Eco 001 Important concepts and Terms
Eco 001 Important concepts and Terms ECO001
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Econ Final Exam Study Guide CHAPTER 9 Most important instrument of monetary policy purchasesale of gov securities For fed short term securities issued by the US treasury in order to nance the governments budget de cit Open market securities bc Fed normally buys them in public markets that are open to traders of all kinds increase in reserve deposits is shown on the left hand side of banking sectors t account and the right hand side of the feds t account banks take advantage of new reserves to make additional loans and the money stock will expand further as the banks create additional deposits through lending the reserve ratio decreases When borrowers withdraw part of the loan proceeds as currency total bank reserves decrease and the reserve ratio falls further When the reserve ratio reaches its target expansion of the money stock ceases when the fed makes an outright purchase of securities from a dealer the effect on the monetary base and the money stock will be permanent repurchase agreement the fed agrees to sell the securities back to the dealer for an agreed price at some speci c date in the future small day to day adjustments once repurchase is completed the effects end federal funds market a market in which banks lend reserve to one another for periods as short as 24 hours federal funds rate the interest rate on overnight loans of reserves from one bank to another borrowing and lending of reserves through the federal funds market had no effect on total bank reserves discount window the department through which the federal reserve lends reserves to banks borrowing from the fed 1 primary credit banks that are fundamentally healthy but which nd themselves temporarily short of reserves because of unexpected withdrawals a discount rate the interest rate charged by the fed on loans of reserve banks 2 troubled banks also ask for loans a lowering the rate to encourage more borrowing Emergency Economic stabilization act of 2008 the fed has the power to pay interest on reserves the banks keep on deposit with the fed increase banks desired holding of excess reserves increase their target ratio of reserves to deposits reduce the money multiplier banks create less money for each dollar of monetary base Changes in required reserve ratios are a third potential policy instrument that central banks can use to control the money stock Money stock Monetary base x 1CURRESCUR The money multiplier as a whole decreases when RES increases That causes the money stock to decrease for any given level of monetary base FED and Treasury can buy and sell assets denominated in foreign currency the effects on monetary base of buying foreign assets is the same as domestic open market purchases purchases and sales of foreign assets tend to affect the exchange rates Changing market conditions can cause the money multiplier to vary the amount of currency a rms and households want to hold per dollar of deposits varies according to the season of the year 1 example the target reserve ratio can also be affected by changing conditions in nancial markets an increase in market interest rates tends to decrease the TRR and increase the money multiplier CH11 349 Stability and prosperity are the twin goals of macroeconomic policy Lags unavoidable delays in the execution of monetary or scal policy 2 lags 1 inside lags delays between the time a problem develops and the time a decision is taken to do something about it some arise because of the time required to collect and report economic data the biggest problem is because of data on GDP available quarterly All macro economic data are in uenced by random events and measurement errors that cause unpredictable ups and downs in monthly or quarterly indicators takes several observations to make a sound policy the time needed to take decisions ST effects of change on interest rate takes 1 year LT effects of change of interest rates takes 3 years or longer Accurate forecasts GDP predictions for a year ahead on wrong on average 1 percentage point What causes reduction of accuracy in forecasts 1 forecasters themselves face problem of lags in data collection 2 the real world economy is much more complex than models 3 forecasts may be biased towards optimism so they don t have to deliver bad news Time inconsistency tendency of policymakers to take actions that have desirable results in the short run but undesirable results in the long run just before an election is not a good time to begin an episode of anti in ationary policy When all combined 2 types of danger 1 because of lags and forecasting errors there is a danger that expansionary or contraction policy will be applied to late in the business cycle a economy could overshoot in ation and unemployment targets at both ends of the business cycle 2 when time inconsistency is added to lags and forecasting errors there many be a bias towards expansion and in ation 2 outside lags delays between the time a decision is taken and the time the resulting policy action affects the economy Policy rules a set of rules for monetary and scal policy that specifies in advance the actions that will be taken in response to economic developments as they occur Instruments targets and goals of economic policy Policy instrument a variable directly under the control of policymakers Operating target a variable that responds immediately to the use of