Lecture set 4 Flashcards
Name three monetary factors.
R, R* and Ee
If global markets are perfectly competitive, all G and S are measured in the same currency, thus PPP, show it.
P=EP*
WHat if P>EP*?
Buy in P* ajd sell in P
What does LOOP imply?
E=P/P*
What is the equation for real exchange rate q?
q=EP*/P
Absolute PPP implies that?
q=+1, the weighted average price should be equal.
What does it mean if q>1
Foregin goods and services more expensive and domestic cheap.
Say E increase in the short run, what happens to q?
q increase too if prices stay fix which they do in the short run.
Relative PPP focus on what as difference to absolute PPP
absolute PPP focus on price levels as relative PPP focus on price changes
What does relative PPP imply?
If P/P increase over time but P increase faster, means foreign inflation is higher and nominal E will go down proportional to the P* increase. Given a fix q.
Is relative PPP having a fix q?
Yes, q is constant
P*/P will be matched by E and q will be?
Constant, thus qe=q
According to APPP, what is q?
q is equal to 1, thus stronger assumption.
The basic monetary model consists of two equations, which?
E=P/P* -(Ms)
P=Ms/L(R,Y) -(Md)
Changes in R & Y affect E only directly through their effect on?
Money Demand
In the short run, if R goes up, E goes down. But in the long run, if R goes up, E goes up too, why?
Because Prices are sticky in the short run, in the long run P can freely adjust.
If the growth rate of Ms increase, what happens in the long and short run for inflation?
Inflation goes up in the long run, in the short run expected inflation goes up, thus R increase in the long runt because of fisher effect
In the general monetary long run model we assume that (3 things)
P is flexible
q is flexible(contrary to the PPP conditions)
Home bias
What is home bias?
Home bias is when domestic consumers are very protectionistic and prefer domestic goods over foreign
What changes and changers not q in the general monetary long run model?
Monetary shocks, Ms, and L(R, Y) will not change q, but non monetary shocks, thus D and Y will change q, and both types of chocks can affect short-run expectations Ee, qe and pi e.
If PPP holds what is true about q?
Then qe=q and R-R*=pi e -pi e *
If PPP does not hold, what is true about q?
Then R-R*=(qe-q/q)+(pi e -pi e *)
