Econ 347 Study Set 1 Q.86-100

Fixed Exchange Rate

A fixed exchange rate, also called a pegged exchange rate, is a type of exchange rate regime where a currency's value is fixed against the value of another single currency or to a basket of other currencies, or to another measure of value, such as gold. A fixed exchange rate is usually used to stabilize the value of a currency against the currency it is pegged to. This makes trade and investments between the two countries easier and more predictable and is especially useful for small economies in which external trade forms a large part of their GDP. It can also be used as a means to control inflation. However, as the reference value rises and falls, so does the currency pegged to it. In addition, according to the Mundell-Fleming model, with perfect capital mobility, a fixed exchange rate prevents a government from using domestic monetary policy in order to achieve macroeconomic stability. Typically, a government wanting to maintain a fixed exchange rate does so by either buying or selling its own currency on the open market. This is one reason governments maintain reserves of foreign currencies. If the exchange rate drifts too far below the desired rate, the government buys its own currency in the market using its reserves. This places greater demand on the market and pushes up the price of the currency. If the exchange rate drifts too far above the desired rate, the government sells its own currency, thus increasing its foreign reserves. There are no major economic players that use a fixed exchange rate.

Flexible (Floating) Exchange Rate

A floating exchange rate or fluctuating exchange rate is a type of exchange rate regime wherein a currency's value is allowed to fluctuate according to the foreign exchange market. There are economists who think that, in most circumstances, floating exchange rates are preferable to fixed exchange rates. As floating exchange rates automatically adjust, they enable a country to dampen the impact of shocks and foreign business cycles, and to preempt the possibility of having a balance of payments crisis. The primary argument for a floating exchange rate is that it allows monetary policies to be useful for other purposes. Under fixed rates monetary policy is committed to the single goal of maintaining exchange rate at its announced level. Yet the exchange rate is only one of many macro economic variable that monetary policy can influence. A system of floating exchange rate leaves monetary policy makers free to pursue other goals such as stabilizing employment or prices.

Loan Capital

Capital held by a business that has been borrowed, through a long-term loan or sale of stock shares. Loan capital must be repaid in within a set period regardless of the financial status of the firm.

Deflation

Deflation is a decrease in the general price level of goods and services. Deflation occurs when the inflation rate falls below 0% (a negative inflation rate). Inflation reduces the real value of money over time; conversely, deflation increases the real value of money - the currency of a national or regional economy. This allows one to buy more goods with the same amount of money over time. The effects of deflation are: 1) Decreasing nominal prices for goods and services; 2) Increasing buying power of cash money and all assets denominated in cash terms; 3) May decrease investment and lending if cash holdings are seen as preferable (aka hoarding); 4) Benefits recipients of fixed incomes

Equity Capital

Equity capital is money that is invested into a company in exchange for an ownership interest in that company.

Financialization

Financialization is a process whereby financial markets, financial institutions and financial elites gain greater influence over economic policy and economic outcomes. Financialization transforms the functioning of economic system at both the macro and micro levels. Its principal impacts are to (1) elevate the significance of the financial sector relative to the real sector; (2) transfer income from the real sector to the financial sector; and (3) increase income inequality and contribute to wage stagnation. There are reasons to believe that financialization may render the economy prone to risk of debt-deflation and prolonged recession.

Inflation

Inflation is a rise in the general level of prices of goods and services in an economy over a period of time. When the general price level rises, each unit of currency buys fewer goods and services. Consequently, inflation also reflects an erosion in the purchasing power of money - a loss of real value in the internal medium of exchange and unit of account in the economy. Inflation's effects on an economy are various and can be simultaneously positive and negative. Negative effects of inflation include an increase in the opportunity cost of holding money, uncertainty over future inflation which may discourage investment and savings, and if inflation is rapid enough, shortages of goods as consumers begin hoarding out of concern that prices will increase in the future. Positive effects include ensuring that central banks can adjust real interest rates (intended to mitigate recessions),[5] and encouraging investment in non-monetary capital projects. Economists generally agree that high rates of inflation and hyperinflation are caused by an excessive growth of the money supply. Today, most economists favor a low, steady rate of inflation.

Stagflation

It is a situation in which the inflation rate is high, the economic growth rate slows down, and unemployment remains steadily high. There are two principal explanations for why stagflation occurs. First, stagflation can result when the productive capacity of an economy is reduced by an unfavorable supply shock, such as an increase in the price of oil for an oil importing country. Such an unfavorable supply shock tends to raise prices at the same time that it slows the economy by making production more costly and less profitable. Second, both stagnation and inflation can result from inappropriate macroeconomic policies. For example, central banks can cause inflation by permitting excessive growth of the money supply, and the government can cause stagnation by excessive regulation of goods markets and labour markets. Either of these factors can cause stagflation. Excessive growth of the money supply taken to such an extreme that it must be reversed abruptly can clearly be a cause. Both types of explanations are offered in analyses of the global stagflation of the 1970s: it began with a huge rise in oil prices, but then continued as central banks used excessively stimulative monetary policy to counteract the resulting recession, causing a runaway wage-price spiral.

Nominal Interest Rate

It is the rate of interest before adjustment for inflation. The real interest rate is the nominal rate of interest minus inflation. In the case of a loan, it is this real interest that the lender receives as income. If the lender is receiving 8 percent from a loan and inflation is 8 percent, then the real rate of interest is zero because nominal interest and inflation are equal. A lender would have no net benefit from such a loan because inflation fully diminishes the value of the loan's profit.

Marxian Economics

Marxian economics refers to economic theories on the functioning of capitalism based on the works of Karl Marx. Marx employed a labour theory of value, which holds that the value of a commodity is the socially necessary labour time invested in it. In this model, capitalists do not pay workers the full value of the commodities they produce; rather, they compensate the worker for the necessary labor only (the worker's wage, which cover only the necessary means of subsistence in order to maintain him working in the present and his family in the future as a group). This necessary labor is, Marx supposes, only a fraction of a full working day - the rest, the surplus-labor, would be pocketed by the capitalist. Marx theorized that the gap between the value a worker produces and his wage is a form of unpaid labour.