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)

Tools of Monetary Policy and 3 Shifts of Money Supply

The Fed adjusting the money supply by changing any one of the following

1. Setting reserve requirements
2. Lending Money to Banks
• Discount rate
3. Open Market Operations
• Buying and selling bonds

The reserve requirement

• Only a small percent of your money is in the safe the rest  of your money has been loaned out. This is called "fractional reserve banking"
• The FED sets the amount that banks must hold. The reserve requirement is the percent of deposits that banks must hold in reserve.

Using Reserve requirement

• If there is a recession, what should the FED do to the reserve requirement?
• Decrease the reserve ratio
1. Banks hold less money and have more excess reserve.
2. Banks create more by loaning out excess
3. Money supply increases, interest rates decrease, AD goes up
• If there is inflation, what should the FED do to the reserve requirement?
1. Increase the reserve ratio
2. Banks hold more money and have less excess reserves
3. Banks create less money
4. Money supply decreases, interest rate increases, AD decreases

Open Market Operations

• Open market operations is when the FED buys or sells govt. bonds
• This is the most important and widely used monetary policy.
• If the FED buys bonds it takes bonds out of the economy and replaces them with money.
• If the FED sells bonds it takes the money and gives the security to teh investor.

The Discount rate

• There are many different interest rates, but they tend to all rise and fall together.
• The discount rate is the interest rate that the FED charger commercial banks for short term loans.

Federal Funds Rate

• The federal funds rate is the interest rate that banks charge one another for overnight loans as reserves.

Prime rate

• It is the interest rate that banks charge their most credit worthy customers.

Money Creation Formula

A single bank can create $ by the amount of it's excess reserves.
The banking system as a whole can create $ by a multiple of the excess reserves.
Money Multiplier = 1/RR
New vs. Existing $

• If the initial deposit in a bank comes from the FED or bank purchase of a bond or other money out of circulation, the deposit immediately increases the money supply
• The deposit then leads to further expansion of the money supply through the money creation process
• Total change in MS if initial deposit is new $ = deposit + $ created by banking system
• If a deposit in a bank is existing $ deposting the amount does not change the MS immediately because it is already counted
• Existing currency deposited into a checking account changes only the composition of the money supply from coins/ paper $ to checking account deposits
• Total change in the MS if deposit is existing $ banking system created money only