Macro Exam 2

Most liquid to least liquid (Liquidity, CH 16)

$20 bill (cash), funds in a savings account, bond, house (Liquidity refers to how quickly an asset can be converted into a medium of exchange. Cash or currency can be used immediately as a medium of exchange, so a $20.00 bill is the most liquid asset listed here. The funds in a savings account must be withdrawn before they can be used to purchase goods and services, but this transaction usually can be done within a day or two, assuming the account is with a local bank. A broker can sell a bond issued by a publicly traded company within a short period of time, and then it may take a few days for the accounts to settle and for you to receive your cash. Your house is the least liquid of the assets because it may take weeks or even months to find a buyer and get your cash.)

Leverage ratio = (bank leverage, CH 16)

( reserves + loans + securities (these are the original assets)) / capital

Real exchange rate (Computing real exchange rates, CH 18)

(e x P)/P* where e is the nominal exchange rate, P is the domestic price level, and P* is the foreign price level

money multiplier (Money creation process, CH 16)

1/r r = required reserve ratio

Trade Deficit (Imports, exports, and the trade balance, CH 18)

A trade deficit occurs when the value of goods and services exported falls short of the value of goods and services imported. Between 1983 and 1984, the deficit grew in dollar terms and grew as a percentage of GDP. Net exports equals exports minus imports. For example, in 1983, net exports equaled $277 billion−$328.6 billion=−$51.6 billion, which was −$51.6 billion/$3535 billion×100=−1.46% of GDP. Similar calculations yield the following results:

long run impact of change in money growth and inflation

According to the Fisher effect, as expectations adjust to the new, higher inflation rate, the nominal interest rate will rise

inflation

An increase in the overall level of prices (The level of prices and the value of money; 17)

Net capital outflow and net exports CH 18

An open economy interacts with the rest of the world through its involvement in world markets for goods and services and world financial markets. Although it can often result in an imbalance in these markets, the following identity must remain true: Net Capital Outflow = Net Exports In other words, if a transaction directly affects the left side of this equation, then it must also affect the right side. The following problem will help you understand why this identity must hold. U.S. exports are goods and services that are produced in the United States but purchased by residents of foreign countries. Similarly, U.S. imports are goods and services that are produced in foreign countries but purchased by residents of the United States. Because net exports is the difference between exports and imports, an increase in exports leads to an increase in net exports, while an increase in imports leads to a decrease in net exports. Because the statistical model you created is produced in the United States and sold in Argentina, your latest product is a U.S. export. Therefore, U.S. exports and net exports increase by ARS 900,000.

arbitrage opportunity

Arbitrage opportunities exist where a good can be bought in one country at a low price and sold in another at a higher price. (Purchasing-power parity 18)

Suppose First Main Street Bank, Second Republic Bank, and Third Fidelity Bank all have zero excess reserves. The required reserve ratio is 20%. Lorenzo, a client of First Main Street Bank, deposits $750,000 into his checking account at First Main Street Bank. What are his assets and liabilities? (Money creation process, CH 16)

Assets- Reserves, 750,000 Liabilities- Deposits, 750,000 When Lorenzo deposits the $750,000 into First Main Street Bank, it creates both an asset and a liability for the bank. On the asset side of the T-account, the $750,000 increases the bank's reserves. The bank can use some of these additional reserves to make loans to other people. On the liability side of the T-account, the $750,000 is recorded as a demand deposit, because Lorenzo could demand his deposit back at any time by coming into the bank and asking for it, by writing a check, or by using a debit card.

GDP Equation

C + I + G + (X-M) Recall that gross domestic product (GDP) is the market value of all final goods and services produced within a country in a given period of time. In this case, the given period of time is defined as the current year. The composition of GDP includes four main types of spending: personal consumption (C), investment (I), government purchases (G), and net exports (NX)or(Exports - Imports).

