Economics Flashcards
Solow Growth Model
TFP + (Growth in capital x Elasticity) + (Growth in labor x Elasticity)
Neoclassical steady state of growth
(TFP/Labor cost in total factor cost) + Labor force growth
TFP formula
Labor productivity growth - Capital deepening
Growth rate of potential GDP
LT growth rate of labor force + LT growth rate of labor productivity
International parity conditions tell us that countries with high expected inflation rates and high yield currencies should see their currencies…
Depreciate over time
International parity conditions tell us that countries with low expected inflation rates and low yield currencies should see their currencies…
Appreciate over time
What does the theory of covered interest rate parity state?
An investment in a foreign-currency-denominated money market investment that is completely hedged against exchange rate risk in the forward market should yield exactly the same return as an otherwise identical domestic money market investment.
What is the formula for uncovered interest rate parity?
CAD/USD x ( (1+Interest rate in CAD)/(1+Interest rate in USD) )^t
What is the formula for covered interest rate parity?
CAD/USD x (Interest rate in CAD - Interest rate in USD + 1)
What is the formula for Purchase Power Parity (Ex ante)?
CAD/USD x (Inflation CAD - Inflation USD)
What happens when the market is on a “risk-on” mode?
The risk appetite is high and the demand for safe assets such as USD decline; USD depreciate and emerging markets currencies appreciate.
According to the covered interest rate parity, the currency of the country with a lower interest rate should be at a forward…
Premium
According to the covered interest rate parity, the currency of the country with the higher interest rate should be at a forward…
Discount
What is a carry trade?
Investors overweight high-yield currencies and short low-yield currencies. This strategy tends to perform poorly when market conditions are highly volatile.
What is the real interest rate parity?
Assuming that both ex ante purchasing power parity and uncovered interest rate parity hold, real inrerest rates across all markets would be the same.
What happens if both covered and uncovered interest rate parity hold?
Forward exchange rate would be an unbiased predictor of future spot rate.
What is the macroeconomic balance approach?
Approach to estimate how much exchange rates will need to adjust to bring a country’s current account balance to a sustainable level.
What is the external debt sustainability?
Approach to estimate what exchange rate level will ensure that a country’s net external asset or liability position stabilizes to a viable level.
Countries with current account deficits will see their currencies…
Weaken over time
Countries with current account surpluses will see their currencies…
Appreciate over time
How does monetary policy affects the exchange rate according to the Mundell-Fleming model?
Through interest rate sensitivity of capital flows.
According to the Mundell-Fleming model, what happens when monetary policy is tight?
Currency appreciate
According to the Mundell-Fleming model, what happens when monetary policy is easy?
Currency depreciate
Under conditions of high capital mobility, countries that simultaneously pursue expansionary fiscal policies and tight monetary policies should see their currencies…
Appreciate over time
What is the portfolio balance model?
Current account imbalances shift financial wealth from deficit nations to surplus nations. Over time, this may lead to shifts in global asset preferences, which in turn could exert a marked impact on the path of exchange rates. For example, nations running large current account surpluses versus the United States might find that their holdings of US dollar–denominated assets exceed the amount they desire to hold in a portfolio context. Attempts to reduce their dollar holdings to desired levels could then have a profound, negative impact on the dollar’s value.
What is unsterilized intervention?
Inflation is not a concern; central banks should expand monetary base and reduce short-term interest rates
What is sterilized intervention?
Inflation is a concern; buying or selling of government bonds
Which factors do not permanently change the growth rate of output per worker?
1) Saving rate
2) Labor force growth rate
3) Depreciation rate
What is capital deepening?
Increase in the capital-to-labor ratio; occurs when growth rate of capital (net investment) exceeds growth rate of labor. Move along the curve.
What is the classical model view?
Growth in per capita income is only temporary because an exploding population with limited resources brings per capita growth to an end.
What is the neoclassical model view?
Sustained increase in investment increases the economy’s growth rate only in the short-run. TFP is regarded as exogenous to the model.
What is the endogenous growth model view?
Allows for the possibility of constant or even increasing returns to capital in the economy. Large positive externalities or spillover effects.
What is the Cobb-Douglas production function and what are its two important properties?
F(K,L) = Ka L1-a
1) Constant returns to scale
2) Diminishing marginal productivity
What is club convergence?
Only countries with appropriate institutions with converge.
What is conditional convergence?
Countries with same saving rate, population growth rate, production function will converge.
What is the absolute convergence?
Rates of growth of productivity and GDP should be higher in the developing countries.
What is regulatory capture?
Regulation that arises to enhance the interests of regulated entities.
What is regulatory competition?
Competition among different regulatory bodies to use regulation to attract certain entities.
What is regulatory arbitrage?
Use of regulation by an entity to exploit differences in economic substance to the entity’s benefit.
What are some of the regulatory tools available to regulators?
1) Price mechanisms (taxes and subsidies)
2) Regulatory mandates and restrictions on behaviors
3) Provision of public goods
4) Public financing of private projects
The bid-offer spread depends on?
1) Currency pair involved
2) Time of day (when key market centers are open)
3) Market volatility
4) Transaction size
5) Relationship between dealer and client
According to the IMF, what are the episodes leading up to a currency crisis?
1) Real exchange rate is higher than its mean level
2) Trade balance does NOT signal impending crisis
3) Foreign exchange reserves tend to decline precipitously as the crisis approaches.
4) Terms of trade deteriorate
5) Inflation is higher is pre-crisis
6) Real economic activity does NOT display any distinctive patterns ahead of a crisis but falls sharply after.
How can we mark-to-market the value of a forward position?
1) Calculate the new forward rate (Spot ask + Forward Points)
2) Settlement amount * (Initial forward rate - New forward rate)
3) Amount in 2 / (1 + LIBOR)^t
When marking-to-market, if the base currency is being sold, which side of the market (bid or ask) should we use?
Bid
Tip: Sold - Bid (SB)
When marking-to-market, if the base currency is being bought, which side of the market (bid or ask) should we use?
Ask
Tip: Bought - Ask (BA)
Carry trades can be profitable when?
Uncovered interest rate parity does not hold
Over time, the return distribution of the fund’s FX carry trades is most likely to resemble a:
Distribution with fat tails and a negative skew
The volatility of the fund’s returns relative to its equity base is best explained by?
Leverage
Which risk management strategy is most likely to reduce some of the negative tail risk associated with FX carry trades?
Exit the carry trade position when implied FX volatility drops below a certain threshold
What best explains the failure of the absolute version of PPP to hold?
Trade barriers exist, and different product mixes are consumed across countries.
If forward rates are unbiased estimators of future spot rates, uncovered interest rate parity…
would also hold.