a policy instrument Intermediate Target variable that responds to the use of a policy instrument or a change in operating target with a signi cant lag Policy goal long run objective of economic policy that is important for economic welfare the link between the operating target of steady money growth and the policy goals of stability and full employment can be expressed by means of the equation of exchange MVPQ In ation targeting a stabilization strategy based on a target range for the rate of in ation The money growth target promotes the long term price stability only if both velocity V and growth rate of real output Q are STABLE If either or both are subject to unpredictable changes even a steady rate of money growth could lead to undesired in ation or de a on The idea of in ation targeting is that policy makers can guard against these sources of instability by using the rate of change of the price level P as their target rather than the rate of growth of money M In ation responds to policy actions only after a lag of up to several years 3 rates involved in interest rateoperating target administrative rates set by central bank 1 discount rate rate central banks charger for reserves that it loans to commercial banks 2 the rate paid on reserves that commercial banks keep on deposit with the central bank 3 interest rate on interbank loans of reserves that commercial banks make to one another Federal Funds rate the lower the interest rate the lower the opportunity cost of holding reserves so greater quantity of reserves demanded The central bank sets a minimum required level of reserves Demand curve becomes vertical as it approaches the minimum required of reserves Becomes horizontal as it approaches the central banks deposit rate 1 fed sets the discount rate and deposit rate They create a corridor within which supply and demand conditions will determined the federal funds rate 2 fed sets an operating target for the federal funds rate the fed tolerates brief moves byt if it moves more than a little it uses open market operations to adjust fed uses forecasting model to predict how a given interest rate target will affect the rest of the economy 1 fed sets intermediate target rate for in ation 2 establish a target range and aim to stay within other strategies target core in ation which means a rate of in ation that omits changes in some of the most variable prices like food and energy Taylor Rule a rule that adjusts monetary policy according to changes in the rate of in ation and the output gap for unemployment CH9 APPENDIX Traditional business model emphasizes pro ts earned by charging interest rates on loans that are higher than those paid on deposits Originate to hold model a model of banking that emphasized making loans and then olding the loans until maturity lemon loan that looks good on paper but is really at risk of going soun RISKS OF BANKING 1 credit risk a the possibility that borrowers will not be able to repay their loans on time or in full b banks list loans as assets on their balance sheets based on the assumption that they will be repaid i the value of the asset decreases as people don t make payments ii liabilities remain the same and capital decreases c insolvent a state of affairs in which the net worth capital of a bank or business falls to 0 2 market risk a any change in market conditions that causes a loss of value of assets or an increase in the burden of liabilities i ex Changes in interest rates ii why banks must maintain an adequate cushion of capital 3 liquidity risk a liquid it can be used directly as a means of payment or easily converted to cash without loss of nominal value b liquidity an assets ability to be used directly as a means of payment or to be readily converted into one while retaining a xed nominal value c the risk occurs when circumstances force banks to sell illiquid assets like bonds or loans at a price lower than their value as stated on the balance sheet d also refusal of other banks to continue supplying the borrowed funds that in addition to deposits appear on the balance sheet as liabilities e Also possibility that a bank may quickly need to raise funds to make a new loan to a valued customer or meet some other contractual commitment to make loans or buy assets Ways to help reserves cash I bank vaults and banks deposits with the federal reserve system Maintain good relations with other banks and non bank lenders from which cash can quickly be borrowed when the need arises Originate to distribute a model of banking that emphasizes the sale of loands soon after they are made and use of the proceeds from the sale to make new loans 1 because banks can turn over money faster they can originate more laons i they can earn more income fro fees to supplement their traditional income from the spread between interest rates on loans and those on deposits 2 the originate to distribute model give banks a new tool for managing credit risk 3 the originate to distribute model bene ts bank customers by making a much larger volume of credit available a because loans are quickly moved off their books less capital is tied up and total lending expands Securitization a process In which a specialized nancial intermediary assembles a large pool of loans or other assets and uses those loans as a basis for issuing its own securities for sale to investors Step 1 to form a specialized nancial intermediary whose job is to act a go between to facilitate the sale of the loan to potential