Y (an economy gross domestic product / national income) = (Saving and net flows of capital and goods, CH 18)

C + I + G + NX

Effect of a new deposit on excess and required reserves when the required reserve ratio is 20%, on a deposit of 750,000 (Money creation process, CH 16)

Change in excess reserves - 600,000 Change in required reserves - 150,000 Because the required reserve ratio is 20%, First Main Street Bank is required to hold 20% of its fresh reserves (that is, the initial deposit). Since 20% of $750,000 is $150,000, this means that First Main Street Bank's required reserve has increased by $150,000. The remaining 80% of the fresh reserves, or $600,000, is excess reserves and can be used to make loans.

inflation rises unexpectedly

If inflation rises unexpectedly, in the short run borrowers and lenders will not set the nominal interest rate to reflect the increase in the inflation rate. The actual real interest rate will, therefore, turn out to be different from the expected real interest rate (The Fisher effect and the cost of unexpected inflation 17)

after tax real interest rate

Compared with higher inflation rates, a lower inflation rate will increase the after-tax real interest rate when the government taxes nominal interest income. This tends to encourage saving, thereby increasing the quantity of investment in the economy and increasing the economy's long-run growth rate ||| Compared with a higher rate of inflation, a lower rate of inflation leads to a higher after-tax real interest rate, which tends to encourage saving. Because the economy's level of investment depends on the pool of savings available to finance investment projects (such as acquiring new tools or machinery or building new plants or office buildings), the higher volume of saving will increase the quantity of investment, thereby increasing the economy's rate of physical capital accumulation and increasing the long-run economic growth rate. Thus, to the extent that the central bank can reduce inflation in an economy in which the government taxes nominal interest income, inflation will encourage saving, investment, and growth.(Inflation-induced tax distortions 17)

1. Sam orders 40 bottles of champagne from a French distributor at a price of $75 per bottle. 2. A U.S. company sells 200 spark plugs to a Korean company at $5.00 per spark plug. 3. Andrew, a U.S. citizen, pays $1,100 for a computer he orders from Dellosoft (a U.S. company). (Accounting for trade in goods and services, CH 18)

Consumption - 4,100 Investment - 0 Govt Purchases - 0 Imports - 3,000 Exports - 1,000 Net Exports - -2,000 GDP - 2,100 -None of the given transactions reflect investment or government consumption, which means that I=0I=0 and G=0G=0. -Andrew's purchase of a computer from a U.S. company as well as Sam's purchase of champagne from a French distributor contribute to personal consumption. So C=$1,100+($75×40)=$4,100. -At the same time, Sam's purchase of champagne from a French distributor is a U.S. import. So, M=$75×40=$3,000. -The spark plugs are sold to a foreign firm and thus do not contribute to personal consumption. Therefore, U.S. exports are X=$5.00×200=$1,000 -Finally, the change in GDP that results from these transactions can be computed as the sum of consumption, investment, government purchases, and net exports from the United States:.

Reserves = (Required and Excess Reserves, CH 16)

Demand Deposits - Loans

Required reserves = (Required and Excess Reserves, CH 16)

Demand Deposits x Required Reserve Ratio (in decimal form)

Outcomes of trade deficit (Saving and net flows of capital and goods, CH 18)

Exports < Imports 0 > Net Exports Y < C + I + G Investment > Saving 0 > Net capital outflow -If a country is experiencing a trade deficit, then the value of imports exceeds the value of exports. Because net exports is defined as exports minus imports, this implies that net exports must be less than zero. Since you know that income (Y) is equal to C+I+G+NX, if net exports is negative, this means that income is less than domestic spending (C+I+G). As you saw in the previous question, saving is what is left over from income after consumption and government purchases (S=Y−C−G). -Because the country is investing more than it is saving, domestic investment must be partially financed by selling assets abroad. Therefore, net capital outflow must be negative.

Net foreign investment and investment

In a large open economy, what is the source of the demand for loanable funds? (Introduction to the loanable funds market 19)

net exports

In an open economy, what is the source of demand for dollars in the foreign-currency exchange market? (Introduction to the foreign-currency exchange market 19)

Change in demand deposits (Money creation process, CH 16)

Initial deposit x 1/r

In the 1950s, imports and exports of goods and services constituted roughly 4% to 5% of U.S. GDP. In recent years, exports have accounted for approximately 12% of GDP, while imports have more than tripled to over 15% of GDP. Which of the following help to explain the increase in international trade and finance since the 1950s?

International trade agreements that lower tariffs and import quotas, Improved transportation, Services such as web conferencing and teleconferencing that facilitate international meetings Better transportation (such as a higher number of international flights and better high-speed rail lines) and communication (thanks to technology and the Internet) facilitate increased trade. The proliferation of free-trade agreements such as NAFTA and GATT has also expanded trade. By contrast, changes in exchange rates would tend to impact only the relative prices of countries' goods and services, which may affect the patterns of international trade but not the overall volume.

