Brainscape's Knowledge GenomeTM

Browse over 1 million classes created by top students, professors, publishers, and experts.


See full index

Macroeconomics > The open economy > Flashcards

The open economy Flashcards

1
Q

Openness in goods market

A

the ability of consumers to choose between domestic goods and foreign goods

How well did you know this?
1
Not at all
2
3
4
5
Perfectly
2
Q

Openness in the financial markets

A

The ability for investors to choose between domestic assets and foreign assets

How well did you know this?
1
Not at all
2
3
4
5
Perfectly
3
Q

Openness in factor markets

A

The ability for firms to choose where to locate production, and for workers to choose where to work

How well did you know this?
1
Not at all
2
3
4
5
Perfectly
4
Q

tariffs

A

taxes on imported goods

How well did you know this?
1
Not at all
2
3
4
5
Perfectly
5
Q

quotas

A

restrictions on the quantity of goods that can be imported

How well did you know this?
1
Not at all
2
3
4
5
Perfectly
6
Q

Proportion of imports and exports in the UK

A

30% of GDP today compared to 205 in 1960

How well did you know this?
1
Not at all
2
3
4
5
Perfectly
7
Q

In an open economy consumers have two options

A

save or buy

buy domestic or foreign goods

How well did you know this?
1
Not at all
2
3
4
5
Perfectly
8
Q

real exchange rate

A

the price of the domestic goods relative to the foreign goods

it is not directly observable

How well did you know this?
1
Not at all
2
3
4
5
Perfectly
9
Q

Nominal exchange rates can be quoted in two ways

A

price of domestic in terms of foreign

price of foreign in terms of domestic

How well did you know this?
1
Not at all
2
3
4
5
Perfectly
10
Q

Nominal exchange rate

A

the price of the domestic currency in terms of the foreign currency. denoted by E

How well did you know this?
1
Not at all
2
3
4
5
Perfectly
11
Q

nominal appreciation

A

an increase in the price of the domestic currency in terms of foreign currency. An increase in the exchange rate

How well did you know this?
1
Not at all
2
3
4
5
Perfectly
12
Q

nominal depreciation

A

a decrease in the domestic currency in terms of foreign currency. A decrease in the exchange rate

How well did you know this?
1
Not at all
2
3
4
5
Perfectly
13
Q

fixed exchange rates

A

where two or more countries maintain a constant exchange rate between their currencies

How well did you know this?
1
Not at all
2
3
4
5
Perfectly
14
Q

revaluations

A

increases in the exchange rate under a fixed exchange rate scheme

How well did you know this?
1
Not at all
2
3
4
5
Perfectly
15
Q

devaluations

A

decreases in the exchange rate under a fixed exchange rate scheme

How well did you know this?
1
Not at all
2
3
4
5
Perfectly
16
Q

GDP deflator

A

index of prices for all good produced

How well did you know this?
1
Not at all
2
3
4
5
Perfectly
17
Q

real exchange rate relation

A

ε= EP/P*

ε= real exchange rate
E= nominal exchange rate
P = price of UK goods in pounds
P* = Price of european goods in euros

Constructed by multiplying the domestic price level by the nominal exchange rate and then dividing by the foreign price level

How well did you know this?
1
Not at all
2
3
4
5
Perfectly
18
Q

real appreciation

A

an increase in the real exchange rate. an increase in the relative price of domestic goods in terms of foreign goods

How well did you know this?
1
Not at all
2
3
4
5
Perfectly
19
Q

real depreciation

A

a decreases in the real exchange rate. a decrease in the relative price of domestic goods in terms of foreign gades with the UK and how much it competes with the UK in other countries

How well did you know this?
1
Not at all
2
3
4
5
Perfectly
20
Q

multilateral exchange rate

A

comparing the exchange rates across more than one country by weighing how much each country

How well did you know this?
1
Not at all
2
3
4
5
Perfectly
21
Q

foreign exchange

A

buying or selling foreign currency

How well did you know this?
1
Not at all
2
3
4
5
Perfectly
22
Q

Another implication of an open financial market

A

allows a country to run trade surpluses and deficits

How well did you know this?
1
Not at all
2
3
4
5
Perfectly
23
Q

Balance of payments

A

transactions such as trade flows and financial flows with the rest of the world

How well did you know this?
1
Not at all
2
3
4
5
Perfectly
24
Q

Current account transaction

A

Exports
Imports
UK residents receive investment income
net transfers received - aid

