Week 10 Flashcards
What is international trade?
The buying and selling of goods and services across international boundaries rather than domestically.
What is required to buy goods from another country?
You need to convert your domestic currency into the relevant foreign currency.
What is the exchange rate?
The rate at which you convert your domestic currency into foreign currency.
Define nominal exchange rate.
The price of a domestic currency in terms of a foreign currency.
Define real exchange rate.
The cost of domestic goods in terms of foreign goods, considering price levels.
How is the nominal exchange rate denoted?
e
How is the real exchange rate denoted?
ε
What is appreciation in terms of currency?
When a currency increases in value relative to other currencies.
What is depreciation in terms of currency?
When a currency decreases in value relative to other currencies.
What does the trade balance (net exports) represent?
NX = EX – IM (Net exports = exports – imports)
What is the value of exports (EX)?
The value of domestically produced goods and services which are sold abroad.
What is the value of imports (IM)?
The value of foreign-produced goods and services which are bought domestically.
What does NX = 0 indicate?
A country has balanced trade.
What does NX > 0 indicate?
A country is a net exporter.
What does NX < 0 indicate?
A country is a net importer.
What is the balance of payments (B of P)?
Records all transactions between the residents of a country and the rest of the world over a given time period.
What is a credit item in the B of P?
Any transaction that leads to a receipt of payment from foreigners.
What is a debit item in the B of P?
Any transaction which leads to a payment to foreigners.
List the forms of transactions recorded in the B of P.
Trade in goods and services
Capital movements
Financial flows
What is recorded in the current account of the B of P?
Trade in goods and services.
What is recorded in the capital account of the B of P?
Capital transfers of non-produced, non-financial assets.
What does the financial account contain?
Foreign direct investment (FDI)
Portfolio investment
Transactions in financial derivatives
The use of reserve assets
‘Other’ investment
What are autonomous transactions?
Transactions undertaken ‘for their own sake’.
What are accommodating transactions?
Transactions undertaken for B of P purposes.
What does the open economy national income identity express?
Y = C + I + G + NX.
What does a negative NX indicate?
Domestic spending exceeds output, resulting in a trade deficit.
What does a positive NX indicate?
Output exceeds domestic spending, resulting in a trade surplus.
What is the formula for net capital outflow (NCO)?
NCO = capital outflow – capital inflow.
What does a balanced NCO mean?
NCO = 0
What does an NCO surplus indicate?
NCO > 0
What does an NCO deficit indicate?
NCO < 0
How are domestic and foreign currency demands interrelated?
Domestic citizens require foreign currency for IM and CO; foreign citizens require domestic currency for EX and CI.
Fill in the blank: The relationship between CA and KFA is expressed as _______.
CA + KFA = 0
What’s the association between the two types of exchange rate?
P -> Overall price level in domestic economy
P* -> Price level in a foreign economy
ε = (e * P) / P*
What does NCO stand for in the Foreign Exchange Market Model?
Net Capital Outflow
NCO is a measure of the supply of domestic currency in the FEM model.
How is NCO calculated?
NCO = S – I
Where S is savings and I is investment.
What does it indicate if NCO is positive?
S > I, relatively more domestic currency is supplied
What does it indicate if NCO is negative?
S < I
What determines NCO in the FEM model?
The real interest rate from the LFM in the domestic economy
What is the demand for domestic currency primarily required for?
Buying goods and assets from the domestic economy
How does relative demand for domestic currency depend on?
The real exchange rate
What happens to the saving curve during expansionary fiscal policy in the LFM model?
It shifts to the left, resulting in a higher real interest rate
What is the effect of expansionary fiscal policy on NCO?
Lower NCO
What happens to the real exchange rate (ε) during expansionary fiscal policy?
It appreciates and NX worsens
What effect does an import quota have on demand for domestic currency?
It restricts demand for domestic currency
What is the result of an import quota on the NX(ε) curve?
It shifts to the right
How does the real exchange rate (ε) change due to an import quota?
It appreciates but NX is unchanged
What are the assumptions in the FEM for a small open economy?
The domestic economy is small
There is perfect capital mobility
Domestic and foreign bonds are perfect substitutes
What does the assumption of perfect capital mobility imply in a small open economy?
A single interest rate (‘world interest rate’, r*)
What happens to the real interest rate in a small open economy during domestic expansionary fiscal policy?
It remains unchanged (r = r*)
What is the effect of domestic expansionary fiscal policy on savings (S) and NCO?
Lower S results in lower NCO
What happens to the real exchange rate (ε) during domestic expansionary fiscal policy in a small economy?
It appreciates and NX worsens
What happens to the world interest rate (r*) during expansionary fiscal policy by large open economies?
r* increases
How does investment depend on r* in a small economy?
Investment decreases as r* increases
What is the relationship between NCO and investment in a small economy?
NCO increases as I decreases
What happens to the real exchange rate (ε) during expansionary fiscal policy by large open economies?
It depreciates and NX improves