Saving equation (open economy)

Investment + Net foreign investment

M1 (Money Aggregates, CH 16)

M1 includes currency (like the money in Paolo's checking account), traveler's checks, and checkable deposits.

M2 (Money Aggregates, CH 16)

M2 includes everything in M1 plus money market deposit accounts, savings account deposits, certificates of deposit (such as Amy's CD), and what are called miscellaneous near-monies.

nominal variables

Measured in monetary units. Any price or wage denominated in money, such as Valerie's $15.00 per hour wage, is an example of a nominal variable. (The classical dichotomy and the neutrality of money 17)

Antonio writes a check for $4,000. (roles of money, CH 16)

Medium of Exchange (Money acts as a medium of exchange by providing an accepted method of payment for goods and services. In this case, Antonio pays the Duper dealership $4,000 as a down payment)

Commodity Money , Intrinsic Value (Kinds of Money, CH 16)

Money taking the form of a commodity with intrinsic value is known as commodity money. An item has intrinsic value if it has value outside of its use as money. Energy bars are used as a medium of exchange by American prisoners, but they also have value outside of their use as money. Specifically, energy bars can be eaten.

Flat Money (Kinds of Money, CH 16)

Money whose value derives from government decree is known as fiat money. U.S. dollars have value because the U.S. government stands behind them. Each U.S. note reads, "This note is legal tender for all debts, public and private." Through its central bank, the U.S. government declares that U.S. dollars are valid, and it does a reasonably good job of managing their circulation. Ultimately, however, the dollar has value because people are willing to accept it in exchange for goods and services with confidence that they can then use it to buy other goods and services.

deflation

Negative inflation, or a decrease in the overall level of prices (The level of prices and the value of money, 17)

Price Level Equation

Nominal GDP/Real GDP or (quantity of money * velocity of money) / quantity of output (17)

capital flight

Now, suppose that Mexico experiences a sudden bout of political turmoil, which causes world financial markets to become uneasy. Because people now view Mexico as unstable, they decide to pull some of their assets out of Mexico and put them into more stable economies. This unexpected shock to the demand for assets in Mexico is known as_________. If people decide to move their capital to safer havens, net capital outflow in Mexico increases for any given real interest rate. This results in a rightward shift of the NCO curve. The demand for loanable funds is composed of net capital outflow and domestic investment, which causes the demand for loanable funds to increase in Mexico, and in turn causes the real interest rate to rise. (Capital flight 19)

The Federal Reserve's primary tool for changing the money supply is_________, In order to increase the number of dollars in the U.S. economy (the money supply), the Federal Reserve will_________.( The Federal Reserve's organization, CH 16)

Open market operations, buy government bonds (Open market operations are the Fed's primary tool for controlling the money supply. Open market operations involve buying and selling U.S. government bonds. To increase the money supply, the Fed creates dollars with which to purchase government bonds from the public. After the purchase, the Fed has bonds and the public has new dollars—an increase in the money supply. To reduce the money supply, the Fed sells U.S. government bonds to the public. After the sale, the public has bonds and the Fed has taken dollars out of circulation, thereby reducing the money supply.)

Nominal GDP equation

Price x Quantity (17)

shoe leather costs

Rapid inflation imposes an inflation tax on people who hold money. As the price level rises, the value of money declines. To avoid the inflation tax, people minimize their money holdings during periods of rapid inflation. They may make more frequent withdrawals from the bank and move quickly to deposit their cash earnings in interest-bearing accounts. They may also attempt to spend their earnings on physical goods as quickly as possible, or convert their money to the currency of a nation with a lower and more stable rate of inflation. The trips and errands associated with reducing money holdings wear on people's shoes; therefore, the inconveniences associated with minimizing money holdings are known as shoe-leather costs. Of course, shoe-leather costs include all the time and energy people devote to reducing money holdings in an inflationary environment, not just the wear and tear on their shoes! EX. Carlos manages a grocery store in a country experiencing a high rate of inflation. He is paid in cash twice per month. On payday, he immediately goes out and buys all the goods he will need over the next two weeks in order to prevent the money in his wallet from losing value. What he can't spend, he converts into a more stable foreign currency for a steep fee. This is an example of the _____________ (Identifying costs of inflation 17)

effects of capital flight

Real Interest Rate [increase], Real Exchange Rate [decrease], Net Capital Outflow [increase] Capital flight results in an increase of net capital outflow for any given real interest rate, which causes the demand for loanable funds to increase. This puts upward pressure on the real interest rate and results in a higher level of net capital outflow. Because the supply curve in the foreign-currency exchange market is equal to the level of net capital outflow, this curve also shifts rightward. This causes the real exchange rate for pesos to decrease (the peso depreciates), which makes Mexican goods and services more attractive in the international market, which then causes an increase in net exports. (Capital flight 19)

effects of a budget deficit

Real Interest Rate [increases], Real Exchange Rate [increases], Trade Balance [deficit] (Effects of a government budget deficit 19)

