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Overview Chapters 12-17

Overview Chapters 12-17. Ch. 12: Int. Fin. Markets. Currency Trading -> Exchange Rate Time lag twix ship and receive bigger than time needed for cable transfer. Solution: commercial bill of exchange Spot vs. Forward XR: risk transferred to speculators Also: Futures, Options, Swaps.

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Overview Chapters 12-17

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  1. Overview Chapters 12-17

  2. Ch. 12: Int. Fin. Markets • Currency Trading -> Exchange Rate • Time lag twix ship and receive bigger than time needed for cable transfer. Solution: commercial bill of exchange • Spot vs. Forward XR: risk transferred to speculators • Also: Futures, Options, Swaps

  3. Capital Flows • To get higher return • To get safer return: risk diversification • SR: Money Market (maturity < 1 year) • LR: Capital Market (maturity > 1 year)

  4. Eurocurrency • E.g., Eurodollar = $-denominated account outside the US

  5. Ch. 13: XR (basic model) • It’s a supply and demand thing. • Demand for currency shifts with income and changing relative prices. • Ditto for supply of currency

  6. Ch. 14: XR (add M and i) • Previous model good for long-term predictions. But other determinants matter in the shorter term: M and i. • What is M? • How does Supply of M work? (Reserve requirement -> multiplier) • Discount rate, Open mkt ops

  7. Demand for M • MD=f(i,P,Y) • MD=MS determines i • Interest arbitrage: capital movement • Affects XR, which affects Exp-Imp

  8. Ch. 15: XRPPP • What are the determinants of the exchange rate over long periods of time? • What effect does monetary policy have on the country’s price level and therefore its exchange rate? • Is there a benchmark for the current exchange rate?

  9. Ch. 15: XRPPP • arbitrage -> law of 1 price -> PPP • relative PPP: • RXR:

  10. Ch. 16: Y and XR (SR) • AD and AS (slopes) • Intersection determines Y and P • Foreign income affects Exp • Domestic income affects Imp • XR affects both Imp and Exp • XR affects composition of output(tradable vs. non-tradables)

  11. Ch.17: Macro Policy • Internal Balance • GDP (full employment) • P (keep inflation in check) • External Balance • X-M (current account balance)

  12. Fiscal Policy (expansionary) (G and/or T)  • direct effect: AD and P • indirect effect: budget deficit  Gov. must borrow  i  attracts foreign capital (until i back at original level)  XR (X-M)  AD and P • net effect: ambiguous! Fiscal policy now used less as a means of stabilizing the economy than 30 years ago b/c of flexible exchange rates and increased international mobility of capital.

  13. Monetary Policy (expansionary) MS  i • direct effect: (C and I)  (AD and P) • indirect effect:  outflow of capital  XR (X-M)  (AD and P) • net effect: clear! monetary policy is more effective than fiscal policy as a stabilization tool b/c of flexible exchange rates.

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