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Unit Overview

  • Unit One: Individual models setup including comparative advantage, production possibility frontier (PPF), and supply and demand.

  • Unit Two: Measuring and modeling the macroeconomy.

  • Unit Three: Understanding government and central bank interventions in the macroeconomy, focusing on short-run policies affecting production, unemployment, inflation, and interest rates.

Focus of Unit Three

  • Current topics include:

    • Short run macroeconomic policies.

    • Types of Policies:

    • Automatic stabilizers (fiscal policy)

    • Discretionary fiscal policy (short run)

    • Discretionary monetary policy (short run)

    • Exchange rates as a policy tool in some countries.

  • Approximately half of the world uses exchange rates as a policy tool, while the other half does not.

Upcoming Schedule

  • Next Week: Exchange rates discussion.

  • Week Following: Long run economic growth section and long run policy tools.

  • Optional Lecture: Development economics before Thanksgiving for extra credit.

  • Recitations Schedule:

    • Thanksgiving week: No recitations

    • Following week: Unit three exam and extra credit recitations.

Recap of Monetary Policy

  • Recap focused on expansionary and contractionary monetary policies by the central bank:

    • Expansionary Monetary Policy:

    • Aimed at reducing unemployment by buying government debt from commercial banks, increasing money supply, encouraging spending, and hiring.

    • Contractionary Monetary Policy:

    • Aimed at reducing inflation by selling government debt, reducing cash in the system to control inflation.

  • Federal Funds Rate Ceiling:

    • Hard ceiling is the discount window lending rate, and primary tool is the interest on reserve balances (IORB rate).

Macro Policy Options

  • Do Nothing: Historical trend where no action is taken.

  • Short Run Policies: Aimed at smoothing business cycles, keeping unemployment at natural rates, and managing inflation.

    • Include:

    • Fiscal policies (automatic stabilizers and discretionary)

    • Monetary policies (discretionary)

  • Long Run Policies: Aimed at economic growth, shifting the production possibility frontier (PPF).

Exchange Rate Policy

  • Importance of Exchange Rates:

    • Example of the Swiss Franc during the 2008 financial crisis:

    • Influx of cash into Swiss banks due to the lack of trust in US banks.

    • Resulted in a surge in demand for Swiss Franc, appreciated value, leading to decreased export competitiveness.

    • Swiss National Bank intervention: dumped currency to reduce value, stabilized exports, indicating interconnectedness of economies and their reliance on exchange rates.

  • Impacts of Exchange Rates on Aggregate Demand:

    • Changes in currency valuation impact aggregate demand, especially for exports.

Balance of Payments (BOP)

  • A country’s balance of payments is a summary of its transactions with other countries, commonly analyzed on an annual basis, consisting of:

    • Current Account:

    • Includes goods and services, primarily net exports, and also remittances (money sent home by workers abroad).

    • Financial Account (formerly Capital Account):

    • Includes transactions relating to financial assets, net capital inflow.

  • Key Definitions:

    • Net Capital Inflow (NCI):

    • Equal and opposite to net exports (NCI = -Net Exports).

    • Balance of payments implying that current account + financial account = 0.

Factors Determining Financial Flows

  • International Differences in Investment Opportunities:

    • Countries like Singapore investing heavily in green technology, leading to capital inflows.

  • Growth Rates:

    • Countries with higher economic growth rates tend to attract more capital.

  • Interest Rates:

    • Higher international interest rates attract money.

  • Perceived Safety of Financial Assets:

    • Investors seek safe havens; during crises (like 2008), capital flows to secure locations (e.g., Swiss banks).

Exchange Rate Mechanism

  • Definition:

    • The exchange rate is the price of one currency relative to another (e.g., USD to CAD).

    • Currency appreciation means stronger purchasing power, while depreciation indicates lesser purchasing power.

  • Market Dynamics:

    • Foreign exchange market determines the exchange rates through supply and demand.

    • Demand for US Dollars: Comes from foreigners wanting US goods/services.

    • Supply of US Dollars: Comes from Americans wanting goods/services from abroad.

    • Equilibrium is established where the price of currency balances the supply and demand.

Practice and Applications

  • Students are encouraged to engage with concepts of supply and demand for currencies, how changes influence exchange rates, and aggregate demand.

  • Real-world problem-solving to determine outcomes based on changing financial circumstances, international events, and investor behavior.

Conclusion

  • Exchange rates central to macroeconomic stability, influencing trade balances and economic policies.

  • Understanding their implications is vital for comprehending international economic relations and domestic policy effectiveness.