Macro Y12 - everything after the march test

Balance of payments

• Account measuring inflows and outflows of money to/from a country

Components:

• Current account - record of international trade

• Financial Account - investments, assets

• Capital account - Small, capital transfers of non-produced and non-financial assets

Current account components

Net trade balance:

• Value of trade in goods

• Value of trade in services

Primary income:

• Earnings from abroad: foreign investments/payments made to foreign investors

• Wages from abroad

Secondary income:

• Current transfers - govt. transfers

• Aid, fees, etc.

Phillips curve

• Effects of unemployment on inflation

• ADD DIAGRAM

• When there are unemployed resources, price level expected to be constant

• When there’s less unemployment, smaller pool of potential employees (wages increase as incentive), workers have more bargaining rights, wages increase, driving prices up, increased spending

Milton Friedman on Phillips Curve

• Attacked it

• Monetarist

• Argued relationship between UE and inflation non-existent in long run

• If economy were to settle down at certain point w/ substantial inflation, people would adapt and economy would return to natural rates of unemployment, whilst inflation keeps rising

Trade off between economic growth and inflation

• As spare capacity in economy depletes, Greater economic growth (fuelled by AD) leads to rising inflation rates

• ADD DIAGRAM

Macroeconomic conflicts

• Economic growth and protection of environment (government choosing whether to prioritise welfare of current or future society)

• Controlled low inflation or balance of payments (Raising interest rates to control inflation makes currency stronger, so net trade deficit worsens)

Demand side policies

• Influence AD

• FISCAL POLICY or MONETARY

International trade fosters…

Interconnectedness of global economies

• INTERDEPENDENCE - policies of one country have global ripple effects

Exchange Rate

Price of one currency in terms of another

Floating exchange rate

Price of one currency in terms of another determined by forces of demand and supply

• In forex markets

• No govt./ central bank intervention - purely market forces determine value of exchange rate

Fixed exchange rate

• Currency is fixed in value to another (by govt.), maintained by regular intervention (usually central bank)

Hybrid exchange rate

• Managed exchange rate

• Usually floating, w/ periodic interventions by authorities

Monetary policy

Manipulation of monetary variables by central bank to achieve macro objectives

Variables:

• Interest rate

• Exchange rate

• Money supply + QE

Expansionary monetary policy

• Decrease nominal interest rates

• Cost of borrowing decreases, stimulates more investment and consumption in economy

• Affects housing market - incentivises new buyers to buy houses (fixed rate mortgages)

• FALL IN REAL INTEREST RATES (if interest 3% and inflation 3%, real interest rate is 0) (possible for real interest rates to be negative)

• Depreciation of exchange rate (less hot money inflows, less demand for currency in forex markets). This increases demand for exports and decreases demand for imports, improving the net trade balance.

Increase money supply:

• QE - central bank buys back govt. bonds from commercial banks with new electronic money

• Commercial banks have increased availability of credit, increased liquidity

• Able to lend at lower interest rates

• Encourages investment, consumption

• The demand for currency falls, currency depreciates

• This makes EXPORTS cheaper for foreign buyers and imports more expensive for domestic buyers

• Reducing trade deficit

• Increasing AD, helping stimulate economic growth

Contractionary monetary policy

• Increase interest rates in case of inflationary pressures

• Reward for saving increases

• Negative multiplier effect - less spending, less revenue, cuts in workforce

• More S, less C and I

• Tightening of credit supply (loans harder to get)

• Appreciation of exchange rate.

Factors to consider when setting interest rates

1) GDP and spare capacity - estimate of output gap

2) Bank lending - consumer credit figures, retail sales (availability of credit)

3) Equity markets and house market

4) Business + consumer confidence

5) Growth of wages, avg. earnings, labour productivity, unit labour costs

6) Trends in forex markets - sterling appreciating or depreciating against other countries

7) International data on trading partners

Transmission mechanism of monetary policy

1) Change in market interest rates (feeds through to borrowing/saving rate)

2) Impact on demand