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Lernmaterialien für OEM an der Universität Konstanz

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TESTE DEIN WISSEN

What is Ricardian equivalence?

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TESTE DEIN WISSEN

Equivalent economic outcomes (consumption/savings choices) can be expected if we use any arbitrary combination to finance government expenditure

Lösung ausblenden
TESTE DEIN WISSEN

What is the IMF’s view on capital flow liberalization?

 

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TESTE DEIN WISSEN
  • It has numerous advantages like:
    1. It enhances the efficiency of resource allocation and the competitiveness of the domestic financial sector
    2. Transfer of technology and management practices through foreign direct investment
    3. Improvement of macroeconomic policy discipline and intensity of trade 
    4. Enablement of welfare-improving current account imbalances which could finance higher investment or smooth consumption 
  • But also, some disadvantages like:
    1. Debt-creating capital flows which might be problematic for a country running a continuous and large CA deficit. If debt is nominated in foreign currency, valuation changes like a depreciation of the domestic currency could be very costly (FDIs always considered positively)
    2. Sudden stops, capital flow reversals, currency crisis 
Lösung ausblenden
TESTE DEIN WISSEN

What is illustrated by "Iceberg Shipping costs"?

Lösung anzeigen
TESTE DEIN WISSEN
  • They illustrate that 
    1. The law of one price and the PPP can be violated due to transaction/transportation costs 
    2. this indicates that the real exchange rate is bounded in a corridor which takes those costs into account
    3. if this corridor is systematically surpassed, infinite profits would be possible by exchanging currencies and importing/exporting goods
Lösung ausblenden
TESTE DEIN WISSEN

What is the Balassa-Samuelson effect?

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TESTE DEIN WISSEN
  • It explains why the PPP may not always hold and why prices in poorer countries are lower in real terms than in richer countries. It also makes predictions how real exchange rates evolve over time
  • Because we can distinguish between tradable and non-tradable goods we can state that marginal productivity differences for non-tradables are low (hairdressers) in contrast to high marginal productivity differences for tradables (engineers) between two countries (rich & poor)
  • Because we assume labor as the only production factor to be mobile across sectors, wages in both sectors must be equal in one country; implying that the price level in the non-tradable goods sector in the developed country is higher (in real terms) than the respective price level abroad
  • The higher GDP growth rate of developing countries is thus typically driven by improving its productivity in the sector for tradable goods rather than for non-tradables
    1. This then leads to a stronger price increase in the sector of non-tradable goods than for tradables 
    2. In the Eurozone, this had led to a relatively higher inflation in countries with low price levels in the services sector which is of course problematic for those poorer countries 
  • Summary: 
    1. The Balassa-Samuelson effect says that because productivity in the tradable goods sector in developed countries is higher, the overall wage level is also higher which induces a higher overall price level for developed countries even though productivity in the services/non-tradable sector is similar everywhere in the world
    2. The ability of the BS effect to explain exchange rate fluctuations is mixed. It is indeed helpful, but the problem is that the law of one price is also violated for tradable goods in reality 
    3. The BS effect can still very well explain differences in the price levels between poorer and richer countries 
Lösung ausblenden
TESTE DEIN WISSEN

