Economics 16-19 Flashcards
16-19
1
Q
Geopolitics
A
Geopolitics refers to interactions among nations, including the actions of state actors (national governments) and nonstate actors (corporations, nongovernment organizations, and individuals).
Geopolitics also refers to the study of how geography affects interactions among nations and their citizens.
2
Q
What are potential areas of cooperation between countries in geopolitics?
A
Potential areas of cooperation include diplomatic and military matters, economic and cultural interactions, freedom of movement for goods, services, and capital, harmonizing tariffs, international standardization of rules, and technology transfers.
3
Q
How can a country’s national interests be analyzed in geopolitics?
A
National interests can be analyzed as a hierarchy, with top priorities ensuring the country’s survival, often influenced by its geophysical resource endowment.
4
Q
How does a country’s resource endowment affect its cooperation priorities?
A
A country’s resource endowment, like having minerals but lacking arable land, can drive it to prioritize cooperation in international trade to exchange minerals for food
4
Q
Why do nonstate actors often seek cross-border cooperation?
A
Nonstate actors, like individuals and firms, seek to direct their resources to their highest-valued uses, which may be in other countries, leading them to cooperate across borders.
5
Q
What is an example of international standardization that facilitates cross-border cooperation?
A
To facilitate the flow of resources, state and nonstate actors may cooperate on standardization of regulations and processes. International Financial Reporting Standards (IFRS) are an example, as they standardize how firms present their accounting data to the public across countries.
6
Q
What is ‘soft power’ in the context of international cooperation?
A
Soft power is the ability of a country to influence other countries without using or threatening force, often through cultural exchange and strong legal and ethical institutions.
7
Q
How can cultural factors influence a country’s level of cooperation?
A
Cultural factors, such as historical emigration patterns or a shared language, can be another inf luence on a country’s level of cooperation. Among these cultural factors are a country’s formal and informal institutions, such as laws, public and private organizations, or distinct customs and habits. Strong and stable institutions can make cooperation easier for state and nonstate actors.
8
Q
Globalisation
A
Globalization refers to the long-term trend toward worldwide integration of economic activity and cultures.
9
Q
Nationalism
A
In contrast to globalisation, nationalism refers to a nation pursuing its own economic interests independently of, or in competition with, the economic interests of other countries.
10
Q
Globalisation to Nationalism Spectrum
A
In general, countries that are closer to the globalisation end of the spectrum are those that more actively import and export goods and services, permit freer movement of capital across borders and exchange of currencies, and are more open to cultural interaction.
11
Q
Autarky
A
Autarky (noncooperation and nationalism) refers to a goal of national self-reliance, including producing most or all necessary goods and services domestically. Autarky is often associated with a state-dominated society in general, with attributes such as government control of industry and media.
12
Q
Hegemony
A
Hegemony (noncooperation and globalization) refers to countries that are open to globalization but have the size and scale to in fluence other countries without necessarily cooperating.
13
Q
Bilateralism
A
Bilateralism (cooperation and nationalism) refers to cooperation between two countries. A country that engages in bilateralism may have many such relationships with other countries while tending not to involve itself in multicountry arrangements.
14
Q
Multilateralism
A
Multilateralism (cooperation and globalisation) refers to countries that engage extensively in international trade and other forms of cooperation with many other countries.
15
Q
Regionalism
A
Kind of multilateralism: Some countries may exhibit regionalism, cooperating multilaterally with nearby countries but less so with the world at large.
16
Q
Portfolio Investment Flows
A
Nonstate actors buying and selling foreign securities
17
Q
Foreign Direct Investment
A
Nonstate actors owning physical production capacity in other countries
18
Q
Why might nonstate actors engage in globalisation even though their governments may not?
A
- Businesses may look outside their home country for opportunities to increase prof its, reduce costs, and sell to new markets.
- Investors may seek higher returns or diversi fication by investing outside their home country.
