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INT ECONOMY AND FINANCES > 4 > Flashcards

4 Flashcards

1
Q

What are the 2 ways to express the purchasing power parity equations?

A

E $/euro = P$/Peuro
or
P$ = E $/euro * Peuro

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2
Q

the law of one price applies to …. while PPP applies to …

A

the law of one price applies to individual commodities while the PPP applies to the general price level

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3
Q

relative PPP implies absolute PPP OR absolute PPP implies relative PPP

A

absolute PPP implies relative PPP

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4
Q

T or F: absolute PPP may be valid even when relative PPP is not

A

F

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5
Q

T or F: relative PPP may be valid even when absolute PPP is not

A

T: relative PPP may be valid even when absolute PPP is not, provided the factors causing deviations from absolute PPP are more or less stable over time

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6
Q

what is the relationship between PPP and the law of one price

A

The law of one price applies to individual commodities while PPP applies to the general price level.
Proponents of PPP argue that its validity in the long run doesn’t require the law of one price to hold exactly. When goods and services temporarily become more expensive in one country than in others, the demands for its currency and its products falls, exchange rate increases and domestic prices decrease and vice versa.

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7
Q

what is the difference between absolute PPP and relative PPP

A

Absolute PPP states that the exchange rate between two currencies equals the ratio of their price levels. Relative PPP states that the percentage change in the exchange rate between two currencies over a given period equals the difference between the inflation rates of those two currencies. (from a statement about P and exchange rate levels to a statement about P and exchange rate changes)

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8
Q

Suppose Russia’s inflation rate is 200% over one year but the inflation rate in Switzerland is only 2%. According to relative PPP, what should happen over the year to the Swiss franc’s exchange rate against the Russian ruble?

A 
relative PPP = % changes
delta Er/f = inf. r - inf.f
delta Er/f = 200% - 2%
delta Er/f = 198%
So there will be a 198% depreciation of the ruble against the franc or, conversely, a 198% appreciation of the franc against the ruble.
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9
Q

in order for the purchasing power parity to hold, what assumptions must be made?

A

both markets are perfectly competitive and there are no transportation costs or restrictions

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10
Q

the monetary approach to the exchange rate is a SR, LR or both theory?

A

the monetary approach to the exchange rate is a long run theory

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11
Q

if PPP holds, the exchange rate, which is the relative price of American and European money, is fully determined in the LR by….

A

if PPP holds, the exchange rate, which is the relative price of American and European money, is fully determined in the LR by the relative supplies of those monies and the relative demands for them

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12
Q

T o F: the interest rate is not independent of the MS growth rate in the long run

A

T, the interest rate is not independent of the MS growth rate in the LR

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13
Q

T o F: the long-run interest rate depends on the absolute level of the MS

A

False, the LR interest rate does not depend on the absolute level of the MS

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14
Q

while the long-run interest rate does not depend on the absolute level of the MS, what will eventually affect the interest rate?

A

continuing growth in the MS eventually will affect the interest rate

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15
Q

under PPP (and by the Fisher Effect), all else equal a rise in a country’s expected inflation will eventually cause what to the interest rate?

A

an equal rise in the interest rate that deposits of its currency offer

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16
Q

in the short run, with sticky prices, what happens to the interest rate when MS falls

A

in the SR, with sticky prices, the interest rate can rise when the domestic MS falls

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17
Q

if prices were fully flexible and could adjust immediately, what would happen to the price level and interest rate if domestic MS falls?

A

when the domestic MS falls, the price lvl would fall right away, keeping the interest rate constant

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18
Q

in the short run, with sticky prices, when MS falls what happens to preserve the money market equilibrium?

