International Economics (Finals)

Emily Fenton
Flashcards by Emily Fenton, updated more than 1 year ago
Emily Fenton
Created by Emily Fenton over 4 years ago
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Flashcards for the second half of International Economics (lecture 7-12)
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Types of Capital/Financial Assets (4) 1. Commodities (real goods/services that you can buy in bulk) 2. Bonds 3. Stocks 4. Money (as an asset)
Primary Institution of Financial Economy Banks: they move capital in the form of credits/loans
Investment Universe What are your investment options if the stock you have is failing (ex. real estate); where do you put things next to make up loss? (usually "safe havens": gold and oil)
Futures Option to buy or sell a predetermined quantity at a predetermined price; used to hedge risk against currency/exchange rate fluctuation More risky for seller, so generally more expensive
Bond "Stock" in the government; you give money to the government and they pay you (relatively low) interest each year; therefore safe. If there is any doubt, interest rates often increase to tempt more people to buy bonds
Stock Share in a company, and the company pays out dividends, based on earnings, to shareholders Owning many shares can give you a "stake" in the company
Options Alternative to a "future", where you have the option to buy or sell in the future; increases risk
Commercial Paper An IOU from a company; often bought by people looking for arbitrage
Money as an Asset Refers to currencies, which can be bought/sold based on exchange rates which can fluctuate
Brief History of Currency 19th C: European countries adopted national currencies 1870-1914: Gold Standard system backed by British pound WWI: break from Gold Standard to individual currency values Post-WWII: pegged, Bretton Woods system 1970's: abandon pegged system for floating currencies
Pros & Cons of Pegged Currencies Pros: capital goes to real goods; rates are predictable; international trade is more transparent Cons: deflation occurs more easily; central bank can't devalue currency; austerity imposed on governments who can't devalue currency
Case Study: China's Manipulation of Currency China has the yuan pegged to the US dollar, which keeps the Chinese currency unnaturally low in value (undervalued); they do this to make Chinese goods cheaper on the foreign exchange market (especially compared to US)
Devaluation of Currencies (3) 1. Good for exports 2. Bad for consumers/businesses who want to import 3. Bad for travelling abroad Caused by bad fiscal management/monetary policy leading to inflation
Appreciation of Currencies 1. Good for businesses importing 2. Good for consumers 3. Good for travelling abroad 4. Exporting is more difficult (goods more expensive on global market) A healthy economy should see an appreciation of currency value
Monetary Policy Ability of government to influence economy based on money supply and manipulating interest rates
How to Defend a Currency Buy own currency with foreign reserves on foreign exchange market; this is why foreign reserves are so important
Risk Encountered by Firms (2 Types) 1. Transaction Risk: gains and losses that may be incurred when monetary transactions are settled in a foreign currency (effects vertical multinational) 2. Translation Risk: risk of having assets and liabilities on a firm's balance sheet denominated in a foreign currency (effects horizontal and vertical multinationals)
Spot Rate The rate you must pay on the spot (right now)
Arbitrage Taking of advantage of comparative gaps between two or more values in one market (generally arbitrage makes gaps close very quickly due to technology)
Bid Rate Price at which banks are willing to BUY a currency
Ask Rate Price at which banks are willing to SELL a currency
Spread The difference between the bid rate and ask rate
Forward Rate Price at which you agree upon today to buy or sell an amount of a currency at a specific date in the future
Flexible Exchange Rate When monetary authorities do not intervene in any way to influence the level of the exchange rate
Fixed Exchange Rate The authorities allow for a band width around the parity rate restricting the amount it can appreciate and depreciate
Key Market Players (4) 1. Commercial banks 2. Firms 3. Non-bank financial institutions (ex. investment brokers) 4. Central banks (modestly involved in market)
PPP = Price Level Exchange rates will equal price level because they are measured similarly based on a basket of goods
Valuation of Currencies Indices (3) 1. Broad indices: measure relative to all foreign currencies 2. Major indices: relative to major foreign currencies 3. OITP: other important trading partners
Uncovered Interest Parity Based on the notion that currency rates will merge in the long run based on price level and interest rate differences (expected change of currency rates); money goes where interest rates are high
Covered Interest Parity When relationship between interest and exchange rates in two countries cancels out any arbitrage opportunity; in equilibrium
Big Mac Index Way of calculating currency value, because even though all Bic Macs are the same, they are not priced the same based on currency values (indicates whether currency is over- or under-valued)
Black Wednesday After the British had entered the European Exchange Rate Mechanism, issues began caused by lack of faith in countries' commitment to ERM. High interest rates in Germany saw capital flowing out of Britain; British speculators panicked and bet against the British pound. UK tried to protect the pound, but it failed and they had to bail out of ERM.
