ECONOM 1051: EXAM 3
96 Cards in this Set
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Functions of Money
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-Medium of exchange (buy and sell goods)
-Unit of account (goods valued in dollars)
-Store of value (hold some wealth in money form)
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Money Definition: M1
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-Currency
-Checkable deposits
-Institutions offering checkable deposits
-commercial banks
-savings and loans associations
-mutual savings bank
-credit unions
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Money Definition: M2
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-M1 and near-monies
-Savings deposits, including Money Market Deposit Accounts (MMDA)
-Small-denominated time deposits (CD = Certificate of Deposit) less than $100,000
-Money Market Mutual Funds (MMMF)
-Money Market securities
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Money Market Deposit Accounts (MMDA)
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A cross between a checking and a savings account. They earn a bit more than interest-bearing checking accounts, but restrict the number of deposits or withdrawals that can be made each month
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Certificate of Deposit (CD)
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A certificate issued by a bank to a person depositing money for a specified length of time, small-denominated time deposits (less than $100,000
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Money Market Mutual Funds (MMMF)
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An open-ended mutual fund that invests in short-term debt securities such as US Treasury bills and commercial paper. Money market funds are widely (though not necessarily accurately) regarded as being as safe as bank deposits yet providing a higher yield.
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Money Market Securities
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Very safe and liquid short term bonds issued by the Treasury Department
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Hedge Funds vs. MMMF
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Larger investments
-Can't get money back fast
-Invest money into buying a company
-Very illiquid and risky
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Why is Money Valuable?
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-Acceptability
-Legal Tender
-Relative Security
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Federal Reserve
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Created in 1912
-Board of Governors: 7 of them, appointed by President, confirmed by Senate for a 14 year non reviewable term
-Headquartered in DC
-12 Federal Reserve banks
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Federal Open Market Committee (FOMC)
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12 appointed members: 7 governors, plus 5 presidents of district banks
-meets 8 times a year
-makes important monetary policy decisions
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Big 4 US Banks
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Bank of America (acquired Merrill Lynch*)
-JP Morgan Chase (acquired Bear Sterns*)
-Citi Group
-Wells Fargo (acquired Wachovia Bank*)
*after recession
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Federal Reserve Functions
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Issue currency
-Set Reserve Requirements: Fed mandates every commercial bank to keep fraction of total deposits in reserve (10%)
-Collect checks
-Act as a fiscal agent for US government
-Supervise banks
-Control the money supply and influence interest rates
-Dual mandate - price s…
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Federal Reserve Independence
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-Established by Congress as an independent agency
-Protects Fed from political pressures
-Fed's policies cannot be reversed
-Fed is given freedom to pursue its own objectives and choose monetary policy tools to do so
-Enables Fed to take actions to increase interest rates in order to …
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Dodd-Frank Act / Wall Street Reform Act of 2010
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Provisions that limit Fed problems
-Make sure the Recession doesn't happen again
-GAO Government Audit (Accountability) Office can audit Fed's lending programs
-Proposal to audit Fed's monetary policy decisions, didn't work out
-Passed to help prevent many of the practices that lead …
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Financial Crisis of 2007-2009
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Mortgage Default Crisis
-Subprime mortgage loans
-Mortgage-backed securities
-Government programs that encouraged home ownership ("The American Dream")
-Insurance companies insured securities
-AIG insured all mortgage loans
-When interest rates increased, real estate values fell,…
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Securitization (or Securities, MBS)
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The process of slicing up and bundling groups of loans into new securities , these securities (MBS) ended up everywhere: bad securities provided by mortgage lenders, declining real estate value
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Credit Rating Agencies
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Moody's , S&P, and Fitch
-Ratings from D to AAA
-Rated AAA on lots of MBS because they got paid by companies that issued those securities
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Troubled Asset Relief Programs (TARP)
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Gave taxpayer $ to failing financial institutions
-$700 bill
-BUT Treasury ended up buying up stock (injected capital)
-saved several institutions from failing/failure
-Fed extensively lent money to financial institutions
*Makes crisis possible in future b/c corporation knows it …
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Major Categories of Financial Institutions
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-Commercial banks
-Insurance companies
-Pension Funds
-Thrifts
-Mutual Fund companies
-Securities firms
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Mutual Funds
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Sell shares to large numbers of small investors and invest funds in diversified portfolio of securities (stocks, bonds, commercial paper), not insured
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Security
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Financial asset
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Financial Asset
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Anything that promised a future steam of income that's traded on the financial market
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Asset
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Something that promises future stream of income
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Stocks
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Pay dividends, not guaranteed, varies with company profitability
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Bonds
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Make fixed payments, guaranteed, does not vary
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Derivative
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Promise to deliver certain asset at a specified price at some future date
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Investment Banks
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Financial institutions that provide various services
-wealth management
-securities trading
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Underwriting
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Helping private start ups go public or helping already established corporations to sell new issues of stocks.
