ECO 369 final

Contractionary policy

Problem- inflation - raises interest rates
Results Aggragate demand decreases, lower prices

Expansionary Monetary Policy

Problem: Weak economy/consumers spending less/ high unemployment rate
Resilts: aggregate demand increases and causes prices to rise

Number of EU member countries

27

Number of EZ countries

20 make up the EZ

How has the makeup of the EU has changed since the beginning of the 2000s

Number of the countries in the EU have doubled
economies has expanded with a lot more voices so it is reduced Germany and Frances voice

What is the evolution of the EU

European coal and steal companie (Fr, It, West Germ, Belgium, Netherlands, Luxemberg)
created an electronic currency then physical coins
14 before 2004, 13 after 2004

Formal plan for creation of the eurozone

The Maastricht Treaty established the framework for the Economic and Monetary Union, leading to the creation of the eurozone

Maastricht convergence criteria

low inflation, low interest rates, stable exchange rates, government finances (low budget deficit and low national debt)

Importances of the degree of synchronization of business cycles and what it means for different eurozone countries

When a country joins the EU, it gives up its ability to choose a monetary policy AND get whatever policy the ECB decides. So countries with a high degree of synchornization of business cycles would benefit if their economic conditions are similar. While if they have a low degree of synchornization, it could make the inflation or deflation aka the challenges they are facing that much more challenging.

High degree of synchronization

monetary policy is appropriate for the country

Low degree of sychonization

The policy chosen is inappropriate for an individual country and is the opposite of what you need

Fixed Exchange Rate

government or Central bank manipulates the exchange rate to keep it flexible

Flexible exchange rate

Price of exchange rate is determined by the private sector of the FOREX market, no govt manipulation

In the forex market what does supply and demand represent

US exports - demand and US imports- supply

Inflation is the us… what happens to supply, demand, forex mkt

Less spending on goods and services, more spending on foreign goods

Supply goes up for USD and Demand goes Down

Value depreciates

Recession in the US… Supply, Demand, etc. on forex mkt

income decreases, consumer spending down,

supply of USD decreases, demand increases

value of USD increases or Appriciates

How does the forex mkt change due to a change in income

Average income decreases

Consumer spending decreases

Less imports means supply goes down or shifts to the left

USD appreciates

If the average income decreased in a foreign country what would that mean for spending in the us

Foreign spending decreases

demand aka exports decreases

USD depriciates

Why the impact of international trade on an exchange rate is unlikely to change the rate much over short term

Consumers imports and exports do not change quickly and neither does income

Why the impact of international investment and currency speculation on an exchange rate can change considerably over the short term

because financial markets are heavily influenced based on belief and speculation

Investors expect IR to go upwards

1. high inflation that consumers are spending more money causing inflation

2. combating inflation with contractionary policy- raise interest rates

3. makes bonds more attractive

4. Buy USD and Sell foreign $

5. Supply decreases of USD and demand increases (draw graph)

Investors expect IR to go down

1. low inflation, weak economy- income/ consumer spending decrease and unemployment increase

2. Use expansionary policy- lower interest rates

3. make US bonds less attractive- sell USD and Buy Foriegn

4. Supply goes up and demand goes down (draw graph)

Why do countries manipulate exchange rates

1. to reduce volatility in ex rate which encourages more international trade, business and investment

Why would a country keep ex rate low

to make important exports cheaper for foreign investors

Why would a country make ex rate higher

To make imports cheaper for domestic consumers

What motivates countries to keep a stable ex rate

Too much volatility can discourage international business and investments, so it gives an incentive to reduce volatility

How does a central bank move its exchange rate down?

Sell its currency to private sector which causes supply to increase/shift right

buying foreign currency “target currency”

Foreign reserves increase

How does the central bank push its exchange rate up?

Buy its own currency on the private sector mkt

adding to demand/shifts right

selling/decreasing foreign reserves

Why might a central bank not want to manipulate the exchange rate

you would give up the ability to have you own monetary policy and end up copying a different countries monetary policy

You have no way to combate economic changes

The impossible trinity- Fixed Exchange rates, Free flows of capital, free use of monetary policy

What is the impossible trinity

Fixed exchange rates, free flows of capital, and free use of monetary policy

If the CBK raises ex rates because of inflation what would happen (trying to keep ex rate fixed/impossible trinity)

The value of the currency would go up, so CBK would sell currency to lower back down

but then, the Money supply would increase which would cause inflation to rise again

The interest rate would go down as a result of the increased money supply starting the cycle again

Currency Crises connection with the cost of ex rate manipulation

weakness in the economy causes investors to take some money out of the country

Private sector demand decreases and supply would increase…

The central bank does not want this to happen, so it sells foreign reserves to keep ex rate afloat

But doing this increases the MS which raises interest rates which then starts the process over. This keeps happening until the Foreign reserves are gone