Currency Cycle Increasing currency value ^ v Exporting becomes Exporting becomes easier difficult ^ v Decreasing currency Trade imbalance value v ^ Slows growth Investments decrease <
Manipulating Currency Cycle with Interest Rates If interest rates go up, investment increases; this pulls money into the economy because high interest rates make investments more profitable If interest rates are increased too much, cost of domestic business becomes too expensive, and therefore the economy slows down Lowering interest rates lead to domestic business growth, which encourages excessive growth which can lead to excessive inflation and increased prices
Currency Crisis Substantial appreciation or depreciation of a currency which creates more of a political or economic impact than it usually would
Actors of a Currency Crisis (2) 1. Portfolio investors 2. Central banks
Self-fulfilling When the actions undertaken by investors vindicate their own doubts that started the speculative attack in the first place
Stages of Currency Crisis (4) 1. Pressure on exchange rate to depreciate 2. Investors sell currency 3. Authorities raise interest rates or sell foreign reserves to defend currency value 4. If the attack continues, currency value declines
Characteristics of Currency Crisis (3) 1. Reversal of capital flow (funds leaving country) 2. Crisis hits after boom period 3. Negatively effects GDP growth
First Generation Crisis Model Model assumes that the domestic economy was badly managed, and that investors have very little say in what happens in the economy. ∆M = ∆F + ∆R M = money supply F = budget deficit R = foreign reserves
Game Theory Model A way of imagining a speculative attack where you can predict whether it is in the investors interest to sell or hold their investment
Criticisms of First Generation Model (4) 1. Assumption of investors having no agency is misled 2. Doesn't allow for governments' ability to manipulating foreign policy 3. Assume all governments' can do is print money 4. Investors only react to environment, don't shape it
Second Generation Crisis Model (and 3 assumptions) Different from first generation because it assumes that behaviour of investors drives the economy, and therefore investors can determine the likelihood of a crisis Assumptions 1. Policy makers have reason to give up fixed exchange rates 2. Policy makers have a reason to keep the fixed exchange rate 3. Cost of policy makers to hold rate increases if investors think they will bail out
Trilemma Difficulty for smaller countries of maintaining capital mobility, policy independence and a fixed exchange rate (now it is a dilemma)
Brief Timeline of Crisis in Mexico (7) 1. 1970's: Mexico finds oil; on a high 2. 1981: price of oil decreases 3. 1982: Mexico declares it can't pay debts 4. mid-80's: IMF/US bailout/austerity measures 5. 1987: fixed exchange rate implemented 6. 1990: doing okay from reforms 7. 1994: new president and investors bail out completely
Austerity Conditions Imposed on Mexico (5) 1. Spend money differently 2. Reduce inflationary public spending 3. Privatization 4. Abolish trade restrictions 5. Sign GATT
Political Dramas in Mexico Contributing to Crash (3) 1. Rise of the Zapatista Army of National Liberation 2. Presidential candidate assassinated 3. Brother of Salinas accused of murdering his own brother-in-law
Tequila Effect When investors pulled out of many emerging economies (especially in Latin America) because of the crisis in Mexico (out of fear)
Types of Financial Crisis (5) 1. Currency crisis 2. Capital account crisis: reversal of capital flow 3. Banking crisis (only domestic; can lead to bank runs) 4. Twin crisis (currency + banking crisis) 5. Sovereign debt crisis: government can't pay dividends on bonds
Financial Crisis (basic definition) Crisis which impairs the ability for the financial system to do what it is meant to do (which is channelling funds to best possible investments)
Asymmetrical Information Is essentially financial risk; has to do with the uncertainty of other's actions in the investment universe
Measuring Currency and Banking Crises Currency Crisis: "speculative pressure index" (measures change in exchange rates, foreign reserves, interest rates) Banking Crisis: "index of bank trouble" (measures bankruptcy, forced mergers, government bailouts)
