Econ 330 Final Exam

Foreign exchange market

trading of currencies and bank deposits denominated in particular currencies

Exchange rate

Price of one currency in terms of another

Spot transaction

Immediate two day exchange rate transation

Forward Transactions

Exchange rate transaction at a specified future date

Appreciation

When a currency increases in value

Depreciation

When a currency decreases in value

When a country’s currency __________, the country’s goods abroad become ______, and foreign goods in that country become _________

Appreciates, more expensive, cheaper

Theory of Purchasing Power Parity

States that the exchange rate between any two country’s currencies is such that a basket of goods and services cost the same in both countries

Real exchange rate

price of domestic goods relative to the price of foreign goods denominated in the domestic currency

If one country’s price level _____ relative to another’s by a certain %, then the other country’s currency _____ by the same %,.

Rises, appreciates

nontradeable

not traded across country borders, like housing, services

tarriffs

taxes on imported goods

quotas

restrictions on the quantity of goods that can be imported

if a factor _______ the relative demand for domestic goods relative to foreign goods, the domestic currency will _____

increases, appreciate

a relative ______ in a country’s price level causes its currency to _______

rise, depreciate

increasing trade barriers causes a country’s currency to _______ in the long run

Appreciate

________ demand for a country’s exports cause its currency to _____ in the long run

increased, appreciate

As a country becomes relatively _____ productive, its currency ______

more, appreciates

An ______ in the domestic interest rate (i^d) shifts the demand curve for domestic assets to the ____ and causes the domestic currency to ______ due to ________

increase, right, appreciate, an increase of the expected return on dollar/domestic assets

an _____ in the foreign interest rate (i^f) shifts the demand curve to the ______, and causes the domestic currency to ______, because of a _______ in the expected return on domestic assets

increase, left, depreciate, decrease

A ________ in the expected future exchange rate E^e_t+1 shifts the demand curve to the ______ and causes an ______ of the domestic currency

Rise, right, appreciation

when domestic real interest rates ____, the domestic currency ______

rise, appreciates

the x axis of the foreign exchange market is:

quantity of currency being trades in the foreign market

the y axis of the foreign exchange market is:

the exchange rate, E, of the foreign currency, with the currency being trades on bottom. Ex: (euros/$) which would have an x axis of quantity of dollar assets

when domestic interest rates rise due to an expected increase in inflation, the domestic currency _____

depreciates

Fisher equation

r = i - Π^e

the theory of purchasing power parity (PPP) suggests that long-run changes in the exchange rate are determined by changes in the relative _______ in two countries

price levels

monetary theory

the study of the effects of money and monetary policy on the economy

Velocity of money equation

V = (P x Y) / M

Y =

aggregate output

quantity theory of money

P x Y = M x V

Demand for money equation

M^d = k x PY

Y is constant in the short run because

fisher believed wages and prices were completely flexible, and that the level of Y would remain at full-employment level

Price level =

P = (M x V) / Y

the quantity theory of inflation indicates that the inflation rate =

growth rate of the money supply - the growth of aggregate of aggregate output

the quantity theory of money is a good theory of inflation in the ______ run, not the _____ run

long, short

government budget constrait

Government Deficit = G - T which equals ΔMB + ΔB

_{T = taxes, ΔMB = change in the monetary base, ΔB = change in government bonds held by the public}

If the government deficit is financed by ____________ by the public there is no effect on the monetary base and money supply

an increase in bond holdings

monetizing the debt

is when the government finances its deficit by increasing the monetary base, usually through the central bank:

1. issuing an amount of bonds to the public

2. banks conduct an open market purchase so the public does not purchase

3. Increases the monetary base and money supply through multiple deposit creation

The financing of a persistent deficit by means of money creation will ______

Lead to sustained inflation

Hyperinflation

Period of extremely high period more than 50% per month

Liquidity Preference Theory

1. Transactions Motive

2. Precautionary Motive

3. Speculative Motive

Transactions motive is ______ to income and can change demand for money as _______ ________ improves

Proportional, payment technology

Precautionary motive: people hold money as a cushion against _________ __________

Unexpected opportunities

Speculative Motive: people hold money as a ______________

Store of wealth

real money balances

the quantity of money in real terms

Liquidity Preference Function Equation

M^d / P = L (i, Y)
- +

An important implication of Keynisan theories of money demand is that velocity is not a ______ but will _______ with changes in ________

