollar.

 

The real appreciation of the dollar makes U.S. exports more expensive and imports into the U.S. less expensive (thereby reducing the relative quantity demanded for U.S. goods to match relative quantity supplied).

 

A decrease in relative demand for U.S. goods causes a real depreciation of the dollar.

Term
An increase in the relative supply of U.S. goods causes:
Definition

An increase in the relative supply of U.S. goods causes the price of U.S. goods relative to the price of foreign goods to fall.

 

This results in a real depreciation of the dollar.

 

The real depreciation of the dollar makes U.S. exports less expensive and imports into the U.S. more expensive.

 

A decrease in relative supply of U.S. goods causes a real appreciation of the dollar.

Term

What are the short run and long run effects of a decrease in a country's money supply on:

 

Price Level

Interest Rate

Nominal Direct Exchange Rate

Real Direct Exchange Rate

Real Money Holdings

Definition

Short Run Long Run

 

Price Level N D

Interest Rate I N

Nominal Direct Exchange Rate D D

Real Direct Exchange Rate D N

Real Money Holdings D N

 

Term

What are the short run and long run effects of an increase in a country's money supply on:

 

Price Level

Interest Rate

Nominal Direct Exchange Rate

Real Direct Exchange Rate

Real Money Holdings

Definition

Short Run Long Run

Price Level N I

Interest Rate D N

Nominal Direct Exchange Rate I I

Real Direct Exchange Rate I N

Real Money Holdings I N

 

 

Term
Suppose Russia's inflation rate is 100% over one year but the inflation rate in Switzerland is only 5%.  According to relative PPP, what should happen over the year to the Swiss franc's exchange rate against the Russian ruble?
Definition
Relative PPP predicts that inflation differentials are matched by percentage change in the exchange rate.  Under relative PPP, the franc/ruble exchange rate would fall by 95%.  That is, the franc is expected to appreciate against the ruble by 95%.
Term
Explain how permanent shifts in national real money demand affect real and nominal exchange rates in the long run.
Definition

A permanent shift in the real money demand will alter the long-run equilibrium nominal exchange rate, but not the long-run equilibrium real exchange rate.

 

A permanent increase in money demand at any nominal interest rate leads to a proportional appreciation of the long-run nominal exchange rate.  Intuitively, the level of prices must be lower in the long run for money market equilibrium.

 

The reverse holds for a permanent decrease in money demand.  The real exchange rate, however, depends on relative prices and productivity terms which are not affected by changes in monetary factors.

Term
A country imposes a tariff on imports from abroad.  How does its action change the long-run real exchange rate between home and foreign currency?  How is the long-run nominal exchange rate affected?
Definition
Since the tariff shifts demand away from foreign exports and toward domestic goods, there is a long-run real appreciation of the home currency.  Absent changes in monetary conditions, there is long-run nominal appreciation as well.
Term
What happens to the nominal and real exchange rates of the U.S. if the U.S. has a decrease in productivity relative to that of other countries?
Definition
A decrease in U.S. productivity relative to that of other countries will cause the real exchange rate to appreciate.  The real appreciation combined with a rise in the U.S. price level makes the effect on the nominal exchange rate ambiguous.
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