Explain how the TNT model determines the trade defecit

Lösung anzeigen
TESTE DEIN WISSEN
  • Like in the BS, we distinguish between tradanle and non-tradable goods to make inference about changes in the real exchange rate between two coutntries. The key difference to the BS model is that the marginal productivity of labor is no longer constant but decreasing 
  • First, firms make their decison about the quantities of goods they want to produce, keeping in mind that marginal productivity of ecah good is decreasing and wages in both sectors are identical. This gives the pridction posssibilty curve which is strictly concave (slope=quotient of marginal productivities for a given input). The output of nontradables is increasing if the ratio of relative prices between non-tradables and tradables is increasing and the optimal output ratio is given where the quotient of marginal productivities of tradables to nontradables is equal to the ratio of relative prices between non-tradables and tradables 
  • We assume homoethic preferences, meaning that if relative prices do not change, a increase in income leads to the same consumption ratio simply with higher quantities
  • We know that as a market clearing condition, consumption of non-tradables has to be equal to the production of non-tradables and thus the consumption of tradables is quantity of non-tradables produced multiplied by the ratio of consumption of tradables to non-tradables
  • The (negative) trade balance is then given by the consumption of tradables which we could determine minus the quqntitiy of tradables produced. Note that the trade deficit is thus only a function of the relative prices (of one single period) and the trade balance decreases strictly with the ratio of relative prices between non-tradables and tradables because the output of tradables increase and the consumption of tradables decrease when the price of tradabkes increase and this increases the trade balance
  • The price level is a function of the ratio of the relative prices and the real exhange rate increases if the ratio increases, meaning that the currency appreaciates for an increase in the price of non-tradables of a country (foreigners have to pay relatively more for a haircut --> I get less dollar for a euro)
Lösung ausblenden
TESTE DEIN WISSEN

​Explain the effects of an increase in the ratio of prices of non-tradables to tradables

Lösung anzeigen
TESTE DEIN WISSEN

If the ratio increases (p_Nt/P_Tt)

  • The production of non-tradables increases because a higher price makes production more profitable. As a consequence, consumption of non-tradables also increases due to market-clearing conditions
  • The production of tradables decreases because a lower price makes production less profitable compared to non-tradables. This directly increases the trade deficit because less can be exported
  • The consumption of tradables increases because a comparably lower price makes tradables more attractive. However, those have to be imported if at the same time production of those goods shrinks and thus the trade defict increses
  • A relative increase in the prices of non-tradables means an increase in the domestic price level and thus directly lead to an increase of the real exchange rate because as a resident, I suddenly get more for one unit of money if I go abroad 
  • This we can conclude that an appreciation of the real exchange rate must lead to an increase in the trade defecit because more goods will be imported and less goods will be exported 
Lösung ausblenden
TESTE DEIN WISSEN

What is the Marshall-Lerner condition and the J-Curve?

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TESTE DEIN WISSEN

Accoring to the TNT model, an appreciation of the domestic currency leads to a deterioration of the trade balance, because more goods will be imported and less exported. Accoring to the ML condition, this is true in the long-term, however in the short-term, the trade balance might even improve as the price of the importabales vecomes cheaper if our currency appreciates. In the long-term, quantities adjust and the trade balance will effectively decrease, which is also illustrated by the J-Curve

Lösung ausblenden
TESTE DEIN WISSEN

How can a large open economy influence world interest rates?

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TESTE DEIN WISSEN

If a large economy increases its demand for consumption, i.e., increases its CA deficit, the world financial market faces an additional demand which moves interest rates up. On the contrary, a higher interest rate will increase the CA surplus 

Lösung ausblenden
TESTE DEIN WISSEN

Can a country run a negative trade balance forever?

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TESTE DEIN WISSEN
  • This depends on the sign of a country's initial NIIP and the assumption that the transversality condition holds
    • A negative net international investment position means that the country is a debtor to the rest of the world. This means the country must generate trade balance surpluses either currently or at some point in the future to service its foreign debt because no country is willing to be a lender at the end of the world
    • Similarly, a positive net international investment position means that the country is a net creditor of the rest of the world. The country can therefore afford to run trade balance deficits forever and finance them with the interest revenue generated by its credit position with the rest of the world, however not arbitrary large. 


  • Because the United States is currently a net foreign debtor to the rest of the world, it follows from this analysis that it will have to run trade balance surpluses at some point in the future. This result extends to economies that last for any number of periods, not just two. 
  •  For infinite-horizon economies, perpetual current account deficits are possible even if the country is an external debtor, if the economy is growing and dedicates a growing amount of resources to pay interest on the debt.
Lösung ausblenden
TESTE DEIN WISSEN

What is the intuition behind the Dornbusch overshooting model?