How well did you know this?
1
Not at all
2
3
4
5
Perfectly
25
Q

current account surplus/deficit

A

if the current account balance is positive/negative

How well did you know this?
1
Not at all
2
3
4
5
Perfectly
26
Q

net capital flows

A

the increase in foreign holdings of UK assets minus the decrease in UK holdings of foreign assets

How well did you know this?
1
Not at all
2
3
4
5
Perfectly
27
Q

Uncovered Interest parity

A

riskless arbitrage opportunity stating if financial assets both foreign and domestic are to be held they must have the same expected return

(1+it)=(1+it*)(Et/Et+1)

How well did you know this?
1
Not at all
2
3
4
5
Perfectly
28
Q

interest parity condition (to be remembered)

A

it ≈ it* - (Eet+1 - Et)/Et

arbitrage by investors implies that the domestic interest rate must me equal to the foreign interest rate minus the expected appreciation rate of the domestic currency

How well did you know this?
1
Not at all
2
3
4
5
Perfectly
29
Q

Demand for domestic goods in an open economy

A

Z=C+I+G+IM/ε +X

How well did you know this?
1
Not at all
2
3
4
5
Perfectly
30
Q

Determinants of imports

A

domestic income and the real exchange rate
If domestic income goes up leads to higher demand for all good and thus imports goes up. If the real interest rate goes up the value of imports will go down and so increase the amount bought.

How well did you know this?
1
Not at all
2
3
4
5
Perfectly
31
Q

Determinants of exports

A

Foreign income and the real exchange rate

An increase in the foreign income will increase the demand for all goods including foreign goods and thus exports. An increase in the real exchange rate will decrease the amount of exports as it is more expensive for the foreign country to buy the foreign goods.

How well did you know this?
1
Not at all
2
3
4
5
Perfectly
32
Q

Net exports

A

the difference between the number of imports and number of exports Is positive if exports is greater than imports. and vice versa

How well did you know this?
1
Not at all
2
3
4
5
Perfectly
33
Q

trade surplus

A

exports>imports

How well did you know this?
1
Not at all
2
3
4
5
Perfectly
34
Q

trade deficit

A

exports<imports

How well did you know this?
1
Not at all
2
3
4
5
Perfectly
35
Q

According to the interest parity condition an increase in the domestic interest rate leads to….

A

an increase in the exchange rat

How well did you know this?
1
Not at all
2
3
4
5
Perfectly
36
Q

According to the interest parity condition an increase in the foreign interest rate leads to….

A

a decrease in the exchange rate

37
Q

According to the interest parity condition an increase in the expected future exchange rate leads to….

A

an increase in the current exchange rate

38
Q

IS relation in the open economy

A

Y=C+I+G+NX(Y,Y, 1+i/1+i E)

39
Q

LM relation in the open economy

A

M/P = YL(i)

40
Q

What effect does and increase in the interest rate have on the IS relation?

A

First, as in the open economy, it has a decrease in investment, a decrease in the demand for domestic goods and a decrease in output.
Secondly, only present in the open economy, is it appreciates the exchange rate making it cheaper to buy foreign goods rather than domestic and thus net exports decreases. This in turn decreases output.

41
Q

What effect does an increase in output have on the LM relation?

A

Increased output has an increase in the demand for money and thus to an increase in the equilibrium interest rate.

42
Q

What effect does an open economy have on the multliplier

A

The multiplier is smaller as the the demand line is flatter

43
Q

When effect does an increase in government spending have?

A

It shifts the demand (ZZ) curve upwards. This creates a trade deficit. The effect on an increase in spending is smaller in an open economy as an increase in demand doesnt just fall on domestic goods

44
Q

What effect does an increase in the foreign output have on domestic output?

A

An increase in foreign output causes there to be an increase in demand for goods and therefore an increase in the demand for exports. This causes net exports to increase and the net exports line to shift upwards. Causes the ZZ line to shift upwards. There is now a trade surplus

45
Q

Coordination

A

whereby the countries coordinate their macro policies as as to increase domestic demand simultaneously in doing so without increasing the trade deficit

46
Q

Reason, in reality, there is limited coordination among countries

A

Some countries might have to do more than other countries and may not want to do so.

