unit 7

Balance of payments

Measure of money inflows and outflows between the United States and the rest of the world (ROW) 

• Inflows are referred to as credits
• Outflows are referred to as debits

The balance of payments is divided into 3 accounts

• Current account

• Capital/financial account

• Official reserves account

Double entry bookkeeping

• Every transaction in the balance pf payments is recorded is recorded twice in accordance with standard accounting practice

• Ex. U.S. manufacturer, John Deere, exports $50 million worth of farm equipment to Ireland. 

• A credit of $50 million to the current account (- $50 million worth of farm equipment or physical assets)

• A debit of $50 million to the capital/financial account (+$50 million worth of euros or financial assets)

Current account

Balance of trade or net exports

• Exports of goods/services - import of goods/services

• Exports create a credit to the balance of payments

• Imports create a debit to the balance of payments

Net foreign income 

Income earned by U.S. owned foreign assets - income paid to foreign held by U.S. assets

Ex. Interest payments on U.S. owned Brazilian bonds - interest payments on German owned U.S. Treasury bonds

Net transfers (tend to be unilateral) 

Foreign aid > a debit to the current account

Ex. Mexican migrant workers send money to family in Mexico

Capital/financial accounts

The balance of capital ownership

• Includes the purchase of both real and financial assets
• Direct investment in the United States is a credit to the capital account

• Ex. The Toyota factory in San Antonio

• Direct Investment by U.S. firms/individuals in a foreign country are debits to the capital account

• Ex. The Intel factory in San Jose, Costa Rica

• Purchases of foreign financial assets represents a debit to the capital account

• Ex. Warren Buffet buys stock in Petrochina

• Purchases of domestic financial assets by foreigners represents a credit to the capital account
• The United Arab Emirates sovereign wealth fund purchases a stake in the NASDAQ

Relationship between Current and Capital account

Remember double entry bookkeeping?

• The current account and the capital account should zero each other out
• That is...if the current account has a negative balance (deficit), then the capital account should have a positive balance (surplus). 

Official reserves

• The foreign currency holdings of the United States Federal Reserve System
• When there is a balance pf payments surplus the Fed accumulates foreign currency and debits the balance of payments

Active vs passive official reserves

• The united states is passive in its use of official reserves. It does not seek to manipulate the dollar exchange rate.

• The people's republic of china is active in its use of official reserves. It actively buys and sells dollars in order to maintain a steady exchange rate with the united states. 

• Foreign exchange (FOREX)

• The buying and selling of currency

• Ex. In order to purchase souvenirs in France, it is first necessary for Americans to sell (supply) their dollars and buy (demand) Euros.

• The exchange rate (e) is determined in the foreign currency markets.

• Simply put. The exchange rate is the price of currency. 

• Do not try to calculate the exact exchange rate. 

Tips

• Always change the demand line on the currency graph, the supply line on the other currency's graph.

• Move the lines of the two currency graphs in the same direction (right or left) and you will have the correct answer. 

• If D on one graph increases, S on the other graph decrease

• If D moves to the left, S will move to the left on the other graph. 

Changes in Exchange Rates

• Exchange rates (e) are a function of the supply and demand for currency. 

• An increase in the supply of a currency will make it cheaper to buy one unit of that currency. 

• A decrease in supply of a currency will make it more expensive to buy one unit of that currency

• An increase in demand for a currency will make it more expensive to buy one unit of that currency

• A decrease in demand will make it cheaper to buy one unit of that currency. 

• Appreciation of a currency occurs when the exchange rate pf that currency increases (e ^)

• Hypothetical: 100 yen is used to buy $1. Now 200 yen buys $1

• The dollar is "stronger"

• Depreciation of a currency occurs when the exchange rate of that currency decreases (e decreases)

• One hundred yen used to buy one dollar. Now 50 yen buys one dollar

• The dollar is weaker because it takes fewer yen to buy the dollar.

Exchange rate determinants

Consumer tastes

• Ex. A preference for Japanese goods creates an increase in the demand of yen and an increase in the supply of dollars in the currency exchange market.

• The increase in demand of the yen leads to the appreciation of the yen.

• The increase in the supply of dollars leads to the depreciation of the dollar. 

Relative income

• Imports tend to be normal good

• Ex. If Mexico's economy is becoming stronger and the U.S. Economy is in recession, then Mexicans will buy more American goods.

Relative price level

• Ex. If the price level is higher in Canada than in the United States, then American goods are relatively cheaper than Canadian goods. 

• This Canadians will import more american goods causing the us dollar to appreciate. 

Speculation

• Ex. If Us investors expect that Swiss interest rates will climb in the future, then Americans will demand Swiss francs in order to earn the higher rates of return in Switzerland. 

• This will cause the Swiss franc to appreciate as demand for it will increase. 

• Supply of the dollar will increase causing it to depreciate. 