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Wall Street
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Financial institutions provide necessary funding to all kinds for long run and day-to-day operations.
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Glass Steagall Act of 1933
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Separated commercial banking from investment and insurance
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Systemically Important Financial Institutions (SIFI)
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-Too big to fail, failure means affect on entire economy
*Living Will: what needs to be done to protect it, it won't fail
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Fractional Reserve System
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Banks create money through lending, banks are subject to panics (or bank runs), US has it, means that only a small fraction of our deposited money stays in the bank, majority is loaned out (like the goldsmiths)
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Goldsmiths
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First banks, stored people's gold and them a receipt to use else where as proof that they have the gold to buy things
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Balance sheets
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Assets = Liabilities + Net Worth
(A=what you own) (L=what you owe) (N.W=what bank owns vs. what bank owes)
*both sides should ultimately be balanced, if not positive, bank will bankrupt
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Necessary Transactions
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1. Create a bank with owner's own money (capital)
2. Accept deposits (liabilities)
3. Make loans
4. Profit
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Fed's Regulation
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Requires we keep 10% of deposits in Reserve that can't be touched
Revenue $9000 - Expense $1000 = Profit $8000
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Liquidity Risk
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-If deposit withdrawals happen on large scale, banks don't have the money ( not enough in Reserve account), causes financial crisis
-To prevent this, tend to keep more than 10% to avoid these risks
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Multiple Deposit Creation
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What happens when an initial deposit creates more deposits in banking system (see 4/12 notes for an example)
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Money Multiplier
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= 1/required reserve ratio or 1/R = the amount of new deposits created by a single dollar of excess reserves
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Interest Rate
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Price paid for the use of money
-Determined by money supply and money demanded
-Cost of borrowing
-Reward for lender
-Equilibrium Interest Rate: changes with shifts in $ supply and $ demand
-Fed can influence $ supply through tools of monetary policy
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Demand for Money
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Asset Demand, Da
-money on store value
-varies inversely with interest rate
Total Money Demanded, Dm
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Tools for Monetary Policy
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Open Market operations conducted at NY Fed
-Two Operations:
1. Open Market Purchase: Fed buys securities by giving reserves to banks
2. Open Market Sale: Fed sells securities to banks
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Reserve Ratio
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Changes the money multiplier
-Lowering the reserve ratio, increases money multiplier, increases money supply
-Increasing reserve ratio, lowers money multiplier, decreases money supply
R=10% M.M. = 1/0.1 = 10
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The Discount Rate
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-Fed acts as lender of last resort
-Increasing discount rate, discourages banks from borrowing so money supply shrinks
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Expansionary Monetary Policy (Easy Money)
Cause and Effect Chain
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-Economy faces a recession
-Fed buys securities
-Lowers reserve rate
-Lowers discount rate
-Excess reserves increase
-Rise of money supply
-Interest rate falls
-Investment spending increases
-Real GDP rises
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Restrictive Monetary Policy (Tight Money)
Cause and Effect Chain
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-Periods of rising inflation
-Fed sells securities
-Increases reserve ratio
-Lowers discount rate
-Excess reserves decreases
-Money supply falls
-Investment spending lowers
-Real GDP lowers
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Advantages of Monetary Policy over Fiscal Policy
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Speed and flexibility
-Isolation from political pressures
-Monetary Policy is more subtle than Fiscal Policy: (conducted by Congress and Pres.)