19
Q
Goals of IMF
A
International Monetary Fund goals:
- Promoting international monetary cooperation
- Facilitating the expansion and balanced growth of international trade
- Promoting exchange stability
- Assisting in the establishment of a multilateral system of payments
- Making resources available (with adequate safeguards) to members experiencing balance of payments diff iculties
20
Q
Goals of World Bank
A
- Fight Global Poverty: Focused on reducing poverty worldwide.
- Promote Sustainable Development: Aims to ensure long-term, inclusive growth.
- Provide Financial Assistance: Offers low-interest loans, interest-free credits, and grants to developing countries.
- Support Various Sectors: Invests in education, health, infrastructure, public administration, financial development, agriculture, and environmental management.
- Operate Through Two Institutions:
1. International Bank for Reconstruction and Development (IBRD): Assists middle-income and creditworthy poorer countries.
2. International Development Association (IDA): Targets the world’s poorest countries. - Facilitate Knowledge Sharing: Provides technical assistance and capacity building in both public and private sectors.
21
Q
Goals of World Trade Organization
A
- Primary Role: Manages global trade rules to ensure trade flows smoothly, predictably, and freely.
- Dispute Settlement: Handles trade disputes by interpreting agreements and ensuring conformity with trade policies, reducing the risk of political or military conflict.
- Multilateral Trading System: Operates based on WTO agreements, which are negotiated, signed, and ratified by member countries.
- Legal Framework: Provides legal ground-rules for international commerce, ensuring important trade rights and binding governments to agreed trade policies.
22
Q
Geopolitical Risk
A
Geopolitical risk is the possibility of events that interrupt peaceful international relations.
3 types:
- Event Risk
- Exogenous risk
- Thematic risk
23
Q
Event risk
A
Event risk refers to events about which we know the timing but not the outcome, such as national elections.
24
Exogenous Risk
Exogenous risk refers to unanticipated events, such as outbreaks of war or rebellion.
25
Thematic risk
Thematic risk refers to known factors that have effects over long periods, such as human migration patterns or cyber risks.
26
Forecasting the effect on investments of a geopolitical risk
Geopolitical risk affects investment values by increasing or decreasing the risk premium investors require to hold assets in a country or region. To forecast the effect on investments of a geopolitical risk, we need to consider its probability (likelihood), the magnitude of its effects on investment outcomes (impact), and how quickly investment values would re lect these effects (velocity).
27
How does cooperation and globalization impact the likelihood of geopolitical risk?
Countries that are more cooperative and globalized tend to have a lower likelihood of risks like armed conflict but a higher likelihood of risks like supply chain disruptions.
28
What is the significance of high-velocity geopolitical risks?
High-velocity risks are short-term and can have rapid effects on financial markets and investment values, requiring quick responses, especially from investors with short time horizons.
29
What is Black Swan Risk?
Black Swan Risk refers to low-likelihood exogenous events that have substantial short-term effects, often unexpected and difficult to predict.
30
How do medium-velocity geopolitical risks affect companies?
Medium-velocity risks can increase costs or disrupt production processes, impacting specific companies or industries.
31
Why is analyzing low-velocity risks important for long-term investors?
Low-velocity risks often impact companies in the "environmental, social, and governance" (ESG) realm, which can have significant long-term effects on investments.
32
What are exogenous risks?
Exogenous risks are external factors that can cause high-velocity effects on financial markets and investments, often unexpected and outside the control of the impacted entities.
33
Tools of geopolitics
the means by which (primarily) state actors advance their interests in the world, as falling into three broad categories of national security, economic, and financial.
34
National security tools
may include armed con lict, espionage, or bilateral or multilateral agreements designed to reinforce or prevent armed con lict. We can say a national security tool is active if a country is currently using it or threatened if a country is not currently using it but appears likely to do so. Armed conf lict affects regions and economies by destroying productive capital and causing migration away from areas of conf lict.
35
Economic tools
Economic tools can be cooperative or noncooperative. Examples of cooperative economic tools include free trade areas, common markets, and economic and monetary unions (each of which we describe in our reading on international trade and capital lows). Examples of noncooperative economic tools include domestic content requirements, voluntary export restraints, and nationalization (i.e., the state taking control) of companies or industries.