Suppose that Third Fidelity Bank currently has $200,000 in demand deposits and $130,000 in outstanding loans. The Federal Reserve has set the reserve requirement at 10%. (Required and Excess Reserves, CH 16)

Reserves = 70,000 A bank's reserves are any deposits that it holds that are not loaned out. In this case, Third Fidelity Bank has $200,000 in demand deposits and has made $130,000 in loans. Required Reserves = 20,000 A bank's required reserves are the portion of its demand deposits that it needs to hold in reserves. The amount of required reserves depends on the legal reserve requirement (in this case 10%) set by the Fed. Therefore, Third Fidelity needs to hold 10% of its $200,000 of demand deposits in reserve: Note: The reserve requirement is often referred to as the required reserve ratio in decimal form. Excess Reserves = 50,000 Any reserves that a bank holds beyond its required reserves are excess reserves. In this case, Third Fidelity Bank holds $70,000 in reserves, but it is required by the Fed to hold only $20,000 in reserves. Therefore, it holds $70,000−$20,000=$50,000$70,000−$20,000=$50,000 in excess reserves and could lend out that amount, if it desired. Because banks pay interest to depositors and earn interest on money lent, banks generally do not maintain high excess reserves.

Seigniorage

Revenue raised through an inflation tax (17)

National saving (S) (Saving and net flows of capital and goods, CH 18)

S = Y - C - G National saving is the income of the nation that is left after paying for government purchases and consumption. S = I + NX / S = I + NCO(net foreign investment)

Antonio has saved $4,000 in his checking account. (roles of money, CH 16)

Store of Value (Finally, money acts as a store of value by providing a means of transferring purchasing power from the present to the future. By keeping money in his checking account, Antonio stores wealth until he is ready to make a purchase.)

change due to a quota

Supply of Loanable Funds, Real Interest Rate, National Saving, Net Exports [All no change] When the U.S. government imposes a quota, net exports will rise for any given real exchange rate. This change translates in this model into an increase in the demand for dollars, which leads to an increase in the real exchange rate. Therefore, the dollar has appreciated. (Analyzing the effects of a trade deficit 19)

Federal reserve board of governors ( The Federal Reserve's organization, CH 16)

The Board of Governors has seven members. They are appointed by the president and serve 14-year nonrenewable terms.

Which of the following statements help to explain why, in the real world, the Fed cannot precisely control the money supply? (The reserve requirement, open market operations, and the money supply, CH 16)

The Fed cannot control the amount of money that households choose to hold as currency, The Fed cannot control whether and to what extent banks hold excess reserves. For most of this problem, you should have assumed that households hold money only in demand deposits and that banks do not hold excess reserves. A more realistic model of the banking system would relax both of these assumptions. In practice, banks can hold any level of excess reserves that they choose, much as households can hold as much currency as they like. Since the Fed cannot precisely control the level of excess reserves or the fraction of money households wish to hold as currency, it cannot precisely increase or decrease the money supply. However, it can get pretty close by monitoring the behavior of banks and households and adjusting monetary policy to reflect changes in banks' preferences for excess reserves or households' preferences for currency.

the intersection of the demand and supply curves

The equilibrium real interest rate and quantity of loanable funds are determined by (Effects of a government budget deficit 19)

Pricing foreign goods, CH 18

The nominal exchange rate for the U.S. dollar-euro tells you how many U.S. dollars you must pay to buy EUR 1.00. In this example, the nominal exchange rate for the U.S. dollar-euro is $1.2151, which means that EUR 1.00 is worth about $1.22 in U.S. currency. Therefore, a bookcase that sells for EUR 830 is worth EUR 830× $1.2151/EUR 1.00 =$1,009EUR

price level

The price level (PP) is a measure of the average level of prices in the economy. The value of money (1P1P) is the value of money measured in terms of goods and services. For example, when the price level is 1.33, the value of money is 11.33=0.7511.33=0.75. The following table shows that the value of money declines as the price level rises. That is, as the prices of goods and services rise, the number of goods and services that can be purchased with one dollar declines. The table also shows the positive relationship between the price level and the quantity of money demanded. As the price level rises (and the value of money falls), the typical transaction requires more money, and people will need to hold a larger quantity of money in the form of currency and demand deposits in order to conduct day-to-day transactions. Conversely, as the price level falls (and the value of money rises), the typical transaction requires less money, and people will not need to hold as large a quantity of money to conduct day-to-day transactions. (Money supply, money demand, and adjustment to monetary equilibrium 17)