Constant, fluctuates, interest rates

Keynsian equation for velocity

V = PY/M = Y / L(i,Y)

as interest rates ______, the expected return on money ______

rise, falls

dominated assets

currency and checkable deposits —> because investors can hold other assets that pay higher returns yet are perceived to be just as safe

inflation hedges

higher variability in the real return of money lowers the demand of money, as people shift into alternative assets

examples of inflation hedges

gold, real estate

when the liquidity of other assets increases, the money demand _____ because money is relatively _____

decreases, less liquid

when inflation risk increases, money demand _____ because money is relatively ________

decreases, more risky

when riskiness of other assets increases, money demand _______ because money is relatively _______

increases, less risky

when wealth increases, money demand _______ because there are ________

increases, more resources to put into money

when payment technology increases, money demand ________ because there is __________

decreases, less need for money in transactions

When income increases, money demand _________ because of _____

increases, higher value of transactions

when interest rates increase, money demand ______ because the _________ _______

decrease, opportunity cost of holding money rises

if interest rates ________ affect the demand for money, velocity is more likely to be ___________

do not, constant

liquidity trap occurs when nominal interest rates ________ because the demand for money is now _____

fall to zero, completely flat

liquidity trap

a situation in which nominal interest rates are at or near zero and monetary policy becomes ineffective because people prefer to hold onto cash rather than invest it.

government spending multiplier

1 / (1-mpc)

Tax multiplier

-mpc / (1-mpc)

an increase in the foreign interest rate causes the demand for domestic assets to _______ and the domestic currency to _______

decrease, depreciate

The keynsian theory of money demand predicts that people will increase their money holdings if they believe that

Bond prices are about to fall

A decrease in unplanned inventory investment for the entire economy equals the excess of

agregate demand over output

unplanned inventory investment =

actual output - planned expenditure which euqls output - agregate demand

STEPS TO SOLVE: if net exports decrease by 250 and the mpc is 0.75, equilibrium aggregate output ______ by _________

Set up the following equation:
1 / (1 - MPC) x NX
_{Where 1/1-mpc is equal to the government spending multiplier}

Then plug in numbers, to get 1/0.25 x -250, which causes eq output to decrease by 1000

The Taylor principle

raise nominal rates by more than any rise in inflation so that real interest rates will rise when there is a rise in inflation, as illustrated by the MP curve.

If domestic interest rates rise, domestic asset demand will ______ and the currency will ______

increase, appreciate

7 demand shocks that can shift AD

1. autonomous monetary policy

2. government purhcases

3. taxes

4. autonomous net exports

5. autonomous consumption expenditure

6. autonomous investmnet

7. financial frictions

Changes in autonomous monetary policy: when real interest rates rise, _______ spending _______, which causes AD to ________

investment, decreases, shift left

Changes in government purhcases: when government spendign rises, aggregate demand _____

shifts right

Changes in taxes: when taxes increase, __________ ____________, which causes aggregate demand to ________

consumption decreases, shift left

changes in autuonomous net exports: when nx increases, aggregate demand shifts ______

right

change in autonomous consumption expenditure: when consumption increases, aggregate demand shifts _____

right

change in autonomous investment: when investment increases, aggregate demand shifts _____

right

Financial frictions

barriers that imede efficent market functioning, such as transaction costs, asymmetric information, and regulation constraints

Changes in financial frictions: when financial frictions increase, __________ spending __________, which causes aggregate demand to _________

Investment, decreases, left

Natural rate of unemployment in the long run is

4-5%

Short run aggregate supply is based on 3 factors driving inflation:

1. expected inflation

2. output gap

3. inflation/supply shocks

when workers expect a positive inflation rate, employers will ______ wages one to one so real wages _______

raise, don’t decrease

when output exceeds the potential output/LRAS, there is a

positive output gap

cost push shocks

occur when supply costs increase, leading to higher prices for goods and services

shifts in LRAS are determined by

1. total amount of capital being supplied in the economy

2. total amount of labor

3. available technology

quantatative easing

an unconventional monetary policy tool used by central banks to stimulate the economy by increasing the money supply through the purchase of government securities.

quantatative tightening

a monetary policy strategy that involves decreasing the money supply, typically by selling government securities, to curb inflation and stabilize the economy.

3 categories of economic shocks

1. demand

2. temporary

3. permanent

For demand and permanent shocks, you can stabilize _____ and ______ stability

price, economic activity

Cost-push inflation results from:

1. _________________

2. ________________

1. temporary negative supply shock

2. push by workers for higher wages higher than justified by productivity levels

Demand-pull inflation is caused by _______

policy makers pursuing policies that increase aggregate demand

In cost push inflation, _______ shifts first. This leads to a ______ in unemployment and a _______ in output. As a response, policymakers would shift ________ to the right.

SRAS, increase, decrease, AD

In demand pull inflation, _______ shifts first to reach a higher ______ target. As a response, ________ will shift ________ because of rising ________.

AD, output, SRAS, left, wages

zero lower bound

federal funds rate is nominal, so it can never fall belore 0

when the 0 lower bound is achieved, the MP curve will _______

slope downward

when the 0 lower bound is achieved, the AD curve will _______

Slope upward

the zero lower bound breaks the ______

self-correcting mechanism

when the output is below the potential output, inflation will ______ causing real interest rates to ______, aggregate output to _______ and continue to spiral

fall, rise, fall