Topic 1- National Income Accounting & BOPNational Income Identity | gross domestic product is given by consumption expenditures, plus investment expenditures, plus government expenditures, plus exports, minus imports | Y=C+I+G+CA | National Savings | the amount of output that is not devoted to private consumption and government spending | S= Y-C(Y-T)-G or S= Sp+Sg or S=I+CA | Balance of Payments | records a country's international transactions with the rest of the world in a given time period- records its payments and recepits from foreigners and shows demand and supply of a country's currency in FEM | *every international transaction enters the BOP accounts twice, once as a credit and once as debit | Credit Entry | any transaction resulting in receiving payments from foreigners | exports of goods, services, assets | Debit Entry | any transaction resulting in making payments | imports of goods services, assets | Components of BOP Accounts | Current Account, Financial Account, Capital Account | CA+KAnon+CapitalAcc= -ORT | Current Account | shows the difference b/w exports and imports of goods and services plus net unilateral transfer | CA= EX-IM+ Net Unilateral Transfer | Financial Account | difference b/w sales & purchases of assets to foreigners | KA= KAnonres+ORT | Non-reserve Portion | the purchases & sales of assets by the private sector | Reserve Portion | the purchases & sales of foreign assets by the country's monetary authority | foreign-currency denominated assets held by central banks |
Topic 4- Price Levels & Exchange Rate in LRPurchasing Power Parity | explains movements in the exchange rate between two countries’ currencies by changes in the countries’ price levels | Absolute PPP | identical basket of goods should be sold for same amount of money in diff countries when expressed in same currency | E= P/P* | Relative PPP | % Δ in exchange rate between 2 currencies over many period equals to the inflation rate differentials between 2 countries | Ee-E/E= π-π* | Monetary Approach to Exchange Rate | shows factors that affect MS and MD will play a role in determining exchange rate | PPP holds, LR Model, shocks are permanent | | | Equilibrium exchange rate | E= (MS/MS)(L(Y,R)/(L(R,Y) | Domestic MS Increases | Exchange rate increases | DC depreciates | Foreign MS Increases | Exchange rate decreases | DC appreciates | Domestic Interest Rate increases | Exchange rate increases | DC depreciates | Foreign Interest Rate increases | Exchange rate decreases | DC appreciates | Domestic Output increases | Exchange rate decreases | DC appreciates | Foreign Output Increases | Exchange rate increases | DC depreciates |
| | Topic 2- Asset Approach to Exchange RateExchange Rate | the price of one currency in terms of another(DC/FC) | EDC/FC=1/EDC/FC | Forward exchange rates | the exchange rate that is contracted today for the exchange of currencies at a specified date in the future | R= R*+Ee-E/E | Interest Parity Condition | the condition that the expected returns on deposits of any two currencies are equal when measured in the same currency | Covered interest Rate Parity | agents can lock in the future exchange rate by getting a forward contract & eliminating uncertainty | R= R*+ F-E/E | Real Rate of Return | the rate at which its value expressed in terms of a representative output basket is expected to rise | Expected ate of return | the rate at which the value of an investment in the asset is expected to rise over time | Arbitrage | the process of buying a currency cheap and selling it dear | Asset Approach | IPR holds & deals with financial capitals | | | Focused on money mkt shocks and impacts on exchange rate (SR & LR) | R, domestic interest rate | return on DC deposits | Ee-E/E | annualized percentage change in the DC/FC exchange rate | R*+Ee-E/E | expecting DC return on FC deposits | Increase in Domestic Interest | R curve shifts right, invest in DC Deposit | Capital inflows & DC appreciates | Increase in Foreign Interest | R* curve shifts right, invest in FC deposit | Capital outflows & DC depreciates | Expected Depreciation of DC | R* curve shifts right, invest in FC deposit | Capital outflows & DC depreciates | Forward Trading | parties agree to exchange currencies on some future date at a pre-negotiated exchange rate | Spot Trading | trades are settled immediately |
Generalized Approach (real exchange rate, q)Real exchange rate, q | measures the purchasing power of a country's currency relative to another country's currency | shows how many baskets of domestic goods are needed to exchange one basket of foreign goods q= E(P/P*) | If q increases | real depreciation of DC | If q decreases | real appreciation of DC | q=1 | Absolute PPP | q= E(P/P*) | q=0 | Relative PPP | qe-q/q=0 | If AD increases-domestic | domestic goods are more valuable | PPP of DC increases and real appreciation of DC | If AD* increases-foreign | domestic goods are less valuable | PPP of DC decreases and real depreciation of DC | Generalized Approach | considers how changes in both monetary and real sides of the economy affect LR exchange rate | in the LR changes in q, changes in P and P* lead to a change in E |
| | Topic 3- Money, Interest Rate & Exchange RateMoney Supply | the total amount of currency and checking deposits held by households and firms | Currency in circulation+Demand Deposit | Aggregate Money Demand | the toal demand for money by all households and firms in the economy | Md= L(R,Y) | L(R,Y) | liquidity function | R | nominal interest rate | opportunity cost of holding money | Y | real income= real GDP | when income increases, consumption increases, volume of transaction increases | | | Interest rate- fisher | R= r+Π | Money market equilibrium | MS/P= L(R,Y) | R adjusts to ensure the money market is in equilibrium in SR | If MS increases | Pressure for R to fall to initial level | If real income Y increases | Consumption increases and we hold more money | L(R,Y) increases and R increases | In the long run | P= MS/L(R,Y) | P= MS/L(R,Y*) | | | Quantity Theory of Money | %Δ MS+%ΔV= %ΔP+%ΔY | | | Level change in MS doesn't impact %Δ in MS | no change in MS means no change in Π | Exchange Rate Overshooting | immediate response to a disturbance is greater than its long-run response | Exchange Rate Undershooting | the immediate depreciation of a currency to a shock is greater than its long run response |
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