May 08, 2017

Foreign exchange

• The buying and selling of currency
• Any transaction that occurs in the balance of payments necessitates foreign exchange
• The exchange rate is determined in the foreign currency market

Changes in exchange rates

• Exchange rates are a function of the supply and demand for currency
• An increase in the supply of a currency will decrease the exchange rate of a currency
• A decrease in supply of a currency will increase the exchange rate of a currency
• An increase in demand for a currency will increase the exchange rate of a currency
• A decrease in demand for a currency will decrease the exchange rate of a currency

Appreciation

• When the exchange rate of a currency increases

Depreciation

• Occurs when the exchange rate of that currency decreases

Exchange rate determinants

• Relative price level
• Speculation

May 4, 2017

Balance of payments

• Measure of money inflows and outflows between the United States and the rest of the world (ROW)
• Balance of payments is divided into three accounts: current account, capital/financial account,

Inflow

• Referred to as credits

Outflow

• Referred to as debits

Current account

• Balance of trade or net exports
• Exports of goods/services - import of goods/services
• Exports create a credit to the balance of payments
• Imports create a debit to the balance of payments
• Net foreign income
• Income earned by U.S. owned foreign assets - income paid to foreign held in U.S. assets
• Ex: interest payments on U.S. owned Brazilian bonds - interest payments on German owned U.S. treasury bonds
• Net transfers
• Foreign aid -> a debit to the current account

Capital/financial account

• The balance of capital ownership
• Includes the purchase of both real and financial assets
• Direct investment in the United States is a credit to the capital account
• Direct investment by U.S. firms/individuals in a foreign country are debits to the capital account
• Purchase of foreign financial assets represents a debit to the capital account
• Purchase of domestic financial assets by foreigners represents a credit to the capital account

Official reserves

• The foreign currency holdings of the United States Federal Reserve System
• When there is a balance of payments surplus the fed accumulates foreign currency and debits the balance of payments
• When there is a balance of payments deficit the fed depletes its reserves of foreign currency and credits the balance of payments
• The official reserves zero out the balance of payments

Balance of trade

• Exports - imports

Balance of goods and services

• Goods exports + services exports - goods imports + services imports

Balance on current account

• Balance of goods and services + net investment + net transfers

Balance on capital account

Official Reserves

• Current account ( +, -) + Capiptal account )-, +) = 0 theoretically

April 24, 2017

Supply Side or Reaganomics

• Manipulating by enacting policies to stimulate incentives to work, save, and invest
• Part of this plan is to increase tax cuts which would increase disposable income
• Disincentives

Laffer Curve

• Displays theoretical relationship between tax rates and government revenue
• As taxes increase, consumers spend less

3 criticisms of the Laffer Curve

• 1) empirical evidence suggests that the impact of incentives to work, save, and invest are small
• 2) tax cuts increase demand which can fuel inflation
• 3) where the economy is actually located on the curve is difficult to determine

April 19, 2017

Stagflation

• Simultaneous rise in inflation and unemployment

Supply shock

• A rapid and significant increase in resource cost which causes the SRAS curve to shift
• Example: depreciation of the dollar, oil embargo

Natural rate of unemployment

• Frictional, seasonal, structural unemployment

Misery index

• A combination of inflation and unemployment in any given year
• Single digit misery is good

April 18, 2017

The Phillips curve

• A trade off between inflation and unemployment
• Inverse relationship
• Each point of the Phillips curve corresponds to a different level of output

Long run Phillips curve

• Occurs at the natural rate of unemployment
• Represented by a vertical line
• There is no trade off between inflation and unemployment in the long run
• The economy produces at the full employment output level 
• The LRPC (long run Phillips curve) will only shift if the LRAS shifts
• Increases in unemployment will shift LRPC right
• Decrease in unemployment will shift LRPC left

SRPC

• Increase in AD = up/left movement along SRPC
• Decrease in AD = down/right along SRPC

SRAS vs SRPC

• SRAS right, SRPC left
• SRAS left, SRPC right

Monetary Policy FRQ

April 03, 2017

Loanable funds

• Is an interest rate of 50% good or bad? Bad for borrowers but good for lenders
• The loanable funds market is the private sector supply and demand of loans
• This market brings together those who want to lend money (savers) and those who want to borrow (firms with investment spending projects)
• This market shows the effect on real interest rate
• Demand - inverse relationship between real interest rate and quantity loans demanded
• Supply - direct relationship between real interest rate and quantity loans supplied
• This is NOT the same as the money market (supply is not vertical)