Countries have a strong incentive to promise to coordinate and then not deliver on that promise

47
Q

Marshall-Lerner condition

A

The condition under which a real depreciation( decrease in ε) leads to an increase in net exports (increase in NX)

48
Q

Effect of real depreciation on exports

A

Exports increases as the real depreciation make the domestic goods relatively less expensive abroad

49
Q

Effect of a real depreciation on imports

A

Imports decrease. The depreciation makes foreign goods more relatively expensive in the domestic economy. SHift in the domestic economy to domestic goods from foreign goods

50
Q

Effect of rela depreciation on “the relative price of foreign goods in terms of domestic goods”

A

1/ε increases. This therefore the import bill as you get less goods for the same price.

51
Q

Further effects of depreciation on the trade balance

A

Similar to an increase in the foreign output. Depreciation leads to a shift in demand, both foreign and domestic, towards domestic goods. This shift in demand leads to both and increase in domestic output and an improvement in the trade balance.

52
Q

The difference between increase in foreign output and real depreciation

A

Whilst they will have the same effect on output and the trade balance, depreciation works by making foreign goods relatively more expensive which can make people worse off and lead to strikes

53
Q

If the economy is a the natural level and is running a trade deficit what combination of policy and exchange rate alterations will rid the deficit whilst maintaining output?

A

It must depreciate the exchange rate to encourage the consumption of domestic goods. This will however shift the demand function also increasing output. In order to avoid the increase in output it must therefore cut government spending.

54
Q

Policy combination for low output but a trade surplus in order to maintain a natural level

A

Increase government spending and depending on the magnitude at which the increased spending affects the trade balance appreciate (still surplus) or depreciate (if becomes a deficit)

55
Q

Policy combination for high output but a trade surplus in order to maintain a natural level

A

Depreciate the real exchange rate which will make foreign goods more expensive and so increase the consumption of domestic goods increase. Depending on how much the depreciation increases the demand by the government may need to increase spending further in order to boost output or decrease spending to reduce the output

56
Q

J- curve

A

graphically displays the idea that initially when depreciation occurs the effects on imports and exports does not take effect immediately due to a lag effect due to consumers taking time to realise relative prices have changed and also for firms to change their suppliers. In this case a depreciation leads to a deterioration of the trade balance leading to decline in NX. And then after some time the trade balance restores to its initial level and then surpasses

57
Q

Private Saving

A

S=Y-C-T

58
Q

Condition of Net exports in relation to saving

A

NX= S+(T-G)-I

A trade surplus must correspond to an excess saving over investment; a trade deficit must correspond to an excess of investment over saving

59
Q

An increase in investment must be reflected in what in the net exports relation?

A

an increase in private saving or public saving, or a deterioration in the trade balance

60
Q

An increase in the budget deficit must be reflected in what in the net exports relation?

A

an increase in private saving, a decrease in investment or a deterioration in the trade balance

61
Q

A country with a high savings rate must have either….

A

a high investment rate or a large trade surplus

62
Q

What effect does an increase in government spending have in the the open economy (in relation to the IS-LM relation)

A

An increase in spending shifts the IS relation to the right due to an increase in the output. This increase in output causes the interest rate to rise. This interest rate increase affects the interest parity relation and causes and appreciation of the exchange rate.

63
Q

Effect of monetary contraction on the

A

a monetary contraction leads to a decrease in output, an increase in the interest rate and an appreciation

LM Curve shifts upwards. Interest rate rises. On the interest rate parity it causes an increase in the exchange rate

64
Q

Crawling peg

A

countries that typically have higher inflation rates that exceed the US choosing a predetermined rate of depreciation against the dollar

65
Q

EMS

A

groups of countries agreed to maintain their exchange rates with each other in a system with narrow limit

66
Q

If the country decides to peg What happens to the interest parity relation?

A

Et becomes Ebar and then as the foreign markets believe the exchange rate will remain pegged their expected future exchange rate is also Ebar. With this the party relation becomes

1+i = 1+i*

Therefore under a fixed exchange rate and perfect capital mobility, the domestic interest rate must be equal to the foreign interest rate

67
Q

In a fixed exchange rate what role does the central bank play?

