Economics Flashcards
Sunset Clause
Requires Regulators to revisit the cost-benefit analysis based on actual outcomes before renewing laws
Technological Progress
An increase in growth rate of potential GDP in developed countries
Tools of Regulatory Intervention
Price Mechanism: Taxes or subsides
Restricting or requiring certain activities
Provision of public goods or financing of private projects
Regulatory Arbitrage
Companies shop for a country rather than changing their behavior (e.g. toxic waste dump)
Regulatory Capture Theory
Eventually the regulator will be influenced or controlled by the industry
Regulators
Statutes: laws made by legislative bodies
Admin Regulations: rules by governments
Judicial Law: findings of the court
SRO: can have conflicts of interest (e.g. FINRA)
Removing Trade Barriers
- Increased investments
- Country can focus on industries where it has an advantage
- Can export goods allowing for economies of scale
- Share of technology
Name the 3 Convergences
Club - only middle and rich nations will match poor countries need to make institutional changes
Absolute: A poorer country will match a richer one no matter what
Conditional: Poor will match rich only if they have same: Population growth, savings rate, and production function
Endogenous Theory
- Technology enhances labor and capital
- No steady stage: Increase in savings is a permanent increase to growth rate
- Need to innovate to grow
- Certain investments increase total TFP (Country benefits from R&D)
- No diminishing returns to knowledge capital
Neoclassical Theory
- Focused on estimating the steady growth rate which is based on TFP
- Economic growth is independent from population growth
- Labor productivity driven by new technology
- Sustainable growth: population growth, labors share of income, and technology
Classical Theory
- No permanent improvement from new technology
- Initial boom in growth than reverts back
- There is a subsistence real wage
Economic Labor
- Quantity of Labor: size of labor * average hours
- Labor Force Participation: Labor force / working age pop.
- Average hours decrease with wealth
Dutch Disease
Demand for a countries resources drives up currency
Note: Natural resources are essential for growth but ownership is not necessary
Cobb-Douglas Formula
Growth of TFP + (share of labor * growth of labor) + (share of capital * growth in capital)
*Constant returns to scale
*subject to diminishing returns
Why Potential GDP and Growth Matter
- Increase in GDP means income will rise, spend more
- Difference in actual and potential GDP is a sign for inflation (gov. policies could change)
- Increase GDP increases credit quality can pay off debt
Stock market and GDP
Potential GDP Growth = growth in equity
Preconditions for Growth
- Savings and investment
- Financial markets (returns/liquidity)
- Political stability and laws
- Investment in education and healthcare 5. Free trade
Foreign Exchange Expectation Relation
The forward rate is an unbiased predictor of the future spot rate.
Covered and uncovered interest rate parity holds
Currency Crisis Warnings
- Deterioration in trade
- Dramatic decline in foreign exchange reserves
- Real rate substantially higher
- Increase in inflation
- Boom-bust cycle
- Bank reserves increase
- Growth of nominal private credit
Dornbusch Overshooting Model
Prices are not flexible and do not immediately reflect changes
Restrictive policy:
- s/t appreciation of currency
Expansionary policy:
- Decrease in real rates
- Decrease in domestic currency
Monetary and Fiscal Policy: Affects on Exchange Rates
Mundell-Flemming Model
Monetary/Fiscal Policy Capital Mobility
High Low
E / E Uncertain Decrease
E / R Decrease Uncertain
R / E Increase Uncertain
R/R Uncertain Increase
E = Expansion
R = Restrictive
FX Carry Trade Risks
- Only profitable if uncovered interest rate parity holds
- Funding currency may appreciate
- Has negative skewness and excess kurtosis (fat fails)
Can limit risks by:
- Volatility filter (limit order)
- Valuation filter
FX Carry Trade
Purpose: Invest in higher yielding currency by borrowing funds from the lower yielding one
Return = Interest earned - funding cost - currency depreciation
Assessing Long-Run Values of Exchange Rates
- Macroeconomic Balance: Clues from current account
- External Sustainability: Clues from external debt relative to GDP
- Reduced Form: estimation of value based on macroeconomic variables
Traylor Rule
Prescribed central bank policy rate
real policy rate + inflation + .5(inflation - target inflation) + .5(log of current level of output - log of the potential output)
Current Account Influences
- Deficit leads to currency depreciation, increases supply, puts pressure on currency
- Surplus usually has financial account deficits
- Deficit leads to financial account surplus
Balance of Payments
Purpose: Method used to track translations between countries
Formula: current + financial + official reserve = 0
Financial: flow of funds for debt/equity investments
Office reserve: monetary reserves
RPPP - Relative Purchasing Power Parity
Purpose: High inflation leads to currency depreciation
Formula: real exchange rate = St [CPIb / CPIa]
Currency is: positively related to real interest rate
negatively related to risk premium
PPP
Purpose: Goods have same price in all locations
Does not hold in the short-term
Formula: S(A/B) = CPI (A) / CPI (B)
Uncovered Interest Rate Parity
Purpose: Currencies fluctuate based an interest rate in each country
Expected Spot = (1 + r quoted currency)^T x spot rate (1 + r base currency)
Note: not bound by arbitrage risk neutral
Covered Interest Rate Parity Forward Rate
Purpose: Investing in any currency would yield the same. Means higher yield will depreciate
Forward: Spot * [1 + r quoted currency (n/360)] [1 + r base currency (n/360)]
Note: bound by arbitrage
Fischer Relation
nominal = real + expected inflation
real = nominal - expected inflation
International Fisher Relation
RnominalA - RnominalB = E(InflationA) - E(InflationB)
Future Spot Currency
Spot = forward * (1 + r foreign) / (1 + r domestic)
Forward Contract Price
FP = Spot0 (1 + Rf)^T
Determine an Arbitrage Opportunity
(1 + r domestic) - [((1 + r foreign) * forward) / spot] = 0
If positive –> Borrow foreign If negative –> Borrow domestic
Currency Implied Forward Rate
(1 + r domestic) * [(1 + r foreign ) * Spot]
Mark to Market Forwards/Futures
Vt = (FPt - FP)(Contract size) / [1 + r (Days / 360)]
Note: r is the quoted currency
Use the bid/ask to EXIT the contract
Forward Premium (discount)
Forward price - spot rate
Bid-Ask Spread
Ask quote - bid quote
Currency Exchange Details
- Bid: price to buy
- Offer (ask): Price to sell
- Spread: Difference between bid and ask
AKA: PIPS –> They are stated in the 10,000
- Bid = 1/ask Ask = 1/bid
Currency Saying
Going up = bid (multiply)
Going down = ask (multiply)
Use the % from the top currency
Note: $1.55 per E1 means: 1.55 USD (quote) 1 E (base)
So USD is domestic, E is foreign
Growth rate in potential GDP
l/t growth rate of labor force + l/t growth rate in labor productivity
Labor productivity already includes:
- Capital deepening
- Changes in total factor productivity
Steady Growth Rate
growth rate of TFP / labor cost %+ labor force growth