36
Financial tools
Financial tools include foreign investment and the exchange of currencies. We can view countries as using these tools cooperatively if they allow foreign investment and the free exchange of currencies, or noncooperatively when they restrict these activities.
37
Sanctions
Sanctions, or restrictions on a specific geopolitical actor’s financial interests, are a financial tool that state actors may use alongside national security tools.
38
impact of geopolitical risk on investments.
- Because analyzing geopolitical risks requires effort, time, and resources, investors should consider whether the impact of geopolitical risk is likely to be high or low, and focus their analysis on risks that could have a high impact. - With regard to those risks, investors should determine whether they are likely to have discrete impacts on a company or industry or broad impacts on a country, a region, or the world.
- Business cycles can affect the impact of geopolitical risk, in that these risks may have greater impacts on investment values when an economy is in recession than they would have during an expansion.
39
How to gauge the potential effects of geopolitical risks?
Investors can use qualitative or quantitative scenario analysis to gauge the potential effects of geopolitical risks on their portfolios. To help identify geopolitical risks over time, investors may identify signposts, or data that can signal when the likelihood of an event is increasing or decreasing, such as volatility indicators in inancial markets.
40
What is the focus of traditional economic models of trade?
Traditional models focus on gains from countries specializing in producing goods where they have a comparative advantage and trading them, which increases total output and wealth for both countries.
41
What factors create comparative advantage in trade?
Comparative advantage results from differences in technology and resource endowments across countries.
42
What do newer models of trade emphasize?
Newer models emphasize gains from economies of scale, increased variety of goods, improved competition, reduced costs, and more efficient allocation of resources.
43
How does free trade benefit consumers in the context of monopolies?
Free trade reduces the pricing power of domestic monopolies by increasing competition, which can lower prices for consumers.
44
How can free trade impact wages and employment in a country with higher labor costs?
Free trade can decrease wages and employment in domestic industries, especially in labor-intensive sectors, potentially increasing income inequality.
44
How can international trade affect consumers in monopolistic competition markets?
International trade can provide consumers with a greater variety of goods and lower costs through specialization, even in markets with differentiated products like automobiles.
45
What are some costs associated with free trade?
The costs include job losses in importing industries, increased economic inequality, and potential price increases in exporting countries.
46
What is the general economic argument for the gains from trade?
The overall gains from trade are considered greater than the losses, especially in the long run, where gainers could theoretically compensate the losers, benefiting both importing and exporting countries.
47
Arguments for Trade Restrictions
- Infant Industry
- National Security
- Protecting Domestic Jobs
- Protecting Domestic Industries
- Retaliation for foreign trade restrictions
- Government collection of tariffs (taxes on imported goods
- Countering effects of government subsidies paid to foreign producers
- Preventing foreign exports at less than their costs of production (Dumping)
48
How are the short-term and long-term effects of free trade different?
In the short term, workers and companies in industries facing import competition suffer, but in the long run, these costs may be mitigated or reversed as workers retrain and find employment in other industries.
49
Types of Trade Restrictions:
1. Tariffs. These are taxes on imported goods collected by the government.
2. Quotas. These are limits on the amount of imports allowed over some period.
3. Export subsidies. These are government payments to firms that export goods.
4. Minimum domestic content. This is the requirement that some percentage of product content must be from the domestic country.
5. Voluntary export restraint. A country voluntarily restricts the amount of a good that can be exported, often in the hope of avoiding tariffs or quotas imposed by its trading partners.
50
Tarrif
- A tariff placed on an imported good increases its domestic price, decreases the quantity imported, and increases the quantity supplied domestically.
- Domestic producers gain, foreign exporters lose, and the domestic government gains by the amount of the tariff revenues.
51
Quota
- Quota restricts the quantity of a good imported to the quota amount.
- Domestic producers gain, and domestic consumers lose from an increase in the domestic price.