Balance of Payments

Balance of payments

• Measure of money inflows and outflows between the United States and the rest of the world (ROW) 

• Inflows are referred to ad credits

• Outflows are referred to as debits

• The balance of payments is divided into 3 accounts

• Current account

• Capital/financial account

• Official reserves account

Double entry bookkeeping

• Every transaction in the balance pf payments is recorded is recorded twice in accordance with standard accounting practice
• Ex. U.S. manufacturer, John Deere, exports $50 million worth of farm equipment to Ireland. 
• A credit of $50 million to the current account (- $50 million worth of farm equipment or physical assets)
• A debit of $50 million to the capital/financial account (+$50 million worth of euros or financial assets)

Current account

Balance of trade or net exports

• Exports of goods/services - import of goods/services
• Exports create a credit to the balance of payments
• Imports create a debit to the balance of payments

Net foreign income

• Income earned by U.S. owned foreign assets - income paid to foreign held by U.S. assets
• Ex. Interest payments on U.S. owned Brazilian bonds - interest payments on German owned U.S. Treasury bonds

Net transfers (tend to be unilateral) 

• Foreign aid > a debit to the current account
• Ex. Mexican migrant workers send money to family in Mexico

Capital/financial accounts

• The balance of capital ownership
• Includes the purchase of both real and financial assets
• Direct investment in the United States is a credit to the capital account

• Ex. The Toyota factory in San Antonio

• Direct Investment by U.S. firms/individuals in a foreign country are debits to the capital account

• Ex. The Intel factory in San Jose, Costa Rica

• Purchases of foreign financial assets represents a debit to the capital account

• Ex. Warren Buffet buys stock in Petrochina

• Purchases of domestic financial assets by foreigners represents a credit to the capital account
• The United Arab Emirates sovereign wealth fund purchases a stake in the NASDAQ

Relationship between Current and Capital account

• Remember double entry bookkeeping?
• The current account and the capital account should zero each other out
• That is...if the current account has a negative balance (deficit), then the capital account should have a positive balance (surplus). 

Official reserves

• The foreign currency holdings of the United States Federal Reserve System
• When there is a balance pf payments surplus the Fed accumulates foreign currency and debits the balance of payments

Active vs passive official reserves

• The united states is passive in its use of official reserves. It does not seek to manipulate the dollar exchange rate.
• The people's republic of china is active in its use of official reserves. It actively buys and sells dollars in order to maintain a steady exchange rate with the united states. 

Foreign exchange (FOREX)

• The buying and selling of currency

• Ex. In order to purchase souvenirs in France, it is first necessary for Americans to sell (supply) their dollars and buy (demand) Euros.

• The exchange rate (e) is determined in the foreign currency markets. 
• Simply put. The exchange rate is the price of currency. 
• Do not try to calculate the exact exchange rate. 

Tips

• Always change the demand line on the currency graph, the supply line on the other currency's graph.
• Move the lines of the two currency graphs in the same direction (right or left) and you will have the correct answer. 
• If D on one graph increases, S on the other graph decreases
• If D moves to the left, S will move to the left on the other graph. 

Changes in Exchange Rates

• Exchange rates (e) are a function of the supply and demand for currency. 
• An increase in the supply of a currency will make it cheaper to buy one unit of that currency. 
• A decrease in supply of a currency will make it more expensive to buy one unit of that currency. 
• An increase in demand for a currency will make it more expensive to buy one unit of that currency.
• A decrease in demand will make it cheaper to buy one unit of that currency. 

Appreciation of a currency occurs when the exchange rate pf that currency increases (e ^)

• Hypothetical: 100 yen is used to buy $1. Now 200 yen buys $1. 
• The dollar is "stronger". 

Depreciation of a currency occurs when the exchange rate of that currency decreases (e decreases)

• One hundred yen used to buy one dollar. Now 50 yen buys one dollar.
• The dollar is weaker because it takes fewer yen to buy the dollar.

Exchange rate determinants

• Consumer tastes

Ex. A preference for Japanese goods creates an increase in the demand of yen and an increase in the supply of dollars in the currency exchange market.

The increase in demand of the yen leads to the appreciation of the yen.

The increase in the supply of dollars leads to the depreciation of the dollar. 

• Relative income

Imports tend to be normal goods

Ex. If Mexico's economy is becoming stronger and the U.S. Economy is in recession, then Mexicans will buy more American goods.

• Relative price level

Ex. If the price level is higher in Canada than in the United States, then American goods are relatively cheaper than Canadian goods. 

This Canadians will import more american goods causing the us dollar to appreciate. 

• Speculation

Ex. If Us investors expect that Swiss interest rates will climb in the future, then Americans will demand Swiss francs in order to earn the higher rates of return in Switzerland. 

This will cause the Swiss franc to appreciate as demand for it will increase. 

Supply of the dollar will increase causing it to depreciate. 