A

in the SR, with sticky prices, a fall in the MS raises the interest rate to preserve the money market equilibrium

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19
Q

in the SR, with sticky prices, an interest rate rise is associated with …. expected inflation and a LR currency …., to the currency …. immediately

A

in the SR, with sticky prices, an interest rate rise is associated with lower expected inflation and a LR currency appreciation, to the currency appreciates immediately

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20
Q

in the SR, an interest rate decrease is associated with …. expected inflation and a currency that will be …. on all future dates

A

in the SR, an interest rate decrease is associated with higher expected inflation and a currency that will be weaker on all future dates

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21
Q

Assume that PPP holds. what are the LR effects of an increase in US output relative to the euro area on the nominal exchange rate?

A

P = MS/L(R,Y)
a rise in the US output raises real US money demand leading to a fall in the LR US price lvl and an appreciation of the dollar

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22
Q

T o F: if relative PPP holds, the interest rate difference between 2 countries must equal the expected inflation difference

A

R$-Re = expected inf $ - expected inf e
T, if, as PPP predicts, currency depreciation is expected to offset international inflation difference, the interest rate difference must equal the expected inflation difference

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23
Q

does the existence of non-tradable goods allow for deviations from PPP?

A

Yes, the existence of nontradables allows deviations from PPP. This is because the price of a nontradable is determined entirely by its domestic supply and demand curves, and in turn fluctuations in demand and supply for these good will affect the price level. Examples include housing, haircut, services etc.

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24
Q

describe the LR (long enough for prices to adjust) response of the nominal and real exchange rate to an increase in the US money supply

A

US prices rise in proportion to MS: all dollar prices increase, including the dollar price of a euro = depreciation of nominal exchange rate. real exchange rate remains the same

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25
Q

describe the LR (long enough for prices to adjust) response of the nominal and real exchange rate to an increase in the growth rate of US money supply

A

the inflation rate, the dollar interest rate, the US price lvl and the nominal exchange rate rise in proportion to Pus. No effect on real interest rate

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26
Q

describe the LR (long enough for prices to adjust) response of the nominal and real exchange rate to an increase in world relative demand for US products

A

both nominal and real exchange rate fall

27
Q

describe the LR (long enough for prices to adjust) response of the nominal and real exchange rate to an increase in relative US output supply

A

dollar depreciates, lowers relative price of US output, rise of real exchange rate and effect on nominal exchange rate is not clear since real exchange rate and Pus work in opposite directions

28
Q

T o F: the prices of identical commodity baskets, when converted to a single currency, are often the same across countries

A

F: they differ substantially across countries

29
Q

is relative PPP a good approximation to the data and how does it perform?

A

relative PPP is sometimes a reasonable approximation to the data but often performs poorly

30
Q

what can explain the failure of relative PPP to hold in reality?

A

Government measures of the price level differ from country to country.
One reason for these differences is that people living in different countries spend their income in different ways.
Because of this inherent difference among countries, certain baskets will be affected more by price changes given their consumptions basket. For example, consumers in country, X, eats more fish relative to another country. More than likely, the government, upon determining a commodity basket to reflect preference, will have an overwhelming representation of fish in their basket. Any price level change in the fish market will be felt particularly by country X, and their overall price level will reflect this. Thus, changes in the relative prices of basket components can cause relative PPP to become distorted.

31
Q

are departures from PPP greater in the SR or LR and why?

A

departures from PPP may often be greater in the SR than in the LR due to price stickiness

32
Q

under the model of LR exchange rate, an increase in the world relative demand for US output causes what to the real exchange rate

A

a long run real appreciation of the dollar

33
Q

a relative expansion of US output causes a LR … of the dollar against the euro, while a relative expansion of European output causes a LR real … of the dollar against the euro

A

A relative expansion of U.S. output causes a long-run depreciation of the dollar against the euro, while a relative expansion of European output causes a long-run real appreciation of the dollar against the euro.

34
Q

n the output market, an increase in the demand for European output leads to …

A

an increase in the long-run nominal dollar/euro exchange rate.

35
Q

what are the predictions of the PPP theory with regards to the real exchange rate?

A

PPP predicts that the real exchange rate never permanently changes

36
Q

interest rate differences between countries depend on…

A

differences in expected inflation, and on expected changes in the real exchange rate.