Which of the following do bankers take into account when determining how to allocate their assets? (bank leverage, CH 16)

The return on each asset When determining how to allocate their assets among reserves, loans, and financial securities, banks must first make sure that their reserves are sufficient to meet the reserve requirement set by their regulators. Bankers can then choose how to allocate the remainder of their assets between holding additional reserves, making loans, and investing in securities. Each one of these asset types comes with a different level of risk and rate of return. Riskier assets tend to yield a higher rate of return; thus, individual banks choose the asset allocation that provides the correct balance of risk and profit. The total size of the monetary base and the total value of liabilities both affect the total value of a bank's assets, but they do not directly influence the manner in which a bank chooses to allocate those assets.

The Federal Reserve's role as a lender of last resort involves lending to which of the following financially troubled institutions?( The Federal Reserve's organization, CH 16)

U.S. banks that cannot borrow elsewhere, The Federal Reserve regulates the U.S. banking system to ensure its health. If a bank finds itself short on cash, with nowhere else to turn, the Fed steps in as a lender of last resort in order to prevent bank failures that might jeopardize the stability of the overall banking system.

Antonio can easily determine that the price of the Super is more than the price of the Duper. (roles of money, CH 16)

Unit of Account (Money acts as a unit of account by providing buyers and sellers a common reference point for valuing goods and services. The fact that the prices of both the Super and the Duper are listed in the same units (dollars) means that Antonio can easily compare the prices of his options.)

Money supply curve

When the Fed fixes the quantity of money, the money supply curve is a vertical line at the quantity it selects—in this case, $3.5 billion. The money demand curve slopes downward, passing through each combination from the table of the value of money and the quantity of money demanded. For example, when the value of money is 1.00, the quantity of money demanded is $1.5 billion. You should have plotted the first point on the money demand curve at the coordinate (1.5, 1.00), the second at (2, 0.75), the third at (3.5, 0.50), and the fourth at (7, 0.25). At the intersection of the money supply and money demand curves, the equilibrium quantity of money is $3.5 billion, the equilibrium value of money (1P1P) is 0.50, and the equilibrium price level is 2.00. (Money supply, money demand, and adjustment to monetary equilibrium 17)

Twin Deficit Problem

When the government experiences a budget deficit, national saving decreases. This leads to a decrease in the supply of loanable funds and an increase in the real interest rate. A higher real interest rate decreases net capital outflow, shifting the supply curve in the foreign-currency exchange market to the left. This causes the real exchange rate to increase and net exports to decrease. Overall, the budget deficit leads to a trade deficit as well. (Effects of a government budget deficit 19)

inflation tax

When the government pays its debts by printing money, the value of money will decline, a phenomenon known as________. By printing money in order to pay its debts, the government effectively taxes anyone who holds money. (Using money creation to pay for government spending 17)

after tax real interest rate equation

after tax nominal interest rate - inflation rate

Suppose the Federal Reserve wants to increase the money supply by $200. Again, you can assume that banks do not hold excess reserves and that households do not hold currency. If the reserve requirement is 10%, the Fed will use open-market operations to ______. (The reserve requirement, open market operations, and the money supply, CH 16)

buy $20 worth of government bonds To increase the money supply, the Fed must buy government bonds. In order to pay for the bonds, the Fed creates money. Its purchase of bonds puts the new money in the hands of the public. Assuming that households do not hold cash, the new money will be placed in demand deposits with banks. At a reserve requirement of 10%, the money multiplier is 10. Therefore, the money supply will grow by 10 times the initial increase in demand deposits from the Fed's open-market purchase. If the Fed buys $20 worth of government bonds, demand deposits and bank reserves will rise by $20. The $20 increase in reserves will support an increase in the money supply of 10×$20=$20010×$20=$200 as banks lend out the excess reserves generated by the Fed's purchase.

