Economics Flashcards
Dutch disease
currency appreciation driven by strong export demand for resources makes other segments of the economy, in particular manufacturing, globally uncompetitive
Neoclassic model
Sustainable growth rate of an economy is a function of population growth, labor share of income, and rate of technological advancement. Growth from savings is temporary
Endogenous model
- no diminishing marginal returns to capital for the economy as a whole
- increasing the saving rate permanently increases the rate of economic growth
-production function = y(e) = f(k(e)) = c*k(e), where y(e) is output per worker, k(e) = capital per worker, c is constant - growth rate of output per capita = delta y(e) = delta k(e) = s*c-o-n, where s is savings rate, c is constant, o is depreciation, n = labor force growth
capital-labor ratio
an increase in the capital-labor ratio, moving along the production function to the right
capital deepening
adding more and more capital to a fixed number of workers increase per capita output, but at a decreasing rate
effect of capital deepening on country with high capital-labor ratio and low marginal product of capital
little impact because of diminishing returns
effect of population growth on gdp growth and per capita gdp growth
increases gdp growth, but no effect on per capita gdp growth
a country with high capital-labor ratio and low marginal product of capital will increase growth in gdp per capita through what?
technological progress
indicators of dutch disease
high export demand for natural resources and high currency appreciation
The key international parity conditions
1) Covered interest rate parity
2) Uncovered interest rate parity
3) Forward rate parity
4 Purchasing power parity
5) International fisher effect
Covered interest rate parity
Investment in a foreign money market instrument that is completely hedge against exchange rate risk should yield exactly the same return as an otherwise identical domestic money market instrument
If the forward and spot exchange rates, as well as one of the risk-free rates are known, the other risk-free rate can be calculated
Uncovered interest rate parity
The proposition that the expected return on an uncovered (unhedged) foreign currency (risk-free) investment should equal the return on a comparable domestic currency investment
Given the spot exchange rate and the expected future change, the future spot exchange rate can be calculated
Forward Rate Parity
Forward exchange rate will be an unbiased predictor of the future spot exchange rate
Not a perfect forecast, just an unbiased one
Why uncovered interest rate parity prediction will not hold
there is no arbitrage condition that forces uncovered interest rate parity to hold
Using forward points to forecast exchange spot rate assumes what about investors
they are risk neutral
Purchasing power parity (PPP)
Exchange rates move to equalize the purchasing power of different currencies
Absolute version of PPP
prices of goods and services will not differ internationally once exchange rates are considered
Relative version of PPP
changes in nominal exchange rates over time are equal to national inflation rate differentials
Real interest rate parity
Real interest rates will converge to the same level across different markets
International fisher effect
nominal interest rate differentials across currencies are determined by expected inflation differentials
Forward rates are unbiased predictors of future spot rates if which two parity conditions hold
Covered interest rate parity and uncovered interest rate parity
International fisher effect requires which parities to hold
ex ante PPP and real interest rate PPP
FX carry trade
Investment strategy that involves taking long positions in high-yield currencies and short positions in low-yield currencies
Carry trades will be profitable when which parity does not hold
uncovered interest rate parity, in the short or medium term
Three accounts that make up country’s balance of payments
Current, capital and financial account
Impact of exports>imports on current account and capital account
Negative current account and current account deficit, must make it up with a surplus in capital account
Impact of long-term current account deficit on currency
Currency will depreciate because that country is financing their acquisitions of imports through the continued use of debt
Why do investment/financing decisions usually dominant exchange rate movements
1) Prices tend to adjust slowly than exchange rates
2) Product of real goods and services takes time, while liquid financial markets allow virtually instant redirection of financial flows
3) Current spending/production reflects purchases and sales of current production while investment/financing decisions reflect reallocation of existing portfolios
4) Expected exchange rate movements can induce very large short-term capital flows.
