Mechanics of Foreign Exchange

The buying and selling of currency
Any transaction that occurs in the balance of payments necessitates foreign exchange
Exchange rate is determined in the foreign exchange
Exchange rate is the price of currency
Exchange rate are a function of the supply and demand for currency

• increase in supply, decrease exchange rate
• increase in demand, increase exchange

Appreciate and depreciation

• Appreciation of currency occurs when the exchange rate of that currency increase
• Depreciation of a currency occurs when the exchange rate of that currency decreases

Exchange rate Determinants

• Consumers tastes
• Relative income
• Relative price level
• Speculation

Unit 7

Specialization - individuals and countries can be made better off if they will produce in what they have a comparative advantage and then trade with others for whatever else they want/ need
Absolute and comparative advantage

• Absolute advantage the producer that can produce the most output OR requires the least amount of input
• Comparative advantage the producer with the lowest opportunity cost
• Countries should trade if they have a relatively lower opportunity cost
• An output problem presents the data as products produced given a set of resources
• An input problem presents the data as amount of resources needed to produce a fixed amount of output
• Identifying absolute advantage input problems change the scenario from who can produce a given amount of resources

Balance of trade: Exports + Imports
Balance of goods: good exports + services exports - goods imports + service imports
Balance on current account: Balance of goods: services + net investment + net transfers
Official Reserves: current account + capital account = 0

Unit 7

Balance and payment - measure of money inflows and outflows between the united states and the rest of the world

• Inflows are refereed as CREDITS
• Outflows are refereed to as DEBIT

The balance of payements is divided into 3 accounts

• current
• Capital/financial
• Official Reserves

Double entry bookkeeping - every transaction in the balance of payments is recorded twice in accordance with standard accounting practice

• Notice that 2 transactions affect each other. Theoretically the balance payments should always equal 0

Current Account

• Balance of trade or Net Exports
• Exports of goods/services - import of goods/services
• Exports create a credit to the balance of payments
• Imports opposite
• Net Foreign Income
• Income earned by US owned foreign assets income paid to foreign held US assets
• Net transfers (tend to be unilateral)
• Foreign Aid - a debit tot he current account

Capital/Financial account

• The balance of capital ownership
• Includes the purchase of both real and financial assets
• Direct investment in the U.S. is a credit tot he capital account
• Direct investment by US firms in a foreign country are debits to the capital account
• Purchase of foreign financial assets represents a debit tot he capital account
• Purchase of domestic financial assets by foreigners represents a credit assets by foreigners represents a credit to the capital account.

Relationship between current and capital account

• The current account and the capital account should 0 each other out
• If current account has a negative balance, then capital account should have positive balance

Official Reserve system

• The foreign currency holdings of the U.S. federal reserve system 
• When there is a balance of payments surplus the fed accumulates foreign currency and debits the balance of payments
• When there is a balance of payments deficit the fed depletes its reserves of foreign currency and credits the balance of payments
• Official reserves 0 out the balance of payment

Unit 6

• Stagflation- high inflation combined with high unemployment and stagnant demand in a countries economy
• Deflation - reduction of the general level of prices in an economy
• Disinflation - decrease in the rate of inflation, slowdown in the rate of increase of the general price level of goods and services.
• Inflation - general level of prices for goods purchasing power of currency is falling
• Causes of adverse supply side shock would be rising oil prices, bad weather and decline in productivity. This causes an unexpected increase in cost or disruption to production
• Demand pull inflation is the result of increase in total spending without any accompanied =
• Cost push inflation is the result of negative shocks to total production capacity. Increase unemployment and reduced production capacity
• Supply side economics focus on the expansion of the long run supply curve. Less government (taxes and spending)
• Economists call the knowledge and skills that make a worker productive a human capital.
• Major measure of economic growth is changes in real GDP per capita

The Phillips Curve

SRPC

• There is a trade off between inflation and unemployment
• Inverse relationship one increase others decrease
• Since wages are sticky inflation changes, moves the SRPC. (Short run Phillips curve)
• If inflation persist and the expected inflation rate increase then the entire SRPC moves upward
• Stagflation - unemployment and inflation spontaneously rise
• Supply shocks - rapid and significant increase in resource cost. Cost SRAS curve to shift
• If inflation expectations drop due to new tech or efficiency then the SRPC moves down

LRPC

• Occurs at the natural rate of unemployment. It is represented by a vertical line. There is no trade off between unemployment and long run.
• Because the economy produces at the full employment output level
• If the natural rate of unemployment (NRU) changes the LRPC moves

NRU

• 3 types of unemployment
• Frictional
• Structional
• Seasonal

LRPC

• Increase in Un will shift LRPC to the right 
• Decrease in Un will shift LRPC tot he left
• Misery Index - combination of inflation and unemployment in any given year. Single diget misery is good.

Monetary Policy

Loan-able Funds Market

Is an interest rate of 50% good or bad?
Bad for borrowers but good for lenders
The loanable funds market is the private setor supply and demand of loans.

• This market brings together those who want to lend money and those who want to borrow.

This market shows the effect on REAL INTEREST RATE

Demand - inverse relationship between real interest rate and quantity loans demanded
Supply - Direct relationship between real interest rate and quantity loans supplied
This is NOT the same as the money market. (Supply is not vertical)