budget deficit

his means that national saving will decrease , which leads to a decrease in the supply of loanable funds. (Effects of a government budget deficit 19)

The federal funds rate is the interest rate that banks charge one another for short-term (typically overnight) loans. When the Federal Reserve uses open-market operations to sell government bonds, the quantity of reserves in the banking system ________ , banks' need to borrow from each other______ , and the federal funds rate ________. (The discount rate and the federal funds rate, CH 16)

decreases, rises, increases To reduce the federal funds rate, the Federal Reserve uses open-market operations to buy government bonds from the public. The Federal Reserve's government bonds purchase injects reserves into the banking system. With additional reserves, banks are no longer as close to their required reserve ratio, so the need for banks to borrow from each other declines, pushing the federal funds rate downward. Similarly, the Federal Reserve sells government bonds in order to raise the federal funds rate. The sale of government bonds reduces the quantity of reserves in the banking system, causing banks' need to borrow from each other to rise, pushing the federal funds rate upward.

The Fisher effect

describes the long-run behavior of nominal interest rates and inflation based on the principle of monetary neutrality—the notion that monetary changes do not affect real variables in the long run. In the long run, borrowers and lenders will agree to a new nominal interest rate as their expectations of inflation adjust. (The Fisher effect and the cost of unexpected inflation 17)

PPP exchange rate equation

divide the price in the United States by the price in the other country

Now, suppose that, rather than immediately lending out all excess reserves, banks begin holding some excess reserves due to uncertain economic conditions. Specifically, banks increase the percentage of deposits held as reserves from 10% to 25%. This increase in the reserve ratio causes the money multiplier to ______. Under these conditions, the Fed would need to_______ worth of U.S. government bonds in order to increase the money supply by $200. (The reserve requirement, open market operations, and the money supply, CH 16)

fall to 4, buy $50 Uncertain economic conditions cause banks to hold some excess reserves, increasing the percentage of deposits held as reserves from 10% to 25% and increasing the reserve ratio from 1/10 to 1/4. The money multiplier falls from 10 to 4—the reciprocal of the new reserve ratio (1/4). When banks hold additional reserves, the Fed will have to buy more bonds in order to increase the money supply by a given amount. Specifically, an open-market purchase of $50 worth of bonds (rather than $20) is now required to increase the money supply by $200. When the Fed buys $50 in government bonds, demand deposits and bank reserves rise by $50. With the smaller multiplier, the $50 increase in reserves will support an increase in the money supply of 4×$50=$2004×$50=$200.

National saving is the income of the nation that is left after paying for_____ (Saving and net flows of capital and goods, CH 18)

government purchases and consumption

increase money supply

impacts only the purchasing power of money (including money in non-inflation-adjusted accounts and assets) held while the government is printing money. Since wages tend to rise with the overall price level, nominal wages will rise to reflect changes in the quantity of money, and the purchasing power of earnings will not be affected in the long run.(Using money creation to pay for government spending 17)

Suppose a new customer adds $100 to his account at Northeastern Mutual Bank, which the owners of the bank then use to make $100 worth of new loans. This would increase the loans account and _______. (bank leverage, CH 16)

increase the deposits account Within any balance sheet, the total value of all accounts on the left-hand side (the assets) must equal the total value of all accounts on the right-hand side (the liabilities). An increase in an account on one side must, therefore, lead to a corresponding increase on the opposite side or a decrease in another account on the same side. Thus, when a new customer adds $100 to his account at Northeastern Mutual Bank, which the owners of the bank then use to make $100 worth of new loans, both loans (an asset) and deposits (liability) increase by $100.

Because of the identity equation that relates to net exports, the ______ in U.S. net exports is matched by _______ in U.S. net capital outflow. Which of the following is an example of how the United States might be affected in this scenario? (Net capital outflow and net exports CH 18)

increase, an increase You purchase ARS 900,000 worth of stock in a Argentine corporation, You buy ARS 900,000 worth of Argentine bonds, You exchange the ARS 900,000 for dollars at your local bank, which then uses the foreign currency to purchase Argentine bonds. Because of how net capital outflow and net exports are defined and measured, a change in one term must result in a change in the other for the identity to remain true. In this case, the increase in U.S. net exports is matched by an increase in U.S. net capital outflow. Net capital outflow is defined as the purchase of foreign assets by domestic residents minus the purchase of domestic assets by foreigners. In order for net capital outflow to increase, either the purchase of foreign assets by domestic residents must increase, or the purchase of domestic assets by foreigners must decrease. Your investment abroad in Argentine assets, such as bonds and stocks, increases the purchase of foreign assets by U.S. residents, which causes an increase in the net capital outflow. Alternatively, if you choose to exchange the ARS 900,000 at your local bank, the subsequent purchase of Argentine bonds by the bank is also considered an increase in the purchase of foreign assets by domestic residents and has the same effect as your personally purchasing Argentine bonds or stocks.