investors Government sponsored enterprisesGSEs privately owned institutions but backed and partially controlled by government Step 2 the purchase by the intermediary of a pool of assets Step 3 intermediary to issue securities backed by the income from the pool or mortgages that are then sold to investors no single investor gets stuck with the lemon tranche each type of security issued senior tranches investors who buy them get rst wins and last to receive losses low tolerance for risk junior tranches rst in line to bear losses and last in line to receive wins high tolerance for risk the rating agencies analyze the likely risks and rewards of each tranche of securities and give them ratings like AAA C to show low medium or high risk credit default swap an arrangement in which one party buys protection against the risk of default on a bond by paying an agreed premium to another party the seller of protection in return for which the protection in return for which the protection seller agrees to compensate the protection buyer if the bond is not paid in full and on time If bond turns out to be good protecting seller pro ts from premium lf bonded faults compensation is paid to the protection buyer and the loss is borne by the protection seller Subprime mortgages mortgages with features like low down payments variable interest rates and prepayment penalties that make them attractive to low income borrowers 3 major features 1 required low down payments 2 variable interest rates that keep mortgage payments affordany low for the rst 2 or 3 years of the mortgage and then increased higher after the owner had a chance to accumulate some equity 3 included prepayment penalties to discourage borrowers from taking advantage of low interest rates and then reselling before high rates a consumer credit in the form of mortgages credit cards and home equity loans became so easy to get households stopped saving if one bank fais all banks hurt gambling with other peoples money principal agent problem duciary duty to choose the strategy that maximizes pro t for shareholders protecting banks 1 Bank supervision and Regulation a The oldest tool b Federal of cials are intended to ensure that banks do not make unduly risky loans and value their assets honestly and maintain adequate levels of new worth and liquidity and have competent management 2 Loans to troubled banks and a The fed has the power to aid the banking system in times of trouble by acting as a lender of last rest 3 deposit insurance a deposit insurance is to short circuit runs on banks i if deposits are insured depositors need not run to the bank to withdraw their funds even if the bank fails the government will pay them their money or arrange for the transfer of their deposits to a solvent bank 1 downside without deposit insurance banks are subject to market discipline from their depositors 2 depositors will be reluctant to put their money in banks that pursue risky strategies a with deposit insurance they will be more willing to gamble with other peoples money SYSTEMIC FAILURE Systemic failure a situation in which simultaneous failure of many banks threatens the ability of the whole banking system to perform its funcUons quotbubble psychologyquot each acceleration of the upward trend in prices was taken as evidence that future price increases would be even greater the bubble burst in 2008 2nol factor was failure of rating function that led to a destruction of liquidity in security markets given AAA when they re much riskier than thought so people stopped buying destroyed liquidity the ability to sell a security easily re ecting its true value REGULATORY FAILURE 3rCI factor failures in the prudential regulations that were suppose to safeguard the soundness of banks 1 fragmentation of regulation a quotregulatory arbitragequot shifting activities around so that they came under the authority of the regulatory agency thought to be most lenient 2 international regulation was even more fragmented a relied too heavily on the banks own assessments of the risks of complex securities and on the work of rating agencies 3 credit default swaps a protect investors against risk of default on bonds b buying protection on bonds they didn t own Who should be helped Triage scarce resources should be use to help those who would not survive without aid Tarp helped all Who should bear the Losses Banks shareholders should stand rst in line Then counterparties Then taxpayers How should Aid be Provided 1 capital injection government provides fresh capital to a troubled bank in order to strengthen its balance sheet while other assets and liabilities of the bank are left unchanged 2 carveout identify speci c bank assets that suffer the largest losses and takes them out and put its good assets like gov bonds tarp did a little of both Americans hit Fiscal Policy in Long Run Perspective Balance of saving and investment A country needs enough investment to replace structures and business equipment as they wear out Investment could be nanced from several sources 1 saving 2 reinvestment of undistributed corporate pro ts 3 surplus in the government budget External Balance Even without adequate source of domestic saving a country can continue to invest by borrowing from abroad by drawing on the savings of other countries International accounts imports greater than exports are balanced by nancial in ow wout the cheap nancial in ows on which the us has become dependent growth could slow and living standards