Prime rate

• The interest rate that banks charge their most creditworthy customers

March 31, 2017

Tools of monetary policy

• 1) reserve requirement
• 2) open market operation
• 3) discount rate

Reserve requirement

• Only a small percent of money is in the safe
• The rest is loaned out
• Set amount bank must hold for lending ability
• If there is a recession, the FED should decrease the reserve ratio
• Banks hold less money and have more excess reserves
• Banks create more money by loaning out excess
• Money supply increases, interest rates fall,  AD goes up
• If there is an inflation, the FED should increase the reserve ratio
• Banks hold more money and have less excess reserves
• Banks create less money
• Money supply decreases, interest rates rise, and AD goes down

Monetary multiplier

• Find change in money supply,

Open market operations

• When the FED buys or sells government bonds (securities)
• This is the most important and widely used monetary policy
• If the FED buys bonds - it takes bounds out of the economy and replaces them with money
• If the FED sells bonds - it takes money and gives the security to the investor
• The effect of the open market ops are enhanced by the multiplier - if banks don't loan that money or people hold the cash, it becomes ineffective

The discount rate

• There are many different interest rates, but they tend to all rise and fall together

March 24, 2017

Money creation formula

• A single bank can create money by the amount of its excess reserves
• The banking system as a whole can create money by a multiple of the excess reserves
• MM X ER = expansion of money
• Money multiplier = 1/RR

New vs existing money

• If the initial deposit in a bank comes from the FED or bank purchase of a bond or other money out of circulation (buried treasure), the deposit immediately increases the money supply
• The deposit then leads to further expansion of the money supply through the money creation process
• Total change in MS if the initial deposit is new $ = deposit + $ created by banking system
• If a deposit in a bank is existing money (already counted in M1; ex - currency or checks), depositing the amount does NOT change the MS immediately because it is already counted
• Existing currency deposit into a checking account changes only the composition of the money supply from coins/paper money to checking account deposits
• The change in the MS if deposit is existing money = banking system created money

March 23, 2017

Demand deposits

• Created through the fractional reserve system

Fractional reserve system

• Process in which banks hold a small portion of their deposits in reserves and they loan out the excess
• The cash that banks keep on hand is called quiet reserves

Total reserves (TR) or actual reserves (AR)

• Equals to required reserves (RR) or excess reserves (ER)

Excess reserves

• What you can lend out (loans)

March 22, 2017

Bonds vs Stocks

• “Bonds are loans, stocks you own”

Bonds

• How are the value of bonds determined? If a corporation issues and then sells a bond
• Is it a liability
• First: if a corporation issues and then sells a bond

Liability for corporation

Asset for the buyer

• If that corporation issues a 10k bond with a 10 yr term and a 5% interest
• Nominal interest is 5%
• If nominal interest rate falls to 3% the value of the bond increases
• If interest rises to 8% then value decreases
• Dividends- which are portions of a corporation's profits, are paid out to stockholders
• Higher the corporate profit, the higher the dividend
• Capital gain- is earned when a stockholder sells stock for more than he or she paid for it
• Capital loss- stockholder sells stock at lower price then bought
• Federal reserve bank= Fed, central bank
• Two goals
• Stabilize economy
• Full employment

The money market

• (Supply and demand for money)
• Demand for money has an inverse relationship between nominal interest rates and the quantity of money demanded
• What happens to the quantity demanded of money when interest rates increase?
• Quantity demanded falls because individuals would prefer to have interest earning assets instead of borrowed liabilities
• What happens to the quantity demanded when interest rates decrease?
• Quantity demanded increases. There is no incentive to convert cash into interest earning assets
• The demand for money
• Money demand is downward slope
• Monday demand shifters
• Changes in price level
• Change in income
• Changes in taxation that affects investment
• Increasing the money supply
• If the FED increase the money supply, a temporary surplus of money will occur at 5% interest.
• The surplus will cause the interest rate to fall to 2%
• How does this affect ad?