If the nominal exchange rate for the U.S. dollar-Japanese yen rises from $0.008538 to $0.0093918 per Japanese yen, the Japanese yen ______ in value, or _____ , relative to the U.S. dollar. (Pricing foreign goods, CH 18)

increases, appreciates The rise in the nominal exchange rate for the U.S. dollar-Japanese yen implies that the Japanese yen increases in value, or appreciates, relative to the U.S. dollar. Whereas it cost about $0.01 to buy JPY 1.00 previously, it now costs about $0.01. The Japanese yen has gained value relative to the U.S. dollar—more dollars are now required to obtain JPY 1.00. This means that the U.S. dollar loses value, or depreciates, relative to the Japanese yen.

The discount rate is the interest rate on loans that the Federal Reserve makes to banks. Banks occasionally borrow from the Federal Reserve when they find themselves short on reserves. A lower discount rate ________ banks' incentives to borrow reserves from the Federal Reserve, thereby ________ the quantity of reserves in the banking system and causing the money supply to______. (The discount rate and the federal funds rate, CH 16)

increases, increasing, rise Banks can borrow funds from the Federal Reserve to make more loans when their own reserves approach the minimum amount allowed by the required reserve ratio. An increase in the discount rate makes borrowing from the Federal Reserve more expensive for banks. Because banks know that lending past the required reserve ratio will be more costly, they will be stingier with their lending, and fewer loans will be made. Fewer loans made means less money is created. A decrease in the discount rate has the opposite effect. Borrowing from the Federal Reserve becomes less expensive, so banks borrow more reserves from the Federal Reserve, increasing the level of reserves in the banking system. The injection of reserves allows banks to make more loans, creating additional money and increasing the money supply.

supply of loanable funds

is derived from national saving (Effects of a government budget deficit 19)

demand for loanable funds

is derived from the sum of domestic investment and net capital outflow (Effects of a government budget deficit 19)

Nominal Interest Rate equation

real interest rate + inflation rate

A lower reserve requirement is associated with a __________ money supply. (The reserve requirement, open market operations, and the money supply, CH 16)

larger The money multiplier is the reciprocal of the reserve ratio. Under the assumption that banks do not hold excess reserves, the reserve ratio will be equal to the reserve requirement set by the Federal Reserve. For a reserve requirement of 25%, the reserve ratio is 1/4, and the multiplier is therefore 4. When the multiplier is 4, a banking system with $500 in reserves can support 4×$500=$2,0004×$500=$2,000 in demand deposits. If the reserve requirement falls from 25% to 10%, the reserve ratio falls from 1/4 to 1/10, and the multiplier rises from 4 to 10. At the lower reserve requirement, the banking system's $500 in reserves supports 10×$500=$5,00010×$500=$5,000 in demand deposits. For a given level of reserves, a higher reserve requirement is associated with a smaller money supply. At the higher reserve requirement, banks must hold a larger fraction of their deposits as reserves. This keeps more reserves away from the money creation process (it keeps new loans from being made, which would lead to more deposits, which would lead to more loans, and so on). Therefore, the higher the reserve requirement, the fewer demand deposits are generated in the money creation process from a given change in reserves.

Real variables

measured in physical units. Any price or wage stated in terms of goods is a real variable. For example, in 2012, the relative price of a donut is 0.6 magazines. (The classical dichotomy and the neutrality of money 17)

velocity of money

measures the number of times the typical unit of currency is used to pay for newly produced goods or services (17)

price of item in other country

multiply the foreign currency price by the exchange rate (Purchasing-power parity 18)

market for foreign currency exchange

net exports = net capital outflow

actual real interest rate equation

nominal interest rate - actual inflation rate

expected real interest rate equation

nominal interest rate - expected inflation rate

New Nominal Interest Rate equation

old nominal interest rate + change in inflation rate

classical dichotomy

separation of real and nominal variables (The classical dichotomy and the neutrality of money 17)

velocity of money equation

velocity = (price level * quantity of output) / quantity of money