Lec 4 Flashcards
Why is CA balance not always equal to the change on a country’s foreign wealth?
Because of changes in valuations.
How does CA relate to net export?
If CA < 0, a country imports more than it exports and it invests more than it saves. E.g. United States runs a major current account deficit
what do CA surpluses look like in merchandise and services for developed and developing economies?
There is generally surplus in developing and deficit in developing. However, when considering services, the deficits/surpluses appear smaller
What were major sources of changes in valuation in Net International Investment Position in the United States?
In 2002-2007:
Assets (liabilities) denominated in foreign currency (dollars) and dollar
depreciated
Foreign stock markets outperformed and equities were significant component of assets
This came back to bite, however, in 2008 - a big hit to the value of US equity portfolio abroad
Somewhat paradoxically, given its net debtor status, the U.S. has had positive net investment income. . .
In our simple model, what determines money demand and money supply?
Money supply is set one-to-one by the Central Bank (no money multiplier)
Real money demand is determined by the real rate (negatively, opportunity cost) and income (positively)
For a fixed exchange rate, what is the effect on an increase in income?
Income goes up increases real money demand. If money supply is unchanged, this drives up the interest rate to make markets clear. This gives appreciative pressures. To keep the exchange rate, the central bank must increase the money supply by buying foreign assets.
This ensures that the exchange rate and real interest rate are unchanged
For a fixed exchange rate, what is the effect of an increase in global interest rate?
This would induce excess demand for foreign assets and a domestic depreciation.
To keep the peg, the central bank must sell foreign assets, thereby decreasing the Ms and increasing the domestic interest rate
In some sense, you ‘import’ a tight monetary policy
How does the interest rate and exchange rate interact under fixed exchange rates?
Read up on this. Parity between domestic interest rate and global interest rate and expected exchange rate movements
Maybe read more
What is the reaction to an expected exchange rate depreciation under fixed exchange rates (assuming the CB really is committed to keeping the peg)?
To keep the peg, the central bank must sell foreign reserves at the pegged rate, thereby decreasing Ms.
Explain Uncovered Interest Parity?
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How can we have multiple equilibria and self-fulfilling prophecies with exchange rate expectations?
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What has happened to developing economy’s foreign reserve holdings?
After the 1990s they have doubled many times throughout the 00s. More flat after the Financial Crisis.
What are some general characteristics of currency crisis?
Kaminsky & Reinhart (1999):
Credit/GDP builds up before and then declines
Gradual and then sudden decrease in currency reserves (you first defend the peg)
M2/reserves tend to increases up to the crisis and then declines dramatically
Terms of trade declines slowly before (suppressing purchasing power)
What is the unholy trinity?
Abrubt capital flow reversal
Element of ‘surprise’
Leveraged common creditors (banks, hedge funds, mutual funds, bond holders
Other theories are: Herding, information cascades, behavioural ‘panic’
What is a ‘twin crisis’
The coincidence of a currency crisis and a banking crisis