37
Q

The expected rate of change in the nominal dollar/euro exchange rate is best described as

A

the expected rate of change in the real dollar/euro exchange rate plus the U.S.-Europe expected inflation difference.

38
Q

The expected real interest rate (re) in terms of the nominal interest rate (R) and the expected inflation rate (πe) is given by

A

re = R - πe.

39
Q

what is the real interest rate parity condition?

A

The nominal interest rates are rates of return measured in monetary terms. The real interest rates are rates of return measured in real terms.

40
Q

if PPP holds, the real interest rate…

A

if PPP holds, the real interest rate = 1

41
Q

a real depreciation (q increase) implies that US goods become more or less expensive relative to EA goods?

A

a real depreciation (q increase) implies that US goods become less expensive relative to EA

42
Q

a real depreciation means that a dollar buys more or fewer EA products than US products?

A

a real depreciation means that a dollar buys fewer EA products than US products

43
Q

a real appreciation means that US goods become more or less expensive relative to EA goods?

A

a real appreciation means that US goods become more expensive relative to EA goods?

44
Q

a real appreciation means there is a rise or a fall in the dollar’s purchasing power of EA products relative to a dollar’s purchasing power of US products?

A

a real appreciation means there is a rise in the dollar’s purchasing power of EA products relative to a dollar’s purchasing power of US products?

45
Q

what influences the real exchange rate?

A
  • relative demand of goods between countries

- relative supply of goods between countries

46
Q

the relative supply curve for US goods is …

A

the relative supply curve of US goods is vertical

47
Q

the relative supply curve of US goods is determined …

A

factor supplies and productivity differentials across countries in the LR

48
Q

the relative demand curve for US goods is … and why

A

upward sloping, because as the real exchange rate depreciates (q increases), demand for US goods increases = relative demand increases

49
Q

what does the relative demand measures?

A

RD measures the worlds demand for US goods minus the world demand for euro area goods

50
Q

what are the effects of an increase in relative demand for US products on the real exchange rate?

A

increase of US goods demand = increase of Pus = LR real appreciation of the dollar (q decreases)

51
Q

what are the effects of a decrease in the relative demand for US products on the real exchange rate?

A

decrease of US goods demand = price decreases = LR real depreciation (q increases)

52
Q

what are the effects of an increase in US productivity (increase of supply of US goods)on the real exchange rate?

A

there is an excess relative supply of US goods = price decreases = demand shifts to eliminate excess supply = long run real depreciation (q increases)

53
Q

what are the effects of a relative increase in euro productivity (increase of supply of euro goods) on the real exchange rate?

A

a relative expansion of european output causes a long run real appreciation of the dollar (q falls)

54
Q

what is the effect on the LR nominal exchange rate of an increase in the US money supply level?

A

proportional increase (nominal depreciation)

55
Q

what is the effect on the LR nominal exchange rate of an increase in the euro money supply level?

A

proportional decrease (nominal appreciation)

56
Q

what is the effect on the LR nominal exchange rate of an increase in the US money supply growth rate?

A

increase (nominal depreciation)

57
Q

what is the effect on the LR nominal exchange rate of an increase in the euro money supply growth rate?

A

decrease (nominal appreciation)

58
Q

what is the effect on the LR nominal exchange rate of an increase in the demand for US output?

A

decrease (nominal appreciation)

59
Q

what is the effect on the LR nominal exchange rate of an increase in the demand for euro output?

A

increase (nominal appreciation)

60
Q

what is the effect on the LR nominal exchange rate of an increase in the output supply in the US?

A

ambiguous

61
Q

what is the effect on the LR nominal exchange rate of an increase in the output supply in the europe?

A

ambiguous

62
Q

what is the condition so that the law of one price can hold?

A

markets are competitive and integrated (no transportation costs or barriers such as tarrifs)

63
Q

T o F: when PPP holds, it implies identical purchasing power across countries

A

T

INT ECONOMY AND FINANCES (11 decks)

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