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Federal Funds Rate
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Rate banks charge each other on overnight loans
-Easy for the Fed to target
-To lower: Fed increases bank reserves by conducting open market purchases
-To raise: Fed decreases bank reserves by conducting open market sales
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Quantitative Easing (Q.E)
or Asset Purchase Program
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In Response to Recession:
-Fed bought trillions worth of securities from the banks
-Critics claim Fed contributed to the crisis by keeping the Federal Funds rate too low for too long
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Lags
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Recognition and operational
-Price level is reported monthly and GDP is reported quarterly
-Takes 3-6 months for interest rates to affect investment spending & economic activity
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Liquidity Trap
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Pumping reserves may not solve problems if banks aren't willing to lend and households/businesses aren't willing to borrow
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Aggregate Demand
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Real GDP desired at each price level
-Inverse relationship
-Households
-Firms
-Foreigners
-Spend less at a higher price level
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Changes in Aggregate Demand
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Change in consumer spending (C)
-Change in investment spending (I)
-Change in government spending (G)
-Change export spending (NX)
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Consumer Spending
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Consumer wealth: stock market and real estate market
-Household borrowing or saving
-Consumer expectations about future income or inflation
-Personal taxes
-Determined by fiscal policy
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Investment Spending
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Real interest rates (cost of borrowing): monetary policy
-Expected returns (of current investment): fiscal policy
-investment spending is more volatile than consumer spending
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Government Spending
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Gov spending increases when aggregate demand increases (as long as interest rates and tax rates do not change)
ex: more transportation projects
-Gov spending decreases when aggregate demand decreases
ex: less military spending
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Foreign Spending
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National Income abroad
-Exchange rates
-Dollar Depreciation:
Foreigners spend more on US goods and services (N.E increases)
-Dollar Appreciation:
Foreigners buy and spend less on US goods and services (N.E decreases)
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Tourism
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Foreign nationals visiting US is our export:
-Weaker dollar promotes country to foreign tourists
-Weaker dollar discourages US tourists from visiting other countries
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Aggregate Supply
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Total real output produced at each price level
-Relationship depends on time horizon (short run vs long run)
-Short Run: A.S. is upward sloping, positive relationship b/w aggregate price level and quantity produced. Sticky prices, input prices are inflexible, fixed in short run
-Long …
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Changes in Aggregate Supply
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Changes in input prices
-Changes in productivity
-Changes in legal-institutional environment
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Input Prices
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Domestic Resources prices
Labor
Capital
Land in natural resources
-Prices of imported resources
Imported oil
Exchange rates
Dollar appreciation implies cheaper imported resources and increased capabilities to produce things here
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Legal-Institutional Environment
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Taxes of subsidies
-Extent of gov regulation, corruption and "red tape"
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Stagflation/Cost Push Inflation
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Inflation rises and contraction/ recession of real GDP
Ex: OPEC oil crisis, price of oil went up really high
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Demand Pull Inflation
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Inflation rises and expansion of real GDP
Ex: stock market is good, real estate boom, global economic expansion
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Recession
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Deflation lowers and recession of real GDP
Ex: stock market crash, real-estate market crash, banking crisis
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Responding to Recession
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Gov will try to stimulate A.D.
