Inflation o Causes discussed several quantity theory MV PQ if V and Q are fixed in short run money supply increases cause price level increase inflationary gap additional supply to close gap allows for more consumption which raises price level Phillips curve studied earlier not clear that this is a causal relationship service sector inflation wages non good prices inertial inflation inflation is expected over time issue of contracts o Effects on creditors amount they are owed is worth less now borrowers easier to pay back debt that costs less now o Monetary policies to fight inflation more flexible more effective during inflation in potential conflict with the Treasury Why Fed has independence That is much less political influence is involved in Fed decision making Also it is easier to raise rates than get Congress to cut spending or raise taxes o Fiscal policies to fight inflation more effective in a recession But is it more feasible complicated due to the budget process o Fisher equation real interest rate nominal interest rate inflation Supply side economics government regulation hurts economic growth taxes are too high high tax rates discourage work savings investment government is wasteful welfare programs discourage work o Laffer curve graph interpret changing the tax rate has an effect on government revenue o Trickle down theory Development economics o ways to jumpstart development in poor countries o poverty trap vicious cycle of poverty low per capita income low savings low investment low productivity low per capita income o World Bank provides capital to developing countries that have limited access to private capital markets Generally provides money for investment projects sanitation water projects dams roads etc also ties loans to institution and government reforms Flexible exchange rates o Graph of demand and supply for a currency o Appreciation value of money INCREASES o Depreciation value of money DECREASES o More elastic demand means that depreciation of that currency will earn greater revenue o More inelastic demand means that depreciation of that currency will earn less revenue Pegged exchange rate the value of one currency is fixed against the value of some other currency o Graph of demand and supply for a currency o Graph of imports and exports for a country o Primary effects o Secondary effects price effects a devaluation could have an inflationary effect income effects assuming the marginal propensity to import is greater than 0 devaluation causes more exports so income goes up Fixed exchange rate o gold standard governments set exchange rate through gold content mechanism of adjustment is the movement of gold o adjustment mechanism gold inflow or gold outflow country o internal equilibrium full employment and price stability o external equilibrium balance of payments equilibrium o Bretton Woods system Allied nations convened at Mount Washington Hotel in Bretton Woods New Hampshire from 1 22 July 1944 each country must have monetary policy that maintains exchange rate by tying it to gold foreign currencies fixed to US dollar US dollar fixed to gold at 35 1 oz of gold IMF will cover temporary gaps in the balance of payments devaluations had to be sanctioned by IMF problems with gold standard still existed internal vs external equilibrium pegged exchange rates and IMF avoids extremes of gold standard and competitive devaluations DECLINE reserve currency currency held in significant quantities as a part of foreign exchange reserves US dollar needed to be held in large quantities in foreign countries for Bretton Woods system to operate How do US dollars get to foreign countries current account deficit foreign aid World Bank in U S gold reserves fall and foreign liabilities rise August 15 1971 Nixon issues executive order to unilaterally abandon the gold standard o International Monetary Fund international lender of last resort organizes loans for countries that are having balance of payments issues usually offer loans tied to agreements to reform institutions trade reform labor reform democratic government etc is an international organization made up of almost all national governments but does not report to one International trade o GATT General Agreement on Tariffs and Trade sought to reach a substantial reduction of tariffs and other trade barriers and the elimination of preferences on a reciprocal and mutually advantageous basis multilateral trade agreement first agreed to in 1947 WTO o multilateral trade agreements Trade Expansion Act of 1962 granted executive the authority to negotiate tariff reductions key feature president can negotiate tariff reductions up to 50 agreements to exempt some tariffs from negotiation to protect industries in future textile quotas to protect US textile firms adjustment assistance worker retraining low interest loans to affected firms to move to new products led to Kennedy Round 19641967 of GATT negotiations Followed Great Depression Smoot Hawley Tariff Act of 1930 raised U S tariffs to extremely high levels sought to protect domestic agriculture from foreign imports competitive devaluations beggar thy neighbor devalue currency to increase exports Followed Decline of BW Smithsonian Agreement of 1971 redesigned the international monetary system gradual introduction of flexible exchange rates Plaza Agreement of 1985 devalued the U S dollar other countries agreed to use their US dollars to buy their own currencies increasing the supply of US dollars devaluation doesn t improve trade deficit in U S elasticity of currencies long term contracts cause lag in changing exchange rates Japan import restrictions doesn t raise its US prices Japanese goods are cheaper but Japan doesn t grow fast enough to absorb imports China exporting more than it imports o tariffs protective tariff taxes on imports in order to protect domestic producers from the competition from foreign imports revenue tariff taxes on imports purely to obtain revenue for government functions specific tax per unit tax a charge per fixed amount of a good sold ad valorem tax a charge based on a fixed percentage of value think of sales tax o non tariff barriers to trade quotas restrictions on how much of a good can be imported customs bureaucracy import and export licenses other requirements to entry other duties or taxes at border government procurement purchasing only domestic goods by government to boost domestic industries standards packaging and labeling restrictions