Condition of Moral Hazard Conduct that occurs when a person is encouraged to take more risk because they know someone else will bear the main responsibility If market is functioning properly, risk-takers take full responsibility for the failure of risky venture
Individual & Institutional Moral Hazards Individual: causes artificially high value of stocks, so funds are inefficiently allocated Institutional: investors can be encouraged through bonuses for unrealistically high gains (incentive to lie/cheat, etc)
Adverse Selection Players forced to pay more because regulation doesn't allow for market to price risk properly
Disruptions Leading to Financial Crisis (5) and Adverse Selection/Moral Hazard 1. Interest rates increasing (increases adverse selection) 2. Increase in uncertainty (increases adverse selection) 3. Decrease in asset prices (increases adverse selection and moral hazard) 4. Deflation 5. Bank run/panic
Equity Financing When companies give holders a state in equity (shares) to gain funds; less preferred because it gives away ownership of assets
Glass-Steagall Act 1933 Firewall between commercial and investment banks in order to protect consumers and spread risk
Keynesianism Method of managing the economy where the government employs fiscal policy Dominant after WWII (still found more in Europe); Obama used "Keynesian" stimulus after 2008 Crisis
Internet Age Led to a boom of new wealth in the 90's, that people thought would never end. Created overnight millionaires, and made people think we'd entered a "growth cycle" rather than a boom/bust cycle
"The Gradual Decline..." (4) 1. George W. Bush elected in 2000 2. Stock options become worthless (internet money goes into real estate) 3. House prices go up 4. Mortgage companies lend to anyone who wants a house (creating subprime borrowers)
New Financial Products to Spread Risk (4) 1. Adjustable rate mortgages (interest rates adjusted periodically) 2. Credit default swaps (credit insurance insulating from subprime defaulting) 3. Mortgage-backed securities 4. Collateralized debt obligation (selling debt as securities)
Sovereign Rating Degree in which bonds are held in esteem to investors
US Government Response to Crisis (2) 1. Allow Lehman Brothers Bank to fail 2. Buy out the rest of banks to avoid full-scale crash
Market Response to Crisis (5) 1. Some banks sold at "fire sale" rates 2. Stock market extremely volatile 3. Unemployment shoots upwards 4. Growth rates go way down 5. Everyone moves to last safe-havens (gold and oil)
Political Response to Crisis (2) 1. Bush held responsible for crash 2. Obama instates American Recovery and Reinvestment Act: $800 billion dollar Keynesian stimulus
Socio-Political Response to Crisis (6) 1. New restrictions (Dodd-Frank bill instated to regulate banks) 2. Top executives punished 3. Restructuring of middle class jobs 4. Lots of lost jobs, homes, and economic uncertainty 5. Rising inequality 6. Occupy Wall Street
Euro Currency Crisis: Hard-Hit Countries (7) 1. Greece (high spending and mismanagement) 2. Ireland (housing bubble) 3. Spain (housing bubble) 4. Italy (bond market run) 5. Portugal (mismanagement) 6. Cyprus 7. Iceland
Leaving the Euro (pros and cons) Pros: currency can devalue, so exports become more competitive, which can foster economic growth and lower cost of living Cons: would create loss of confidence and wipe out European assets and in global economies
European Policy Responses to Sovereign Debt Crisis (5) 1. Providing liquidity 2. Supply-side economics (fiscal stimulus for business) 3. Strengthening of financial institutions 4. IMF supervising bailouts, balance-of-payments problems 5. ECB buys bonds from struggling economies
European Social Responses to Sovereign Debt Crisis (5) 1. Government changes 2. Greece: rise of far-right parties, violence, strikes 3. Spain: protests 4. Germany: public distrust of southerners 5. Rise of Euroscepticism
Results of the Sovereign Debt Crisis Responses (pros and cons) Pros: economic/social crisis mostly averted; learned a lot Cons: everyone basically still needing support/recovering; high unemployment; spending is down; house values down; rising Euroscepticism
