1. Technology enhances labor and capital 2. No steady stage: Increase in savings is a permanent increase to growth rate 3. Need to innovate to grow 4. Certain investments increase total TFP (Country benefits from R&D) 5. No diminishing returns to knowledge capital

1. Focused on estimating the steady growth rate which is based on TFP 2. Economic growth is independent from population growth 3. Labor productivity driven by new technology 4. Sustainable growth: population growth, labors share of income, and technology

1. No permanent improvement from new technology 2. Initial boom in growth than reverts back 3. There is a subsistence real wage

1. Quantity of Labor: size of labor \ average hours 2. Labor Force Participation: Labor force / working age pop. 3. Average hours decrease with wealth

Economics Flashcards by J K

Sunset Clause

Requires Regulators to revisit the cost-benefit analysis based on actual outcomes before renewing laws

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Technological Progress

An increase in growth rate of potential GDP in developed countries

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Tools of Regulatory Intervention

Price Mechanism: Taxes or subsides

Restricting or requiring certain activities

Provision of public goods or financing of private projects

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Regulatory Arbitrage

Companies shop for a country rather than changing their behavior (e.g. toxic waste dump)

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Regulatory Capture Theory

Eventually the regulator will be influenced or controlled by the industry

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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)

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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

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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

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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

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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

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Classical Theory

No permanent improvement from new technology
Initial boom in growth than reverts back
There is a subsistence real wage

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Economic Labor

Quantity of Labor: size of labor * average hours
Labor Force Participation: Labor force / working age pop.
Average hours decrease with wealth

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Dutch Disease

Demand for a countries resources drives up currency

Note: Natural resources are essential for growth but ownership is not necessary

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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

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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

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Stock market and GDP

Potential GDP Growth = growth in equity

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Preconditions for Growth

Savings and investment
Financial markets (returns/liquidity)
Political stability and laws
Investment in education and healthcare 5. Free trade

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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

1. Deficit leads to currency depreciation, increases supply, puts pressure on currency 2. Surplus usually has financial account deficits 3. 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

1. Bid: price to buy 2. Offer (ask): Price to sell 3. Spread: Difference between bid and ask AKA: PIPS --\> They are stated in the 10,000 4. 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: 1. Capital deepening 2. Changes in total factor productivity

Steady Growth Rate

growth rate of TFP / labor cost %+ labor force growth