- The right to export a speci fic quantity to the domestic country is granted by the domestic government, which may or may not charge for the import licenses to foreign countries.
- If the import licenses are sold, the domestic government gains the revenue.
52
Quota rents
In the case of a quota, if the domestic government collects the full value of the import licenses, the result is the same as for a tariff. If the domestic government does not charge for the import licenses, this amount is a gain to those foreign exporters who receive the import licenses under the quota and are termed quota rents.
53
Deadweight Loss
In terms of overall economic gains from trade, the deadweight loss is the amount of lost welfare from the imposition of a quota or tariff. From the viewpoint of the domestic country, the loss in consumer surplus is only partially offset by the gains in domestic producer surplus and the collection of tariff revenue.
54
voluntary export restraint (VER)
It refers to a voluntary agreement by a government to limit the quantity of a good that can be exported. VERs are another way of protecting the domestic producers in the importing country. They result in a welfare loss to the importing country equal to that of an equivalent quota with no government charge for the import licenses—that is, no capture of the quota rents.
55
Export subsidies
Export subsidies are payments by a government to its country’s exporters. Export subsidies bene it producers (exporters) of the good but increase prices and reduce consumer surplus in the exporting country. In a small country, the price will increase by the amount of the subsidy to equal the world price plus the subsidy. In the case of a large exporter of the good, the world price decreases and some bene its from the subsidy accrue to foreign consumers, while foreign producers are negatively affected.
56
Effects of the Protectionist Policies
With respect to the domestic (importing) country, import quotas, tariffs, and VERs all do the following:
- Reduce imports
- Increase price
Decrease consumer surplus
- Increase domestic quantity supplied
- Increase producer surplus
57
What is the exception of the protectionist policies that increases national welfare
With one exception, all protectionist policies will decrease national welfare. Quotas and tariffs in a large country could increase national welfare under a specific set of assumptions, primarily because for a country that imports a large amount of the good, setting a quota or tariff could reduce the world price for the good.
58
What are capital restrictions?
Capital restrictions are measures that limit or prohibit the flow of financial capital across borders, including prohibitions on foreign investment, taxes on foreign income, and restrictions on repatriation of earnings.
59
What are some examples of capital restrictions?
Examples include outright prohibition of foreign investment, taxes on income from foreign investments, restrictions on foreign investments in certain industries, and limits on repatriating earnings.
60
How do capital restrictions impact economic welfare?
Capital restrictions are generally thought to decrease economic welfare in the long term.
61
What are some short-term benefits of capital restrictions for developing countries?
They can help avoid the impact of large inflows of foreign capital during expansion periods and large outflows during corrections or market panic.
62
What is a potential long-term downside of capital restrictions?
Long-term costs may include exclusion from international financial markets, which can outweigh the short-term benefits.
63
What is the essence of trade agreements among countries?
The essence of trade agreements is to reduce trade barriers among countries.
64
What are the positive effects of reducing trade restrictions?
Positive effects include increased trade according to comparative advantage and increased competition among firms in member countries.
65
What are the negative effects of reducing trade restrictions?
Negative effects include decreased wealth and income for some firms, industries, and groups of workers, who may need to learn new skills to find new jobs.
66
How does reducing trade restrictions impact economic welfare?
On balance, economic welfare is improved by reducing or eliminating trade restrictions.
67
What are trading blocs or regional trading agreements (RTAs)?
RTAs are types of agreements among countries, listed in order of their degrees of integration, to facilitate trade by reducing barriers.