for future generation of Americans could be undermined Balance vs cyclical recovery Government borrowing to nance development projects like improved public health education and infrastructure can boost long term eco growth and help generate resources to repay debt Gov budget constraint the relationship between what the government buys and the sources of funds needed to make the purchases Government expenditures into 2 pars lnterest payments on gov debt All other expenditures Primary de cit government expenditures excluding interest cost minus tax revenue as long as interest expenses are greater than 0 the de cit will be greater than the primary de cit 10 selling newly issued government securities nances most of the government s de cit quottreasury billsquot if ST bonds if LT sold through an auction process and interest based on supply and demand conditions When the government nances a signi cant portion of its budget in this way it is often said to be quotprinting moneyquot lndirect 4 step process rather than printing currency 1 the country s treasury sells bonds or securities to the central bank which credits the equivalent amount to a special account help by treasury 2 the treasury draws on this account using checks or electronic transfers to make its purchases 3 businesses and households deposit the gov payments in their own account in commercial banks 4 reserves of the commercial banks increase thereby increasing the monetary base monetizing the de cit nancing a government budget de cit through an increase in the monetary base government budget constraint primary budget de cit interest costs new borrowing newly created money GT rD changeinD changeinB GT primary budget de cit r interest rate D size of the outstanding gov debt rD is annual interest cost changeinD change in outstanding debt changeinB the change in the monetary base all are adjusted for in ation in real terms Sustainability To be sustainable in the long run base of pyramid cant grow gt real GDP 3 options for unsustainable budget de cit 1 default on the debt 2 monetize the de cit a excessive monetization has a cost of its own in ation 3 scal consolidation a raise taxes or cut spending by enough to bring the governments borrowing needs back within the limits of sustainability 11 if de cit is sustainable the debt will stabilize at some constant fraction of GDP The equilibrium debt ratio de cit rate of growth of nominal GDP good to keep below 60 of GDP United states can borrow abroad in its own currency more easily than any other country Important for sustainability bc 1 if a country can easily borrow abroad it does not have to sell as many securities at home which reduces the possibility that domestic nancial markets will become saturated with government securities driving interest rates higher and creating a larger crowding out effect 2 if a country borrows abroad in its own currency the cost of debt service is not affected by changes in exchange rates future entitlement obligation are a nal reason to be concerned about the LR sustainability because they ave to pay but don t have the fund for them yet signs that debt is growing beyond sustainability 1 increase dif culty in selling new government securities a buyers become unwilling to take on additional debt without higher interest rates b debt service rises geometrically c impossible to borrow enough cut waste in gov monetize CH13 ln a on Short run aggregate supply curve shifts up or down with changes in expectations about the level of wages and other input prices Demand side in ation in ation caused by an upward shift of the aggregate demand curve while the aggregate supply curve remains xed or shifts upward at no more than an equal rate Response a rst moves up and to the right along SRAS b real output and price level increase unemployment decreases c lag d SRAS starts to shift upward a If AD remains in new position i economy moves up and to the left along it to a new long run equilibrium where everything returns to natural rate 12 sustained expansionary policy often allows aggregate demand to grow con nuougy as the SRAS is shifted up by expectations of ever higher input pdces aggregate demand keeps pace with it Real output doesn t fall equilibrium just moves up in a straight line initial cost is only a little in ation in ation must accelerate to a higher rate each year to sustain a positive output gap 2 choices 1 stop the stimulus a in ation slows and eventually stops b output falls back to natural level c unemployment increases 2 continue expansionary policy a pos output gap can be maintained for an extended pedod b Year after year of ever faster in ation Supply side in ation in ation that is caused by an upward shift in the aggregate supply curve while the aggregate demand curve remains xed or shifts upward more slowly Supply shocks an event not arising from changes in aggregate demand that changes the average level of expected input prices Outputs that are inputs prices directly affect expected costs of production lncreases in prices of commodities will affect the cost of living for their workers to that nominal wages will sooner or later have to be adjusted Natural disasters unusually bad weather changes in exchange rates Short run effects of a supply shock a higher expected level of input prices with no matching increase in aggregate demand make rms revise their production and pricing plans b as they raise prices they nd its not longer pro table to produce as much as before c can use