Lösung anzeigen
TESTE DEIN WISSEN
  • The model wants to explain why nominal exchange rates can heavily fluctuate by assuming than prices of goods adjust slowly and the covered/uncovered interest parity holds
  • Suppose there is a unexpected permanent increase in the money supply and prices don’t adjust instantly. This has several effects in the short-and the long-run
  • In the long-run
    1. real money supply is the same as before because prices will adjust
    2. the nominal exchange rate will depreciate and then stay on a constant level
  • In the short run
    1. The nominal exchange rate will depreciate even further than in the long run to come up for an expected increase in the nominal exchange rate
    2. The exchange rate is expected to appreciate because the domestic interest rate has to decrease if money supply increases. If the uncovered interest parity holds, a decrease in the domestic interest must be followed by an expected increase in the exchange rate 
  • Compared to the monetary approach the exchange rate reacts more strongly to a change in the quantity of money
Lösung ausblenden
TESTE DEIN WISSEN

What is the n-1 problem of fixed exchange rate regimes?

Lösung anzeigen
TESTE DEIN WISSEN
  • In the presence of fixed exchange rates between n countries, it is sufficient that one country (which is large enough) changes its monetary policy and consequently, all other countries have to follow to keep exchange rates constant
    • If one CB tightens the money supply, real interest rates will rise, and this will lead to a capital inflow in this country and thus to an excess demand for this country’s currency 
    • the other countries must do the same to restore the equilibrium and to appreciate their currencies (which decreases exports)
  • Are there alternatives to keep the exchange rate fixed and maintain monetary power?
    1. Yes, as the CB can buy arbitrary amounts of foreign currency (but only sell as longs as they have foreign reserves)
    2. This means the CB can, if there is an excess demand of domestic currency, prevent the currency always from appreciating by buying foreign currency while it cannot always prevent depreciation

 

Lösung ausblenden
TESTE DEIN WISSEN

Explain the Feldstein-Horioka puzzle

Lösung anzeigen
TESTE DEIN WISSEN
  • According to FH, savings shoks have no impact on investments in an economy  because the country can borrow from abroad and would just deteriorate their CA balance. 
  • Their suggestion is in line with our model of a small open economy with production because firms decisions to produce solely depends on the interest rate and not on a change in savings and consumption decisons from the households, thus only the CA is affected by a change in savings 
  • Here lies the problem of the FH approach because only a savings shock (discount factor shock) for small economies is meaningful because an increase in savings for large economies lead to a decrease of the world interest rate which in turn leads to an increase in investments despite the country being open. It is thus a bad measure of capital mobility beacsue savings and investements can move at the same time 
Lösung ausblenden
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Q:

What is Ricardian equivalence?

A:

Equivalent economic outcomes (consumption/savings choices) can be expected if we use any arbitrary combination to finance government expenditure

Q:

What is the IMF’s view on capital flow liberalization?

 

A:
  • It has numerous advantages like:
    1. It enhances the efficiency of resource allocation and the competitiveness of the domestic financial sector
    2. Transfer of technology and management practices through foreign direct investment
    3. Improvement of macroeconomic policy discipline and intensity of trade 
    4. Enablement of welfare-improving current account imbalances which could finance higher investment or smooth consumption 
  • But also, some disadvantages like:
    1. Debt-creating capital flows which might be problematic for a country running a continuous and large CA deficit. If debt is nominated in foreign currency, valuation changes like a depreciation of the domestic currency could be very costly (FDIs always considered positively)
    2. Sudden stops, capital flow reversals, currency crisis 
Q:

What is illustrated by "Iceberg Shipping costs"?

A:
  • They illustrate that 
    1. The law of one price and the PPP can be violated due to transaction/transportation costs 
    2. this indicates that the real exchange rate is bounded in a corridor which takes those costs into account
    3. if this corridor is systematically surpassed, infinite profits would be possible by exchanging currencies and importing/exporting goods
Q:

What is the Balassa-Samuelson effect?

