Macroeconomics 2

Updated 2006-10-28 00:38

Section V

Question Answer
1st Principle of MacroeconomicsExpectations, formed either adaptively and/or rationally, influence the economy.
2nd Principle of MacroeconomicsExogenous shocks (war, plague, natural disasters, technological innovations, etc) can influence the economy.
3rd Principle of MacroeconomicsThe economy is basically stable; after a shock, it will eventually return to its normal trend paths for output and employment. However, because of rigidities in the economy, this return could be slow.
4th Principle of MacroeconomicsMoney supply growth influences inflation, nominal long-term interest rates, and the exchanges of all goods and service.
Proved Reserves vs. Unproved ReservesDeveloped / Undeveloped vs. Probable / Possible
Impact of Oil Prices on the Economy- IMF: If a $10 increase in Poil is sustained for 1 year, this will decrease: World GDP Growth Rate by 0.5 percentage point, US GDP Growth Rate by 0.3 - 0.6 percentage point. - D.O.E.: Every 100% increase in the price of oil sustained over a year can reduce U.S. GDP growth by one point from what it should have been.
Why do crude oil prices impact US economy?- Thesis 1: The US is a Large Consumer of Oil - Thesis 2: Fed's actions to stop inflationary impact of oil shock.
Why are the currently High Oil Prices not hurting the US?1. Demand shock, rather than a supply shock.
2. It is hurting, because GDP growth rate might have been over 5%, rather than below 4%.
3. US is more efficient consumer than during past shocks.
Money: Simple definitionAn article of faith that guides transactions
Money: Formal definitionanything that meets the following four criteria:
1. Debt Settlement (accepted to pay off loan)
2. Medium of Exchange (accepted to buy goods and services)
3. Store of Value (can be held for future purchases)
4. Unit of Account (can be used to compare prices and calculate opportunity costs)

Section VI

Question Answer
Three primary measures of money1. M1: Currency Notes + Checking accounts; Highly Liquid
M2: M1 + Savings Accounts + Money Market Mutual Funds (which are similar to Savings Accounts) + Short-Term, Small CDs; Less Liquid
M3: M2 + Long Term Time Deposits Not Very Liquid = not as important
"High Powered Money"currency notes, coins, and reserves, called "High Powered" because it's the money directly controlled by the government
Long Term Interest RatesPrice (in terms of what you give up) to acquire funds for major investment
Short Term Interest RatesPrimarily is the price (in terms of what you give up) to hold money in pocket or spend it.
T-Notesgov't bonds with maturities of typically 2 to 10 years
T-Billsgov't bonds with maturities of 3 months, 6 months, and 1 year
T-bondsgov't bonds with maturities 10 years or more
Banking- Entity that transfers money from savers to investors (often called financial intermediaries). Banks profit from interest profits (iloan - iborrow or deposit). - Government bonds are perfect substitutes for loans. This is why ST rates are influenced heavily by t-note / t-bill rates and LT rates are influenced heavily by t-bond rates.
Discount LoanA loan in which a bank borrows money directly from its district Federal Reserve Bank
required reserve ratioratio of reserves to deposits that a bank must maintain per the federal reserve's standards
To increase money supply...The federal reserve purchases government debt with cash that it created out of nowhere (i.e., money has been created)
To decrease money supply...The federal reserve sells new government bonds and then hits the "delete" key to remove this money from circulation (i.e., money has been taken out of circulation)
BMIFamous explanation of the Law of one Price: Big Mac index is published annually by economist magazine and depicts the price of big macs around the world, and compares implied exchange rates with actual exchange rates

Section VII

Question Answer
OMO in Reality: Lagged Effect- Businesses, Consumers and the economy do not respond instantly to changes in interest rates - can take approx. 9 months for rate change to have impact
OMO in Reality: Interest Rates aren't the only factor- Other things play into investment decisions (shocks, etc.) - Most important factor is Expected Inflation - Investment Decisions are not based on Nominal interest rate, but on Real Interest Rate. - When you borrow money, you want to pay back as little as possible in real terms (inflation good for borrower).
Normal Yield Curve- If Fed lowers S.T. i-rates, this means additional reserves will cause the money supply to grow - According to Monetarism, more money will increase inflation in the long run - Therefore, Yield Curve is NORMAL because low S.T. rates is expected to result in long-term inflation.
Flat Yield CurveIf Fed raises S.T. i-rates, expectations of inflation in the future decreases. Therefore, L.T. i-rates begin to fall.
Inverted Yield CurveIf Fed continues to raise S.T. i-rates, inflation expectations will fall further, thereby lowering L.T. i-rates even further. Inverted yield curves commonly occur just before a recession
International Competitive Advantage- "absolute advantage" (country being best at producing everything), but usually refers to firm/nation's market share. - not economically useful because economists don't view world trade as a competitive, zero-sum game.
International Comparative Advantage- Opportunity cost is what a country sacrifices to produce a good. - A country has a comparative advantage when it can produce a good at an opportunity cost that is lower than another country.
TradeExchange of goods and services across borders
Offshore OutsourcingThe purchase of services at arm's length with the buyer and seller staying in their respective countries.
Foreign Direct Investment (FDI)Foreign investment in plant and equipment.

Section VIII

Question Answer
Indicators of trade and Outsourcing- Export and Imports - Foreign Direct Investment
OECDOECD stands for Organization for Economic Cooperation and Development. The OECD is an international agency which supports programs designed to facilitate trade and development. 90% of FDI outflow and 70% of FDI inflow is from OECD countries.
mercantilist ideology / trade protectionismprotect domestic market from imports
Example: Imports from China destroy US jobs.
Three common contemporary arguments:
1. International trade has destroyed US Manufacturing.
2. Opening of countries to foreign investment and information technology has led to the offshore outsourcing US white collar jobs.
3. Trade and the ability of US companies to build facilities in other countries (FDI) has expanded the labor supply, thereby placing downward pressure on wages.
State of ManufacturingEmployment is less than in y2k, but productivity is up! This suggests higher productivity levels from technology. Worldwide, manufacturing employment has declined 11% since 1995.
Lump of Labor FallacyThe false belief that the number of jobs or the amount of available labor is fixed
Charles DuellUS Commissioner of Patents, 1899, said "Everything that can be invented has been invented."
Balance of PaymentsAn accounting snapshot of a country's international transactions
Current AccountOne component of the Balance of Payments, measured as Exports - Imports
Private Capital AccountOne component of the Balance of Payments, measured as Investment Inflow (FDI and Portfolio) - Investment Outflow (FDI and Portfolio). Purchasing of US assets by a foreigner is an inflow
Official Capital Account: International Reserves1. Foreign currency in the back vault of central bank
2. Used to clear purchases of imports by private sector that are not paid for either through direct payment with foreign country's currency or granting of private domestic assets to foreigner (ex: writing a check).
Exchange RatesPrice of a country's currency, expressed in terms of another country's currency, always expressed as a ratio
Exchange Rates and the Private BOPIn theory, if more money is entering country (through sale of exports and flow of investment funds) than is leaving country (through purchase of imports and outflow of investment funds), then currency appreciates.


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