-Congress would pursue expansionary fiscal policy (lowering taxes and giving rebates) and Fed would employ expansionary monetary policy (lower interest rate and increase money supply)
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Targeting Inflation
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Fed pursues tight money, lowered A.D. to fight inflation but causes GDP to lower and increase unemployment (severe inflation)
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Targeting Unemployment
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Fed pursues easy money, lower interest rate, raises GDP, lowered unemployment rate but causes severe deflation
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Supply Side Economics
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Less regulation
-Lower taxes and give tax breaks for firms
-"Reaganomics"
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US Trade Facts
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US trade deficit in goods (import>export): $738 billion
-US trade surplus in services (export>import): $178 billion
-US has a trade deficit/negative net exports
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Foreign Investments
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Main reason it is possible for US to get stuff from foreigners (despite deficit) is by two ways: Foreign Direct Investment or Foreign Public Investment
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Foreign Direct Investment (FDI)
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selling domestic assets to foreigners
ex: InBev purchasing Anheuser-Busch
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Foreign Portfolio Investment
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Borrowing money from foreign institutions
ex: Japanese pension fund buying Facebook stock
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Public (or National) US Borrowing
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US government selling debt securities (bonds) to foreigners
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Private US Borrowing
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Microsoft selling bonds to Chinese bank or taking out loan from a French bank
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Principal US Exports
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Chemicals
-Food/Agricultural products
-Consumer durables
-Semiconductors (computer insides)
-Aircraft (civil and military)
*US provides 8.5% of world's exports (China is largest)
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Principal US Imports
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-Oil
-Cars
-Metal
-Households appliances
-Computers
*Trading is more important for smaller countries than for larger countries
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Exchange Rates
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-Foreign exchange market determines the foreign exchange rates
-Big participants are banks that trade deposits denominated in different currencies on behalf of multinational corporations
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Exchange Equation
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Changing amount of money between two different currencies:
ex: $1,000,000 USD $800,000 euro
$1 mil / $1 mil = $800,000/$1 mil
$1 USD = $0.8 euro per USD
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Dollar Appreciation
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The dollar gains value
*appreciation makes goods/services more expensive to foreigners, hurts US companies exporting goods/services, tourism in US less attractive
*appreciation makes foreign goods/services cheaper to US consumers, encourages US imports, cheaper for US tourists to study …
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Dollar Depreciation
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The dollar loses value
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Who Demands Dollars?
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Foreigners
-to by US goods/services, must use $ to purchase, so they demand the US $
-buying US assets (i.e. stocks)
-tourism
Speculators
-buy $ to profit if $ is predicted to appreciate
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Who Supplies Dollars?
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US Residents
-in order to buy foreign goods/services, use the $ in exchange for foreign currency
-buying foreign assets (i.e. stocks)
Speculators
-buy foreign money to profit if $ predicted to depreciate
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Determinants of Flexible Exchange Rates
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Changes in tastes
-Relative income changes
-Relative inflation rate changes
-Relative interest rates
-Relative expected returns on assets
-Speculation
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Speculators
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Expect future dollar appreciation, will buy dollar to sell for profit later, which drives up demand and dollar appreciates
-Expect future dollar depreciation, will sell dollar, drives up supply and dollar depreciates
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Fixed Exchange Rate
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-Some currencies have fixed exchange rates, governments and/or central banks intervene to maintain fixed value of currency.
-Or a country links/pegs their currency to another country's
-Makes trade easier, less volatile, more certain
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Trade Barriers and Export Subsidy
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ariffs: special tax on imported goods
-Import quotas: limits # of what can be imported
-Nontariff Barrier (NTB): makes harder for foreigners to sell in the US
-Export Subsidy: US can export more/control amount US exports
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Economic Impacts of Tariffs
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Decline in consumption
-Increase in domestic production
-Decline in imports
-Tariff revenue
-Foreign producers lose revenue and sales
-Spillover effects to other domestic industries
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Net Costs of Tariffs
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Price of imported products goes up
-Consumer shifts purchases to higher priced domestic goods
-Domestically produced goods become more expensive as import competition declines
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Three Arguments for Trade Protection
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1. Increased domestic employment
2. Cheap foreign labor
3. Protection against dumping: practice where some foreign firms sell products below actual cost
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Infant Industry Argument
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A way of protecting infant companies that are just starting up by raising tariff price on the products of larger, global companies
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Trade Adjustment Assistance Act
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Helps those who lose their jobs because of foreign/international trade
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Offshoring of Jobs
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Shifting work previously done by American workers to foreign workers abroad
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World Trade Organization (WTO)
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153 member nations, starting in 2011
-Oversees trade agreements and rules on disputes
-equal, nondiscriminatory trade between member nations
-Reduction in tariffs
-Eliminates trade quotas
-Critics say it allows nations to circumvent certain environmental and worker protection laws
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European Union (EU)
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-Created in 1958 as a Common Market
-Abolished tariffs and import quotas between member nations
-Common tariff with countries outside of EU
-Created euro zone (same currency: euro), though not all EU members use euro
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