A:
  • It explains why the PPP may not always hold and why prices in poorer countries are lower in real terms than in richer countries. It also makes predictions how real exchange rates evolve over time
  • Because we can distinguish between tradable and non-tradable goods we can state that marginal productivity differences for non-tradables are low (hairdressers) in contrast to high marginal productivity differences for tradables (engineers) between two countries (rich & poor)
  • Because we assume labor as the only production factor to be mobile across sectors, wages in both sectors must be equal in one country; implying that the price level in the non-tradable goods sector in the developed country is higher (in real terms) than the respective price level abroad
  • The higher GDP growth rate of developing countries is thus typically driven by improving its productivity in the sector for tradable goods rather than for non-tradables
    1. This then leads to a stronger price increase in the sector of non-tradable goods than for tradables 
    2. In the Eurozone, this had led to a relatively higher inflation in countries with low price levels in the services sector which is of course problematic for those poorer countries 
  • Summary: 
    1. The Balassa-Samuelson effect says that because productivity in the tradable goods sector in developed countries is higher, the overall wage level is also higher which induces a higher overall price level for developed countries even though productivity in the services/non-tradable sector is similar everywhere in the world
    2. The ability of the BS effect to explain exchange rate fluctuations is mixed. It is indeed helpful, but the problem is that the law of one price is also violated for tradable goods in reality 
    3. The BS effect can still very well explain differences in the price levels between poorer and richer countries 
Q:

Explain how the TNT model determines the trade defecit

A:
  • Like in the BS, we distinguish between tradanle and non-tradable goods to make inference about changes in the real exchange rate between two coutntries. The key difference to the BS model is that the marginal productivity of labor is no longer constant but decreasing 
  • First, firms make their decison about the quantities of goods they want to produce, keeping in mind that marginal productivity of ecah good is decreasing and wages in both sectors are identical. This gives the pridction posssibilty curve which is strictly concave (slope=quotient of marginal productivities for a given input). The output of nontradables is increasing if the ratio of relative prices between non-tradables and tradables is increasing and the optimal output ratio is given where the quotient of marginal productivities of tradables to nontradables is equal to the ratio of relative prices between non-tradables and tradables 
  • We assume homoethic preferences, meaning that if relative prices do not change, a increase in income leads to the same consumption ratio simply with higher quantities
  • We know that as a market clearing condition, consumption of non-tradables has to be equal to the production of non-tradables and thus the consumption of tradables is quantity of non-tradables produced multiplied by the ratio of consumption of tradables to non-tradables
  • The (negative) trade balance is then given by the consumption of tradables which we could determine minus the quqntitiy of tradables produced. Note that the trade deficit is thus only a function of the relative prices (of one single period) and the trade balance decreases strictly with the ratio of relative prices between non-tradables and tradables because the output of tradables increase and the consumption of tradables decrease when the price of tradabkes increase and this increases the trade balance
  • The price level is a function of the ratio of the relative prices and the real exhange rate increases if the ratio increases, meaning that the currency appreaciates for an increase in the price of non-tradables of a country (foreigners have to pay relatively more for a haircut --> I get less dollar for a euro)
Mehr Karteikarten anzeigen
Q:

​Explain the effects of an increase in the ratio of prices of non-tradables to tradables

A:

If the ratio increases (p_Nt/P_Tt)

  • The production of non-tradables increases because a higher price makes production more profitable. As a consequence, consumption of non-tradables also increases due to market-clearing conditions
  • The production of tradables decreases because a lower price makes production less profitable compared to non-tradables. This directly increases the trade deficit because less can be exported
  • The consumption of tradables increases because a comparably lower price makes tradables more attractive. However, those have to be imported if at the same time production of those goods shrinks and thus the trade defict increses
  • A relative increase in the prices of non-tradables means an increase in the domestic price level and thus directly lead to an increase of the real exchange rate because as a resident, I suddenly get more for one unit of money if I go abroad 
  • This we can conclude that an appreciation of the real exchange rate must lead to an increase in the trade defecit because more goods will be imported and less goods will be exported 
Q:

What is the Marshall-Lerner condition and the J-Curve?