- Free Trade Areas
- Customs Union
- Common Market
- Economic Union
- Monetary Union
68
Customs Union
1. All barriers to import and export of goods and services among member countries are removed.
2. All countries adopt a common set of trade restrictions with nonmembers.
68
Free Trade Areas
1. All barriers to import and export of goods and services among member countries are removed.
Eg: North American Free Trade Agreement (NAFTA)
69
Common Market
1. All barriers to import and export of goods and services among the countries are removed.
2. All countries adopt a common set of trade restrictions with nonmembers.
3. All barriers to the movement of labor and capital goods among member countries are removed.
70
Economic Union
1. All barriers to import and export of goods and services among the countries are removed.
2. All countries adopt a common set of trade restrictions with nonmembers.
3. All barriers to the movement of labor and capital goods among member countries are removed.
4. Member countries establish common institutions and economic policy for the union.
Eg: European Union
71
Monetary Union
1. All barriers to import and export of goods and services among the countries are removed.
2. All countries adopt a common set of trade restrictions with nonmembers.
3. All barriers to the movement of labor and capital goods among member countries are removed.
4. Member countries establish common institutions and economic policy for the union.
5. Member countries adopt a single currency.
Eg: Eurozone
72
What is an even larger market than the one for goods and services in foreign currency markets?
The market for capital flows, including the purchase of foreign physical assets and financial securities.
72
What is the primary function of foreign currency markets?
They serve companies and individuals that purchase or sell foreign goods and services denominated in foreign currencies.
73
What type of risk do many companies face due to cross-border transactions?
Foreign exchange risk.
74
How can a company hedge against foreign exchange risk?
By entering into a forward currency contract to lock in an exchange rate, reducing or eliminating the risk.
75
What is speculating in the context of foreign exchange markets?
It refers to transactions or positions that increase currency risk.
76
FX: Buy Side v Sell Side
The primary dealers in foreign exchange (FX) and originators of forward FX contracts are large multinational banks. This part of the FX market is often called the sell side. On the other hand, the buy side consists of the many buyers of foreign currencies and forward FX contracts.
77
Buyers of FX forward Contracts
- Corporations
- Investment accounts: Real Money Accounts & Leveraged Accounts
- Government & Government Entities
- Retail FX Market
78
Real Money Accounts
Real money accounts refer to mutual funds, pension funds, insurance companies, and
Video covering this content is other institutional accounts that do not use derivatives.
79
Leveraged Accounts
Leveraged accounts refer to the various types of investment f irms that use derivatives, including hedge funds, f irms that trade for their own accounts, and other trading f irms of various types.
80
Exchange Rate
An exchange rate is simply the price or cost of units of one currency in terms of another. In this book we state exchange rates in the form 1.416 USD/EUR, to mean that each euro costs $1.416.
81
Price currency v Base Currency
In a foreign currency quotation, we have the price of one currency in units of another currency. These are often referred to as the base currency and the price currency. In the quotation 1.25 USD/EUR, the USD is the price currency and the EUR is the base currency.
82
Direct Quote or Indirect Quote
An exchange rate expressed as price currency/base currency is referred to as a direct quote from the point of view of an investor in the price currency country and an indirect quote from the point of view of an investor in the base currency country. For example, a quote of 1.17 USD/EUR would be a direct quote for a USD-based investor and an indirect quote for a EUR-based investor.
83
Nominal Exchange Rate
The exchange rate at a point in time is referred to as a nominal exchange rate. If this rate (price/base) increases, the cost of a unit of the base currency in terms of the price currency has increased, so that the purchasing power of the price currency has decreased.
84
Real Exchange Rate
The real exchange rate between two currencies refers to the purchasing power of one currency in terms of the amount of goods priced in another currency, relative to an earlier (base) period.
85
What happens to the purchasing power of the USD in the Eurozone when the nominal USD/EUR exchange rate increases?
The purchasing power of the USD decreases in the Eurozone, while the purchasing power of the EUR increases in the United States.
Real USD/EUR rate increases
86
What happens to the purchasing power of the USD in the Eurozone when the nominal USD/EUR exchange rate decreases?
The purchasing power of the USD increases in the Eurozone, while the purchasing power of the EUR decreases in the United States.
Real USD/EUR rate decreases
87
What happens to the real USD/EUR exchange rate if the price level in the Eurozone increases relative to the United States?
The real USD/EUR exchange rate increases, decreasing the purchasing power of the USD in the Eurozone.