monetary or scal policy to ACCOMIDATE the shock a they increase demand so less impact on output and unemployment is felt i cost a higher rate of in ation than there otherwise would have been 13 supply side in ation can also be caused by past experiences of demand side in ation in ation inertia in ation momentum a tendency of rms and workers to expect prices to continue rising in the future at the same rate as in the immediate past this causes a series of upward shifting short run aggregate supply curves halting the growth of aggregate demand will not stop in ation in its tracks people expect and have made contracts around it so they expect it to continuously rise since AS moves up while AD stays same 0 real output decreases o unemploymentincreases in ation momentum will continue to shift the aggregate supply curve further upward in ationary recession an episode in which real output falls toward or below its natural level and unemployment rises toward or above its natural rate while rapid in ation continues quotcold turkeyquot approach 0 people would revise their expectation o slowing in the rise of coast of living and then a decline 0 lower nominal wages 0 lower levels of expected input prices would cause AS to shift down quotsoft landingquot 0 slow the growth of aggregate demand gradually 0 quotDO SOMETHINGquot hyperin ation very rapid in ation always begins the same way government can neither raise enough taxed nor borrow enough money to pay its bills it starts printing money as money increases rapidly a chain reaction of MVPQ happens 1st money stock grows faster than real output MltQ 2nCI this causes upward pressure on P 3rCI velocity number of times per year on average each unit of the money stock is used to make purchases increases 4th People try to spend money ASAP because they know it ll be worth less with M and V increasing and Q decreasing P is squeezed to cause million of in ation ENDING INFLATION 14 1 hyperin ation in the lower rage on extreme can be ended with conventional tightening of monetary policy a must be fully completed 2 exchange rate based stabilization a a policy that uses a xed exchange rate as the principal tool for ending hyperin ation i dollarization adopting another currency ii currency board own currency In name but peg it to different currency Problems with ERB stabilization 1 will not work if governments commitment to economic reform is not credible a if people don t believe things are going to change they wont change therefore velocity wont change 2 It could leave country with a xed exchange rate policy that is not suitable in the long run a How closely the country s trade is tired b How exible its labor markets are c How exposed it is to external economic shocks DEFLATION Demand side de ation a period of falling prices caused by a decrease in aggregate demand Supply side in ation a period of falling prices caused by a decrease in the expected costs of production In the aggregate supply and demand model demand side de ation looks like the mirror image of demand side in ation Asymmetries in labor markets Asymmetries between in ation and de ation concerns the ease with which labor markets adjust to increases and decreases in labor demand If demand for labor increases a as workers started to switch jobs to export sector labor shortages would develop for rms that product domestic sae b wages would rise c if organized rising labor demand better contracts d if not employers would have to offer better wages and hire new ones if demand were to fall a export industries would cut back output shorten house and begin to lay off workers b some would be protected c psychological resistance to accepting nominal wage cuts can persist 15 asymmetries in nancial markets when jobs are plentiful and wages are rising people are eager to move to better housing expansion of the housing sector feeds on itself when economy downturns the dynamic of the mortgage market become much more difficult the contraction feeds on itself nominal interest rates stated in nancial contracts real interest rates corrected for in ation real interest rate nominal rate of in ation when de ation sets in it can become impossible to adjust the nominal interest rates downward by enough to keep the real interest rate constant zero interest rate bound the principle that nominal interest rates cannot fall below zero since ZIRB raises real interest rates during de ation credit becomes more expensive People become less willing to take out loans to build houses buy cars and upgrade production equipment Falling investment reduces aggregate demand when fed wants to tighten monetary policy it raises its target interest rate This raises the opportunity cost to commercial banks of holding reserves They raise their loan rates and tighten lending standards Borrowing slows down Aggregate demand decreases Liquidity trap The interest rate operating target works until de ation causes nominal interest rates to approach 0 Opportunity costs to banks of holding reserves falls to zero Banks lose their normal incentive to put reserves to work quickly by lending them out to rms and consumers as nominal interest rates approach 0 opp cost for rms to hold money decreases velocity slows and P and Q will both decrease liquidity trap a situation in which monetary policy loses its effectiveness as a nominal interest rates approach 0 16 expansionary monetary policy succeeded in expanding the monetary base but failed to restore growth of nominal GDP On the