Bull-Whip Effect Tiny decline for final products creates a reduction in inventories across the sector and a greater reduction to industrial output
Benefits of International Capital Mobility (2) 1. Channels national savings towards productive investment opportunities (savings = investment funds) 2. Improved allocation of investment risk (risk is spread thanks to larger pool of investment opportunities
Limits of International Capital Mobility (4) 1. Savings and investments are not necessarily in equilibrium 2. No need for any correlation between national savings and national investment 3. Ratio between national savings and national investment usually high 4. Capital should, ideally, flow from North to South, but it doesn't
Problem with Globalization & Growth It is not as easy as previously expected for emerging economies to catch up to developed economies (moving growth target)
Solow Model Helps us find the optimal ratio between capital and labour in order to maximize growth. Too many workers means there is less capital per worker.
Total Factor Productivity Productivity factor which is multiplied by simple inputs of labour and capital; if increased properly, can move towards Solow's Model of optimal growth
Human Capital and TFP Human capital can make a difference for the growth path, but it is difficult to measure because it is usually based on years of schooling (does increasing average years of education from 1 to 2, really double human capital?)
Technology and TFP Having more technology will improve optimal growth pattern; Solow says this "just happens", but this doesn't really make sense. More importantly, we need Schumpetarian growth (importance of knowledge, quality, new goods, innovation, market power)
Open Economies and TFP Not concerned with the market, but concerned with the extent to which the economic institutions work (allow for comparative advantage, integration of markets, risk sharing, incorporating foreign knowledge)
"Transfer" Company "Latin Business Consultancy" Advises Dutch companies who want to expand into Latin language countries; advises companies on social differences between Latin Americans and Dutch and how to deal with the different market style
Corruption According to "Transfer" A company like Transfer doesn't like to think too much about corruption in Latin America; better to sweep it under the rug and pretend it isn't happening. He also questions what we consider corruption, and suggests it might not be so uncommon in the Netherlands either
Vocational Economics The type of economics learned in business school which prepares you for working in a company, or similar. Focuses on profit maximization, dealing with the corporate model, sometimes teaching politicians how to run fiscal/monetary policy
Human Economics The type of economics we do in International Studies which goes beyond the business school paradigm. Though there is less "real-world" application of this type, it is concerned with sustainability, equality, justice, peace, satisfaction Less lucrative, but more important
Problems with Economic Globalization (4) 1. Continuous growth is unsustainable 2. Continuous population growth is unsustainable 3. Fuel might run out or become too expensive 4. Pollution and global warming (environmental impact)
Issue of Long-Term (In)Equality (Piketty) When growth grows more than wealth, people become rich. When wealth grows more than growth, then only a few economic elites become rich. Industrialization period caused growth to grow more than wealth, which is why we are so optimistic
Pros and Cons of Globalization Pros: leads to increased growth for all, and especially benefits businesses Cons: creates a race to the bottom, and things become more expensive
Gini Coefficient A way of measuring inequality by looking at income distribution within a state. High inequality = 1, low inequality = 0.
Reasons for Increasing Inequality (5) 1. Supply-side policies 2. End of industrialization 3. Competition from developing world 4. Race to bottom
Reasons Global Equality is Increasing 1. Race to bottom 2. Population density limit 3. Labour protections 4. Current inequality short- or medium-term trend?
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