88
What happens to the purchasing power of the EUR in the United States when the price level in the Eurozone increases relative to the United States?
The purchasing power of the EUR increases in the United States.
89
What happens to the real USD/EUR exchange rate if the price level in the Eurozone decreases relative to the United States?
The real USD/EUR exchange rate decreases, increasing the purchasing power of the USD in the Eurozone.
89
What happens to the purchasing power of the EUR in the United States when the price level in the Eurozone decreases relative to the United States?
The purchasing power of the EUR decreases in the United States.
90
End of Period P/B Real Exchange Rate
real P/B exchange rate = nominal P/B exchange rate x CPIbase/CPIprice
- An increase (decrease) in the nominal exchange rate over the period increases (decreases) the end-of period real exchange rate, and the purchasing power of the price currency decreases (increases).
- An increase in the price level in the price currency country relative to the price level in the base currency country will decrease the real exchange rate, increasing the purchasing power of the price currency in terms of base country goods.
- Conversely, a decrease in the price level in the price currency country relative to the price level in the base currency country will increase the real exchange rate, decreasing the purchasing power of the price currency in terms of base country goods.
91
Spot Exchange Rate
A spot exchange rate is the currency exchange rate for immediate delivery, which for most currencies means the exchange of currencies takes place two days after the trade.
92
Forward Exchange rate
A forward exchange rate is a currency exchange rate for an exchange to be done in the future. Forward rates are quoted for various future dates (e.g., 30 days, 60 days, 90 days, or one year). A forward is actually an agreement to exchange a specif ic amount of one currency for a specif ic amount of another on a future date speci fied in the forward agreement
93
Is it correct to say that depreciation of base currency in % terms = appreciation of price currency in % terms
No - would need to reciprocate and calculate
94
Exchange Rate Regimes
For countries that dont have their own currency:
- Formal Dollarization
- Monetary Union
For Countries that have their own currency
- Currency Board Arrangement
- Conventional Fixed peg arrangement
- Target Zone
- Crawling Peg
- Management of Exchange Rates within crawling Bands
- Managed f loating exchange rates
- Independently floating,
95
Formal Dollarization
A country can use the currency of another country. The country cannot have its own monetary policy, as it does not create money or issue currency.
96
Monetary Union
A country can be a member of a monetary union in which several countries use a common currency. Within the European Union, for example, most countries use the euro. While individual countries give up the ability to set domestic monetary policy, they all participate in determining the monetary policy of the European Central Bank.
97
currency board arrangement
A currency board arrangement is an explicit commitment to exchange domestic currency for a speci fied foreign currency at a fixed exchange rate. Hong Kong only issues currency when it is fully backed by holdings of an equivalent amount of U.S. dollars.
98
What is the monetary benefit for Hong Kong under its currency board arrangement?
The Hong Kong Monetary Authority can earn interest on its U.S. dollar balances.
99
What is dollarization, and how does it differ from a currency board arrangement in terms of income?
Dollarization is when a country uses a foreign currency (like the U.S. dollar) instead of its own, and in this case, the income from interest-bearing assets is earned by the U.S. Federal Reserve, not the domestic monetary authority.
100
What are the limitations of a currency board arrangement regarding monetary policy?
The monetary authority gives up the ability to conduct independent monetary policy and essentially imports the inflation rate of the outside currency.
101
conventional f ixed peg arrangement,
- A country pegs its currency within margins of ±1% versus another currency or a basket that includes the currencies of its major trading or f inancial partners.
- The monetary authority can maintain exchange rates within the band by purchasing or selling foreign currencies in the foreign exchange markets (direct intervention).
- The country can use indirect intervention, including changes in interest rate policy, regulation of foreign exchange transactions, and convincing people to constrain foreign exchange activity.
102
Target Zone
In a system of pegged exchange rates within horizontal bands or a target zone, the permitted fluctuations in currency value relative to another currency or basket of currencies are wider (e.g., ±2%). Compared to a conventional peg, the monetary authority has more policy discretion because the bands are wider.