Phillips Curve

Phillip's curve

Short run

• Represents the relationship between employment and inflation
• Trade off between inflation and unemployment that only occurs in the short run 
• There is an inverse relationship between unemployment and inflation 
• Has relevance to Okun's law. 
• Since wages are sticky, inflation changes, move the points on the SRPC
• If inflation persists and the expected rate of inflation rises, then the entire SRPC moves upward due to stagflation 
• If inflation expectations drop, due to new technology or economic growth, then the SRPC moves downward 

Long run

• Long run Phillips curve occurs at the natural rate of unemployment  
• Represented by a vertical line
• No trade off between unemployment and inflation in the long run, which means that the economy produces at the full employment level 
• Will only shift if the LRAS curve shifts
• Structural, seasonal, and frictional unemployment 
• Full employment is around 4-5% 
• Major LRAC assumption is that more worker benefit create higher natural rates. Fewer worker benefits create lower natural rates. 
• Whatever shifts PPC, will shift LRAS

• Aggregate supply shocks cause both the rate of inflation and the rate of unemployment to increase (rapid and significant increase in resource cost)

The long-run Phillips curve (LRPC)

• Because the long-run Phillips curve exists at the natural rate of unemployment (Un), structural changes in the economy that affect Un will also affect cause the LRPC to shift.
• Increases in Un will shift LRPC >
• Decreases in Un will shift LRPC <
• Increase in AD = up/left movement along SRPC
• Decrease in AD = down/right along SRPC
• SRAS > = SRPC < 
• SRAS < = SRPC > (stagflation) 

Stagflation 

• When inflation and unemployment increase simultaneously
• Baby boom 1946-1964
• Women's movement 
• Civil rights movement
• Vietnam war ends
• All embargo of 1973 and 1979

Disinflation

• Reduction in the inflation rate from year to year 
• Occurs when aggregate demand declines

Deflation

• General drop in the price level

Misery index 

• Combination of inflation and unemployment in any given year single digit misery is good

Supply side economics

• Belief that the AS curve will determine levels of inflation, unemployment, and economic growth 
• To increase the economy the AS curve will have to shift to the right which will benefit the company first
• Supply side economists focus on marginal tax rates 
• Amount paid on the last dollar earned, or on each additional dollar earned
• Lower taxes are incentives for businesses to invest in our economy
• Lower taxes are incentives for workers to work more and harder, thereby becoming more productive 
• Lower taxes are incentives for people to increase savings and therefore create lower interest rates which will increase business investment
• Supply side economists support policies that promote GDP growth by arguing that high marginal tax rates along with our current system pf transfer payments such as unemployment compensation or welfare programs provide disincentives to work, invest, innovate, and undertake entrepreneur ventures 

Reaganomics 

• Lowered the marginal tax rate to get the U.S. out of a recession 
• Deficit

Laffer curve

• Trade off between tax rates and government revenue
• Used to support the supply side argument 
• As tax rates increase from 0, tax revenues increase from 0 to some maximum level and then decline 

Progressive tax rate

• Increases per year
• 37% breakoff point
• No point in working if there are more taxes

3 criticisms

1. Research suggests that the impact of tax rates on incentives to work, invest, and to save are small

2. Tax cuts also increase demand which can fuel inflation and it causes demand to exceed supply

3. Where the economy is actually located on the curve is yet to be determined

Revisiting AD and AS

Revisiting AD/AS 

Short run aggregate supply 

• Time is too short for wages to adjust to the price level 
• Workers may not be aware of changes in their real wages due to inflation and have adjusted their labor supply decisions and wage demands accordingly 
• Fixed contract, no pay increase

Ranges

• Horizontal/Keynesian
• Intermediate
• Vertical/classical 

Wages

• Nominal wage
• Amount of money received per hour per day or per year
• Sticky wages
• Where the nominal wage level is set according to an initial price level, and it does not vary

Levels

Keynesian

• Price level is fixed
• Wage level is fixed
• unemployment level is flexible
• (Output depends on changes in employment)

Intermediate

• Price level is flexible
• Wage level is fixed
• Employment level is flexible
• (Output depends upon changes in price level and employment) 

Classical

• Price level is flexible
• Wage level is foxed
• Employment level is fixed
• (Output depends on changes in proce level) 

Long run aggregate supply

• Flexible wage and price level 
• They offset each other
• Shifts are connected to the PPC graph
• Time is long enough for wages to adjust to the price level
• Growth in some format, technological change, capital stock gains (shifts) 

Demand pull inflation

• Pulling something towards you
• AD will increase

Cost push inflation

• Pushing something away
• Decrease production 

Recession

• Not going to be spending
• AD is decreasing 

Economic growth

• Prices are going to be going up
• AD is decreasing

AP ECONOMICS VIDEO

Video 6

http://www.youtube.com/watch?v=k37Y6BKcpsY&feature=bf_next&list=PL2CB281D126F65E26&lf=results_video

         In the 6th video, the discussed about money market, loanable funds, and the AD-AD graphs. They should all be side by side in order to see the change in demand or supply. The MV should always be equal to PQ. Increasing interest rate drives an increase in price level, they call this the fisher effect. The walker effect explains how for every cookie you eat, thats one less cookie.

Video 5

http://www.youtube.com/watch?v=1tUC59pz95I&feature=bf_next&list=PL2CB281D126F65E26&lf=results_video

         In the 5th video , they discussed about the Money Creation Process. The way banks create money is by making loans. Multiplier and multiplier desposit expansion both fall under the creating process. Reserve Ratio is the percentage of banks total requirments. The process of the multiple deposits is to add up all the potential loans. But this is only an assumption, from all the banks thats have no excess reserves.