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EC201 - MACRO TERM 1 > TERM 1: CA & endowment economy > Flashcards

TERM 1: CA & endowment economy Flashcards

1
Q

small economy =

A

taken world IR & prices as given

Cannot influence them

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2
Q

Choice variables for households

A

C1, B1* (bond holdings)

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3
Q

Initial wealth inherited from past

A

(1+r0)B0*

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4
Q

Period 1 BC

A

C1 + B1* - B0* = r0B0* + Q1

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5
Q

Period 2 BC

A

C2 + B2* - B1* = r1B1* + Q2

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6
Q

Transversatility condition

A

B2*=0

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7
Q

Intertemporal BC

A

C1 + C2/(1+r1) = (1+r0)B0* + Q1 + Q2/(1+r1)

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8
Q

Lifetime utility function

A

U = ln(C1) + ln(C2)

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9
Q

4 properties of ICs

A
  1. downwards sloping
  2. monotonic
  3. Ics do not cross
  4. ICs convex to origin
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10
Q

What’s does ICs convex to origin imply about preferences?

A

Diminishing MRS of C2 for C1

As we have more C1, only willing to give up a small amount of C2 for one extra unit C1.

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11
Q

Where is the optimal graphically

A

Where intertemporal BC tangent to IC.

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12
Q

Optimal C* depends on (4)

A

Preferences, endowments, initial wealth, IR

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13
Q

Wealth (exogenous) =

A

W = (1+r0)B0* + Q1 + Q2/(1+r1)

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14
Q

How do C2 and C1 relate from FOCs

A

C2* = (1+r1)C1*

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15
Q

C2* as a fucntion of W and r1

A

C2* = 1/2 W(1+r1)

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16
Q

C1* as a fucntion of W

A

C1* = 1/2 W

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17
Q

C1* as a fucntion of r0, B0*, Q1, Q2, r1

A

C1* = 1/2[(1+r0)B0* + Q1 + Q2/(1+r1)]

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18
Q

C1* is increasing in

A

Q1, Q2, (1+r0)B0*

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19
Q

C1* is decreasing in

A

r1

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20
Q

TB1 is equal to

A

TB1 = Q1 - C1

difference between output and consumption

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21
Q

IF C1 > Q1

A

Must import from ROW therefore TB1 < 0

22
Q

IF C1 < Q1

A

Export to ROW therefore TB1 > 0

23
Q

CA1 =

A

CA1 = r0B0* + TB1

24
Q

TB1* formula

A

1/2[-(1+r0)B0* + Q1 - Q2/(1+r1)]

25
Q

CA1* formula

A

1/2[-(1-r0)B0* + Q1 - Q2/(1+r1)]

26
Q

What does free K mobility mean? Implicationfor IR too

A

households can borrow and lend in international financial market.
r1 = r* i.e. domestic IR = world IR

27
Q

If r1 > r* what happens?

A

investors borrow in international markets, lend in domestic markets. Excess supply in dom = r1 falls. Excess demand in inter. = r* rises. Arbitrage opporuntities disappear.

28
Q

A temporary output shock

A

Q1 rises, Q2 stays the same.

29
Q

How does a temporary +VE output shock affect CA1*? Explain.

A

Housholds know shock is temporary, want to smooth consumption, so increase C1 but also increase S1 to save for period 2. Increase in Q1 > increase in C1. Therefore TB1 improves, CA1 improves as more saving.

30
Q

Formula for effect of permanent output shock on CA1*. Explain.

A

change CA1* = 1/2 r/(1+r) change in Q1.

Smaller change in CA1 as do not need to increase saving to smooth consumption as Q2 increases too.

31
Q

Difference between impact of temporary and permanent shocks

A

Finance tempoary shocks by running CA surpluses/deficits to smooth consumption.

Adjust to permanent shocks by changing consumption in the LR to keep CA stable.

32
Q

What have we assumed so far avout the goods?

A

That there’s just one good which is consumed, imprted and exported.

33
Q

Terms of trade = + formula

A

The relative price of exportable goods in terms of importable goods.

TT = Px/Pm

34
Q

Now we assume bonds are denominated specifically in terms of…

A

Importable goods Pm

35
Q

Period 1 and 2 BC including TT

A

C1 + B1* - B0* = r0B0* + TT1 Q1

C2 + B2* - B1* = r1B1* + TT2 Q2

36
Q

Intertemporal BC including TT

A

C1 + C2/(1+r1) = (1+r0)B0* + TT1Q1 + TT2Q2 /(1+r1)

37
Q

How are TT determined in a small open economy?

A

They are GIVEN

38
Q

A TT shock is just like an…

A

endowment shock

39
Q

temporary TT shock effect on CA

A

large effect on TB & CA to smooth consumption

40
Q

permanent TT shock on CA

A

small effecr on TB & CA

41
Q

What about the shock matters to determine impact on CA?

A

whether agents THINK the shock is permanent/temporary, doesnt actually matter whether it was ex-post

42
Q

2 effects higher IR can have on C1 and CA1

A
  1. SE - higher r* = C2 more attractive relative to C1 = C1 falls, S1 rises = CA1 improves
  2. WE - higher r* = makes debtors poorer, lenders richer. C1 falls for debtors = CA improves; C1 rises for lenders. = CA worsens
43
Q

Which effect dominates? Under what condition?

A

SE > IE. When utility preferences are log.

44
Q

Explain effect of rise in r* graphically for debtor

A

Steeper BC = pivots around endowment point
Original equilibrium not feasible
C1 falls and C2 rises
TB1 & CA1 improve

45
Q

Rationale for K controls

A

To curb CA deficits which arguably risk future crises and reduce C2

46
Q

Strong form of K controls requires:

A

B1* >=0

Can lend but cannot borrow

47
Q

Impact of K controls on C1 and C2 - new equilibrium

A

C1 falls so C1=Q1
C2 rises so C2=Q2
New equi at endowment point

48
Q

What has to happen to domestic IR to make the endowment point the new optimum after K controls?

A

Increase domestic IR r1 above r* world IR

Encourages saving so now happy not to borrow = no longer a debtor.

49
Q

formula for r1 under K controls scenario

A

C2=(1+r1)C1
C2 = Q2 and C1 = Q1
therefore: r1 = (Q2 / Q1) - 1

50
Q

How r1 related to Q2 and Q1

A

The lower Q1 is relative to Q2, the more households want to borrow against future income. To make them not do this, r1 has to be even higher.

EC201 - MACRO TERM 1 (9 decks)

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