103
Crawling Peg
With a crawling peg, the exchange rate is adjusted periodically, typically to adjust for higher in flation versus the currency used in the peg.
This is termed a passive crawling peg as opposed to an active crawling peg, in which a series of exchange rate adjustments over time is announced and implemented.
An active crawling peg can inf luence inf lation expectations, adding some predictability to domestic in flation.
Monetary policy is restricted in much the same way it is with a fixed peg arrangement.
104
management of exchange rates within crawling bands
the width of the bands that identify permissible exchange rates is increased over time. This method can be used to transition from a fixed peg to a floating rate when the monetary authority’s lack of credibility makes an immediate change to floating rates impractical. Again, the degree of monetary policy flexibility increases with the width of the bands.
105
managed floating exchange rates
the monetary authority attempts to inf luence the exchange rate in response to specific indicators such as the balance of payments, inflation rates, or employment without any speci fic target exchange rate or predetermined exchange rate path. Intervention may be direct or indirect. Such management of exchange rates may induce trading partners to respond in ways that reduce stability.
106
independently floating
When a currency is independently f loating, the exchange rate is market determined, and foreign exchange market intervention is used only to slow the rate of change and reduce short-term fluctuations—not to keep exchange rates at a target level.
107
How do changes in exchange rates affect the goods market compared to capital flows?
The effects on the goods market (imports and exports) occur more slowly than the effects on capital flows between countries.
108
What does it mean if a country has a trade deficit?
It means the country imports more goods and services than it exports, resulting in a trade imbalance.
109
What is the balance of payments?
The balance of payments is the record of all economic transactions between residents of one country and the rest of the world, where capital flows must offset any imbalance between a country's exports and imports.
110
How do capital flows relate to trade imbalances?
Capital flows, such as purchases of assets, must offset the trade imbalances between countries.
111
Common objectives of capital restrictions imposed by governments.
- Reduce the volatility of domestic asset prices.
- Maintain fixed exchange rates
- Keep domestic interest rates low.
- Protect strategic industries.
112
Why might a country restrict capital flows to reduce the volatility of domestic asset prices?
To prevent drastic drops in asset prices during macroeconomic crises, especially for liquid assets like stocks and bonds, by limiting foreign investment capital inflows and outflows.
113
How do capital restrictions help countries maintain fixed exchange rates?
By limiting foreign investment capital flows, it becomes easier to meet exchange rate targets, allowing countries to focus on domestic economic goals using monetary and fiscal policy.
114
Why might a country prohibit foreign investment in certain industries?
To protect strategic industries important for national security, such as telecommunications and defense, from foreign control.
115
cross rate
A cross rate is the exchange rate between two currencies implied by their exchange rates with a common third currency. Cross-rates are necessary when there is no active FX market in a currency pair. The rate must be computed from the exchange rates between each of these two currencies and a third currency, usually the USD or EUR.
116
Explain the arbitrage relationship between spot and forward exchange rates and interest rates
When currencies are freely traded and forward currency contracts exist, the percentage difference between forward and spot exchange rates is approximately equal to the difference between the two countries’ interest rates. This is because there is an arbitrage trade with a riskless prof it to be made when this relation does not hold.
117
No Arbitrage Condition
The no-arbitrage condition requires that “you cannot earn more than your domestic riskless rate of interest by borrowing your domestic currency, converting it to a foreign currency to invest at the foreign riskless rate, and exchanging back to your domestic currency.” So:
118
forward discount or forward premium
The forward discount or forward premium for a currency is calculated relative to the spot exchange rate. The forward discount or premium for the base currency is the percentage difference between the forward price and the spot price.
= [ Forward - Spot ] / Spot
119
The spot rate on the New Zealand dollar (NZD) is NZD/USD 1.4286, and the 180- day forward rate is NZD/USD 1.3889. This difference means Interest rates in the US are (higher/lower) than NZ
USD depreciates - high inflation - high interest rates
Therefore, HIGHER