monetary policy side the best began by pushing interest rates as low as it could also began purchasing a wider range of assets began buying long term government bonds commercial paper assets related to securitized mortgages student loans and other securities quantitative easing the use of central bank policies that increase the quantity of bank reserves and money in order to stimulate the economy after interest rates have hit the zero bound Full scale demand side de ation is so hard to stop it is accepted that prevention is the best cure Aim for 23 to absorb shock SUDDIV side in ation Occurs when a favorable supply shock lowers expected production costs and shifts and the short run aggregate supply curve downward Financial markets tend to mark up nominal interest rates above real interest rates by an amount that re ects the rate of in ation expected over the life of loans and currently being made De ation and long term productivity growth can cause more problematic form of supple side de ation 2 effects 1 economies long term natural level of real output increases because the existing stock of labor and capital can now produce more output than before 2 improved productivity lowers the expected cost of production because fewer units of input will be needed to produce any given quantity of output productivity driven supply side de ation causes real wages to increase makes workers better off not as much fear of widespread loan defaults unintended consequences of monetary policy to stop de ation when productivity is growing unempoyment rate falls as real output grows beyond natural level househods and business must be able to borrow as much as they want for any purpose 17 asset price bubbles a situation in which the prices of assets rise to unsustainable levels compared to prices of goods and services Central bank can follow a policy of planned gradual de ation that is just sufficient to keep real output close to its natural level could increase risk of demand side de ation CHAPTER 14 Externalities third party effects Pollution the contamination of soil water or the atmosphere by noxious substances Pollution abatement taking measure to reduce discharge of harmful byproducts into the environment through changes in production methods recycling capture and storage or other methods Marginal cost of abatement the cost of reducing waste discharged into the environment by one unit Negatively slopped curve Marginal external costs the total of the additional costs borne by all members of society as the result of an added unit of pollution The point of intersection of the 2 curves is the economically optimal quantity of pollution To the right of the intersection additional abatement efforts To the left of intersectionpollution abatement is not justified Uncertainties degree of warming associated with any given increase in green house gasses in the atmosphere No uniform change in climate Economists have to convert costs into dollar terms Market damages effects on climate that can be converted into dollar values Nonmarket damages Economic growth is the root cause of increases greenhouse gas emissions Increased incomes cause the earth to warm and are harmful to economic growth Biggest difficulty in measuring external costs of climate change and costs of abatement is comparing costs and bene ts that occur now with those that occur in the distant future The environmental policy should not only be guided by economic trade offs but to respect peoples rights Ownership 18 Ownership of forest includes a right to prevent pollution of the forest air Ownership of a mill includes a right to emit wastes into the air regardless of where they end up 1 negotiations between parties will always result in an optimal quantity of pollution 2 if pollution is to be reduced the most ef cient means of abatement will be used 3 these results will be achieved regardless of the initial assignment of property rights The Coase Theorem the proposition that problems of externalities will be resolved efficiently through private exchange regardless of the initial assignment of property rights provided that there are no transaction costs Real estate development Legally binding agreements that limit what owners can do in their property Tort aw the area of civil law concerned with harmtorts done by one person to another Command and control approach a speci c pollution control technology must be used without considering its cost compared with alternative methods Emission charges polluters are given an incentive to balance marginal abatement with marginal external costs and move toward optimal level of pollution Fixed amount per unit of waste Tax is set where cost curves intersect optimal level Cap and trade Cap overall limit on the amount of pollution allowed from all sources in the affected area Once limit has been determined it is divided into a xed number of permits that are distributed among pollution sources Higher pollution buying more permits Median voter model a model showing that there is a tendency for decisions in a democracy to re ect the interests of voters whose preferences lie near the middle of the scale Median voter voter whose age is exactly ln middle Lower opportunity costs cause members of groups to speak with a louder voice relative to their numbers Free rider problem want the good part without putting in the work 19 Logrolling practice of trading votes among members of a legislative body CHAPTER 15 Absolute advantage the ability of a