A:

Accoring to the TNT model, an appreciation of the domestic currency leads to a deterioration of the trade balance, because more goods will be imported and less exported. Accoring to the ML condition, this is true in the long-term, however in the short-term, the trade balance might even improve as the price of the importabales vecomes cheaper if our currency appreciates. In the long-term, quantities adjust and the trade balance will effectively decrease, which is also illustrated by the J-Curve

Q:

How can a large open economy influence world interest rates?

A:

If a large economy increases its demand for consumption, i.e., increases its CA deficit, the world financial market faces an additional demand which moves interest rates up. On the contrary, a higher interest rate will increase the CA surplus 

Q:

Can a country run a negative trade balance forever?

A:
  • This depends on the sign of a country's initial NIIP and the assumption that the transversality condition holds
    • A negative net international investment position means that the country is a debtor to the rest of the world. This means the country must generate trade balance surpluses either currently or at some point in the future to service its foreign debt because no country is willing to be a lender at the end of the world
    • Similarly, a positive net international investment position means that the country is a net creditor of the rest of the world. The country can therefore afford to run trade balance deficits forever and finance them with the interest revenue generated by its credit position with the rest of the world, however not arbitrary large. 


  • Because the United States is currently a net foreign debtor to the rest of the world, it follows from this analysis that it will have to run trade balance surpluses at some point in the future. This result extends to economies that last for any number of periods, not just two. 
  •  For infinite-horizon economies, perpetual current account deficits are possible even if the country is an external debtor, if the economy is growing and dedicates a growing amount of resources to pay interest on the debt.
Q:

What is the intuition behind the Dornbusch overshooting model?

A:
  • The model wants to explain why nominal exchange rates can heavily fluctuate by assuming than prices of goods adjust slowly and the covered/uncovered interest parity holds
  • Suppose there is a unexpected permanent increase in the money supply and prices don’t adjust instantly. This has several effects in the short-and the long-run
  • In the long-run
    1. real money supply is the same as before because prices will adjust
    2. the nominal exchange rate will depreciate and then stay on a constant level
  • In the short run
    1. The nominal exchange rate will depreciate even further than in the long run to come up for an expected increase in the nominal exchange rate
    2. The exchange rate is expected to appreciate because the domestic interest rate has to decrease if money supply increases. If the uncovered interest parity holds, a decrease in the domestic interest must be followed by an expected increase in the exchange rate 
  • Compared to the monetary approach the exchange rate reacts more strongly to a change in the quantity of money
Q:

What is the n-1 problem of fixed exchange rate regimes?

A:
  • In the presence of fixed exchange rates between n countries, it is sufficient that one country (which is large enough) changes its monetary policy and consequently, all other countries have to follow to keep exchange rates constant
    • If one CB tightens the money supply, real interest rates will rise, and this will lead to a capital inflow in this country and thus to an excess demand for this country’s currency 
    • the other countries must do the same to restore the equilibrium and to appreciate their currencies (which decreases exports)
  • Are there alternatives to keep the exchange rate fixed and maintain monetary power?
    1. Yes, as the CB can buy arbitrary amounts of foreign currency (but only sell as longs as they have foreign reserves)
    2. This means the CB can, if there is an excess demand of domestic currency, prevent the currency always from appreciating by buying foreign currency while it cannot always prevent depreciation

 

Q:

Explain the Feldstein-Horioka puzzle

A:
  • According to FH, savings shoks have no impact on investments in an economy  because the country can borrow from abroad and would just deteriorate their CA balance. 
  • Their suggestion is in line with our model of a small open economy with production because firms decisions to produce solely depends on the interest rate and not on a change in savings and consumption decisons from the households, thus only the CA is affected by a change in savings 
  • Here lies the problem of the FH approach because only a savings shock (discount factor shock) for small economies is meaningful because an increase in savings for large economies lead to a decrease of the world interest rate which in turn leads to an increase in investments despite the country being open. It is thus a bad measure of capital mobility beacsue savings and investements can move at the same time 
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