Economics Flashcards
Quote convention USD / GBP exchange rate
1.6278 / 1.6283
What is the bid and offer rate?
Bid 1.6278 buy USD
Offer 1.6283 buy GBP
Calculate the market implied offer rate via 2 FX bid / offer rate.
EG Bid 0ffer rate
USD / EUR are BID1 / OFFER1
JPY/USD are BID2 / OFFER2
The market implied bid offer for JPY/EUR is cloest to?
The market implied bid rate
Buy JPY and Sell EUR
JPY/EUR bid = BID2 * OFFER1
The market implied offer rate
Sell JPY and Buy EUR
Calculate the forward FX using the covered interest rate parity,
Define the covered interest rate parity.
Forward = Spot * (1 + interest rate foreign * (Actual / 360)) / (1 + interest rate base * (Actual / 360))
Allows forward rates to be calculated from spot rates using interest rate differentials.
Define Uncovered interest rate parity.
Uncovered interest rate parity allows using interest rate differentials to calculate the exchange rate between two currencies.
The currency with higher interest rate is expected to depreciate.
Change in exchange rate = interest rate foreign - interest rate base
Define 3 forms of Purchasing power parity.
Law of one price - A good should cost the same in all countries when prices are converted into a common currency. This does not hold because of transport costs and trade barriers.
Absolute PPP - A basket of goods should cost the same in all counties when prices are converted into a common currency. Does not hold.
Relative PPP - The % change in nominal exchange rates will reflect inflation differentials between two currencies.
Percentage change in exhange rate = foriegn inflation - local inflation
Real FX rate = spot rate * (1 + foregin inflation / 1 + base inflation)
Define the international fisher effect.
The international fisher effectis the relationship between the nominal interest rate, real interest rate, and expected inflation.
If the real interest rate equal globally, then interest rate differentials can be explained by inflation differentials.
nominal interest rate = real interest rate + expected inflation
What is carry trade?
Investing in high yield currency and borrow in low yield currency.
- when exchange rate volatility is low.
- Leveraged position can suffer significant risk when return distribution is more peaked than the normal distribution, with fat tails and negative skew.
Mundell Fleming model with high capital mobility (developed economy).
Under expansionary / restrictive monetary policy
Under expansionary / restrictive fiscal policy
Under Expansionary monetary policy
- reduce the Interest rate
- together with expansionary fiscal policy, increase govt spending -> Ambiguous
- together with restrictive fiscal policy -> local currency depreciates
Under Restrictive monetary
- increase interest rate
- together with expansionary fiscal policy, increase govt spending -> local currency appreciates
- together with restrictive fiscal policy -> Ambiguous
Mundell Fleming model with high capital mobility (Developing economy).
Under expansionary / restrictive monetary policy
Under expansionary / restrictive fiscal policy
Calculate GDP growth rate
GDP growth rate = growth in total factor productivity + alpha * growth in capital investment + (1 - alpha) * growth in labour force
Alpha = 1 - (Labour cost / Total factor cost)
The difference in long term growth rate of labour production under classical, Neoclassical, and Endogenous theory.
Classical: Zero, population become larger but the increase is temporary.
Neoclassical: Depend on total factor producitivity. Capital deepening lead to rapid growth > steady state growth, then grow at samerate as capital per worker.
Endogenous: Depend on growth in capital per worker. Higher savings and investment can lead to higher growth rate permanently.
Impact of growth rate if developing country open its economy to foreign trade unde neoclassical and endogenous theory?
Neoclassical:
- growth convergence should happen more quickly.
- gloabl savers will invest in developing countries
- Faster capital growth enable faster productivity growth.
- Growth rate will raise in the short term.
- No permanent increase in economy growth rate, will converge to steady state rate of growth.
Endogenous:
- open trade will permanent increase growth rate of gloabl economy becasue of selection, scale and backwardness effect.
- selection effect - increase foreign competition increase productivity.
- scale effect - benefit from global economies of scale.
- Backwardness effect - less developed countries can learn from more developed countries.
- boost R&D, as comapnies can generate profit from global markets.
- Rate of return and economic growth both increase.
Define the difference between Classical, Neoclassical and Endogenous theory.
Classical -
Population boom
Increase in wealth is temporary
Long run labour growth rate is 0
Neoclassical -
Capital increase leads to rapid growth
Labour productivity grows at the same rate as capital per worker.
Increase in wealth is permanent because increase in productivity.
Labour productive growth dependent on Total Factor producitivity TFP growth.
Endogenous -
Techology progress
Higher savings and investment lead to higher growth rate.
Increase in wealth is permanent because growth
Labour productive growth dependent in capital per worker.
Describe three appraoch to acces long term equilibrium for exchange rate.
Macroeconomic balance
External sustainability
Reduced form econometric model
Macroeconomic balance - based on the predicated movement in exchange rate needed to narrow the gap between medium term current account deficiit and sustainable level of deficit.
External sustainability - based on predicted movement in exchange rates needed to stabilise a country net foregin liability to GDP ratio at its benchmark level.
Reduced form econometric model - predicts how exchange rates will move based on the key macroeconomic variables.