country to produce a good at a lower cost in terms of quantity of factor inputs then the cost at which trading partners can produce the good The country in which the opportunity cost of a good is lower is said to have a competitive advantage in producing that good Effects of trade specialization improves the efficiency of the world economy as w hole increases productions of both goods and leaves both countries better off than if they did not trade Ricardos theory of comparative advantage suggests that each country will export goods for which its labor is relatively productive compared to that of its trading partners Ricardian model of comp advantage focused of a singled factor of production labor Heckscher Ohlin theorem the proposition that countries tend to export goods that make intensive use of the factors of production that the country possesses in relative abundance Tendency to trade with similar level of economic development Competitiveness heart of its concern that foreign workers work harder and foreign business managers have become smarter than their US counterparts International nancial transactions are important because they allow a country to import more goods and services than it exports or to export more than it imports in a given year Foreignexchangemarkets where one currency can be traded for another The international monetary fund was created in 1944 to maintain a stable nancial climate for trade Protectionism any policy that is intended to shield domestic industries from import competition Tariffs a tax on imported goods Import Quotas a limit on the quantity of a good that can be imported over a given period of time NAFTAnorth American free trade agreement 20 This could create a tendency of blocs to raise protectionists barriers against outsiders Also refers to the preventing of export of jobs outsourcing Shifting jobs from one country to another antidumping cant sell goods in a foreign market for less than the price which it sells at home or for the cost of producing them Who gains and who loses depends partly on the degree of specialization of factors of production When specialized skills and locational factors are taken into account and the effects of trade include Changes in relative wages Periods of unemployment Costs of retraining Moving expenses The uneven impact of changes in trade patterns on the live and jobs of speci c categories of workers turns out to be one of the main sources of political support for protectionism International competition tend to drive wages and returns to other factors of production towards the level of opportunity costs Protection against foreign competition relieves the pressure and permits the protected rms and workers to earn rents Some opponents of free trade speak a simple language of self interest using money and political power to advance their position regardless of effects on others quotrace to the bottomquot don t want people to stop paying their workers fairly or cut back on costs in different ways if policies encouraged production to move to the countries that most agrantly ignored core labor standards total costs of production including both internal and external costs are likely to be higher not lower in the country where externalities go uncontrolled CHAPTER 11kinda In ation targeting is the most widely used stabilization policy rule among major economies Also use exchange rates as its principal policy target Foreign exchange market a market in which the currency of one country is traded for that of another Done through transfers of funds among deposits in commercial banks Large banks in the worlds money centers NY trading banks 21 If Mexican wants to buy treasury bill it can exchange a deposit denominated in pesos for a deposit denominated in dollars and use those dollars to buy the treasury bills the rate depends on supply and demand the demand curve for dollars re ects the activities of everyone who comes to the foreign exchange market with pesos that they want to exchange for dollars Y AXIS pesosdollar foreign exchange rates the prices of one currency in terms of another appreciate increases in value such as the value of one country s currency increasing relative to the currency of another country depreciate the decreases in value of a currency relative to the value of the currency of another country swine u can cause depreciation because there s less dollars supplied b US changes in nancial ows can affect exchange rates an increase in Mexican taxes on investment income or a threat of political instability in Mexico could also increase nancial out ows purchases of foreign assets are an instrument of expansionary policy they increase bank reserves and the monetary base exactly as do domestic open market purchases Sell dollars to keep pesos the same The exchange rate is the operating target for the central bank not in itself a goal of policy Exchange rates are important because of the effects they have on intermediate targets like in ation and employment Reason 1 Exchange rates in uence patterns of trade lf appreciated less expensive to buy goods made in other countnes Harms exporters and rims that compete with importers Reason 2 to use an exchange rate target as a basis for economic policy is to help control in ation promotes domestic price stability 22 the choice of an in ation target an exchange rate target or some mixed policy target involves both economic and political consideration
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