International Finance Exam

Absolute Purchasing Power Parity (PPP)

A theory suggesting that identical baskets of goods should cost the same in different countries once exchange rates are accounted for.

Relative Purchasing Power Parity (PPP)

A theory that explains exchange rate changes based on inflation differentials between countries.

Long-Run Theory of Exchange Rate

The exchange rate model based on PPP, which is considered long-run because price adjustments occur slowly over time.

Fundamental Equation of the Monetary Approach

The equation E=PUS/PE=(MUS/L(R,YUS))/(ME/L(R∗,YE), indicating that exchange rates depend on relative money supplies and demands.

Fisher Effect

The theory that nominal interest rates rise one-for-one with expected inflation.

Current Account (CA)

A balance in the economy that depends negatively on disposable income and positively on real exchange rates.

Temporary Fiscal Expansion

A short-term increase in government spending which boosts output temporarily but does not affect long-run output.

Overshooting

A phenomenon where the exchange rate initially moves beyond its new equilibrium level before gradually returning.

Sterilization

Central banks offset foreign-exchange interventions with domestic operations to stabilize the money supply.

Impossible Trinity (Trilemma)

The economic principle that states a country cannot simultaneously achieve fixed exchange rates, independent monetary policy, and free capital mobility.

Devaluation

An intentional reduction of the fixed value of a currency relative to others, which tends to stimulate exports and reduce imports.

Gold Exchange Standard

A monetary system where countries hold reserves in currencies that are convertible into gold rather than gold itself.

Seigniorage

Revenue earned by a government from issuing currency.

Austerity Measures

Spending cuts or tax increases implemented to reduce government deficits, often required during international bailouts.

Subprime Mortgages

Loans issued to borrowers with poor credit, which contributed to the 2008 financial crisis through widespread defaults.

Current Account Improvement Effects

Refers to how currency depreciation can initially worsen the current account but improves over time as exports rise and imports decrease.