A

It has to alter the money stock in order to maintain the interest and exchange rate and still meet the demand for money. With this it gives up monetary policy as a policy instrument

68
Q

What is the effect of fiscal policy under a fixed exchange rate?

A

A fiscal expansion will cause the IS curve to shift rightwards. This not only increases output but also the interest rate which is “fixed”. In order to return to the agreed interest rate the central bank undergoes monetary accommodation to shift the LM curve down. This further increases output.

69
Q

Disadvantage of fixed exchange rates

A

country gives up powerful tool for correcting trade balances or changing economic activity

gives up control of interest rate. country must match movements in the foreign interest rates at the risk of unwanted effects in its own activity

Only one policy instrument

70
Q

Open economy aggregate demand relation

A

Y=Y(EbarP/P*, G, T)

71
Q

Aggregate supply relation in the open economy

A

P=Pe(1+μ)F(1-Y/L , z)

72
Q

What happens to the price level if output is below the natural level?

A

The lower equilibrium point will cause the AS curve to shift downwards, moving along the AD curve until AS=AD=Yn

This causes a reduction in the price level over time and therefore a decrease in the real exchange rate. The steady decrease in price level has the effect of increasing output until it is at the natural level

73
Q

What effect can a one-time devaluation have in the medium run in a fixed exchange rate?

A

A shift in the AD curve rightwards and therefore making the relation AD=AS=Yn. This will however increase the price level which in turn can increase the price of imports and the price of a consumption basket. With this workers will push for higher wages

74
Q

What happens if the domestic currency is overvalued i.e the exchange rate is too high?

A

real depreciation is called for. This can be achieved in the medium run but governments may opt to just devalue

75
Q

When is an overvaluation likely to happen?

A

When a country pegs its nominal exchange rate to the currency of a country with lower inflation. Higher relative inflation implies a steadily increasing price of domestic goods relative to foreign goods, a steady real appreciation and a steady worsening trade position

76
Q

What if a country wants to decrease its interest rates?

A

It can float its exchange rate in order to break from fixed to flexible scheme and trigger a decrease in the nominal exchange rate

77
Q

What options does a government have when faced with an exchange rate crisis?

A
  1. Give in and devalue

2. fight and maintain the parity at the cost of high interest rates and potential recession.

78
Q

The relation of Et being determined by an expected exchange in the future means that the current exchange rate depends on two things:

A
  1. current and expected domestic and foreign interest rates for each year over the next 10 years
  2. The expected exchange rate 10 years from now

(taking 10 to be a large number for n)

79
Q

Exchange rates and the current account

A

Countries do not wish to borrow - run a current account deficit - forever and will not want to lend - run a current account surplus forever. News that affects the forecasts of the current account in the future is likely to affect the exchange rate today.

80
Q

Exchange rates and current and future expected interest rates

A

Any factor that moves the interest rates between years t and t+n moves the current exchange rate to. i.e increase in current or expected future domestic interest rates causes an appreciation

81
Q

Exchange rate volatility

A

In reality it is hard to work out whether the mechanism of lowering the interest rate by the central back in temporary or for longer. All this makes it difficult to predict the effect of a change in the interest rate on the exchange rate

82
Q

argument against flexible exchange rates

A

the exchange rate is likely to fluctuate a lot and so will be difficult to control through monetary policy

83
Q

Way to reduce money growth and inflation

A

fixed exchange rate approved by the monetary authority

84
Q

Hard peg

A

making it symbolically or technically harder to change the parity

85
Q

Extreme form of hard peg

A

changing the entire currency to that of a foreign one

86
Q

Dollarisation

A

when an extreme form of hrd peg is taken up and the chosen currency is the dollar

87
Q

currency board

A

when the central bank stands ready to exchange foreign currency for domestic.

88
Q

Common currency

A

where large areas or group or groups of countries share a currency

89
Q

Two conditions for optimal currency (one of two needs to be satisfied)

A
  1. the countries have to experience similar shocks

2. If the countries experience different shocks they must have high factor mobility - i.e. movement of workers

Macroeconomics (5 decks)

Brainscape helps you reach your goals faster, through stronger study habits.
© 2024 Bold Learning Solutions. Terms and Conditions