Impact on domestic currency | Expansionary monetary policy + expansionary fiscal policy with low capital mobility
domestic currency depreciates
Impact on domestic currency | restrictive monetary policy + expansionary fiscal policy with low capital mobility
indeterminate
Impact on domestic currency | Expansionary monetary policy + restrictive fiscal policy with low capital mobility
indeterminate
Impact on domestic currency | restrictive monetary policy + restrictive fiscal policy with low capital mobility
appreciates
Potential GDP
the maximum amount of output an economy can sustainably produce without inducing an increase in the inflation rate
output level that corresponds to full employment with consistent wage and price expectations
Grinold-Kroner Model
E(r) = dividend yield + expected repricing + inflation rate + real economic growth - change in shares outstanding
Classical growth theory - economics
in the long run, the adoption of new technology results in a larger but not richer population, thus the standard of living is constant over time and there is no growth in per capita output
Increase in the savings rate under neoclassical model
implies higher capital-to-labor ratio (k) and higher output per worker (y) because a higher saving rate generates more saving/investment at every level of output
Increase in labor force growth (n) under neoclassical model
reduces equilibrium capital-to-labor
increase in Deprecation rate (o) under neoclassical model
reduces equilibrium capital-to-labor
Why are emerging market countries better able to influence their exchange rates
Their reserve levels as a ratio of average daily FX turnover are generally much greater than those of DM countries
What happens to foreign exchange reserves during currency crises
they decline
What happens to broad money growth during currency crises
they increase
Behavior of trade balance right before a currency crises
no change
Impact on domestic currency | expansionary fiscal policy | restrictive monetary policy with high capital mobility
currency appreciation
impact on domestic currency | expansionary monetary policy | restrictive fiscal policy with high capital mobility
currency depreciation
impact on domestic currency | expansionary monetary policy | expansionary fiscal policy with high capital mobility
ambiguous
impact on domestic currency | restrictive monetary policy | restrictive fiscal policy with high capital mobility
ambiguous
Relative to a normal distribution, the distribution of carry trade returns are more
peaked with negative skew
Are forward rates good predictors of forward spot rates
no
Under what time frame do international parity conditions hold
medium-to-long-term
Under what time frame do international parity conditions not hold
short-medium term
Formula under UIRP
inflation(foreign) - inflation(domestic)
which key determinant of exchange rates is absent in the Mundell-Fleming model
inflation rates
What two conditions must hold for real interest rate parity to hold
UIRP and ex ante PPP
Under UIRP, country with higher rates, what happens to their currency
depreciates
Formula for pure capital deepening
Growth in labor productivity - growth in TFP
the larger the difference, the more important capital deepening is as a source of growth
Most important factor in long-term stock market growth
Growth in GDP
Club convergence
The idea that only rich and middle income countries sharing a favorable set of characteristics (part of the club) will converge to the income level of the richest countries
The club includes institutional structures, property rights, political stability, etc.
Absolute convergence
The idea that all countries will eventually converge to the same gdp per capita output
Conditional convergence
The idea that countries will only catch the richest countries if they have the same savings rate, population growth rate, and production function
Douglas-Cobb Function
Y(L,K) = AL^y * K^x
Y - total production
A - total factor productivity
L - labor
K - capital
The premise is constant returns to scale, and does display diminishing returns to scale
Regulatory Competition
When regulators compete to provide a more conducive environment for businesses
Regulatory Capture
Regulation arises to enhance the interests of the regulated
Independent Regulators
Regulators recognized and granted authority by the government. They are not part of the government and do not rely on government funding
Self-regulating Bodies
Private, non-government bodies that both regulate and represent their members. Some SROs are also independent regulators
Self-regulating organization
Self-regulating body given authority by the government
Coase Theorem
If an externality can be traded and there are no transaction costs, then the allocation of property rights will be efficient
Substantive Law vs. Procedural Law
Substantive focuses on the rights and responsibilities of entities and relationships of entities, while procedural focuses on the protection and enforcement of substantive laws
GDP Growth Rate
1) Long-term growth rate of technology + (x * long-term growth rate in capital) + (1-x) * (long-term growth rate in capital)
2) Long-term growth rate of labor force + long-term growth rate in labor productivity
Sustainable growth of output per capita under neoclassical model
Growth rate in technology / labor’s share of GDP (1-a)
Sustainable growth rate of output under neoclassical model
sustainable growth rate of output per capita + growth of labor
Adverse Selection
When sellers have information that buyers do not
The correlation between the ownership of natural resources and subsequent real GDP growth
insignificant, but not different from 0
Growth due to TFP
growth from labor productivity - capital deepening
